Pricing For Profit


One of the most important aspects of launching and growing a successful product is correct pricing, one of the major components of profits. The right price gets you an order and maximizes your chances for reorders. The wrong price—on the low side—leaves valuable profits on the table. The wrong price–on the high side– may decrease your orders, your chances for getting reorders, and invite competition.

This may not appear to be a Bootstrap strategy. It is included because a high percentage of businesses do not give enough attention to this important profit element. They too quickly determine price by their costs or by what competition or perceived competition is doing. The result is that profits are left on the table, or more succinctly, you are depriving yourself of precious cash…your life blood.

All too often, companies put a selling price on their product or service when they’re under some sort of time pressure—for example, when they’re dying to rush out there and get some orders. It’s not until later that they discover they didn’t account for some important costs in that selling price. These costs might include commissions (yes, people forget commissions), extra trade discounts in key markets, displays, servicing, advertising, or whatever. Now comes the trap: in many cases it’s very tough to raise prices. (We’ll return to this shortly.) So they find themselves stuck with a low-margin item or without the money to run a successful marketing program.

Think of pricing as a balancing act. If you have a unique product, a patentable product, a time advantage, a manufacturing edge, or some other kind of competitive advantage, you can and should get a higher than average margin. At the same time, your high margins may hurt your sales and are very likely to act as a beacon for competitors or knock-offs.

In light of these many calculations, I suggest that you involve all the relevant constituencies within your company in initial pricing discussions. Your accountant may claim that this is his/her domain exclusively. If so, don’t let him/her win this argument. Salespeople, production personnel, and even your key customers can provide valuable insights into the pricing decision. You as the manager have to balance these sometimes competing interests and arrive at an appropriate course of action. Notice that I didn’t say the “right” course of action. In many cases there’s more than one legitimate pricing strategy that can be pursued.

Pricing needs to be revisited regularly. You may find that in order to maintain your margins, you are under pressure to raise your prices. Be forewarned though that you may have major customers who won’t accept price increases despite your increased costs. This is particularly true with large quantity buyers. The small company does not have the leverage to demand a justified price increase. I would encourage you–with good humor–to ask for this increase, pointing out your increased costs. If your effort fails and you don’t want to hold firm and risk losing the account, you might want to change the product. This change could be accomplished by altering its appearance, adding value to it, changing the package, and even changing the name. Give it a new style number and inform your buyer you are dropping the old one and adding a new one. This can aid a sympathetic buyer who has been instructed by his management to accept no price increases. This way they get around this unfair rule. You should be aware of the fact that if you play hardball and raise your price, you sometimes can win and keep your customer buying the product. Remember it is the buyer’s job to keep pressing for the best price. A lot depends on how important the customer’s volume is to your business and your mental toughness.

There are four major components to creating profits:

  • Selling price
  • Cost of product
  • Overhead
  • Volume

Before you settle on a selling price—especially a price that you may not be able to change easily–here’s a list of the selling price and cost of product components you may want to consider. There are also some strategic considerations to weigh before final pricing is done. Not all factors may apply to your product.

Selling Price

  1. Analyze the uniqueness of your product. What makes your product different? Are you unique and in a hot classification? Or is yours a me-too offering in a declining category, which is unlikely to command good margins? Is it a commodity product, which again will yield poor margins?
  2. Analyze the barriers to entry behind your product. What’s your sustainable advantage if any? Is it easy for anyone to replicate your business model or copy your products?
  3. Think life span. The shorter your product’s expected life span, the higher your margins should be. Remember that “life spans” apply not only to products but also to whole classes of products.
  4. Know what your market will bear. Is your product comparable in value to existing products but able to be produced at a lower cost? If so, you might consider pricing close to (or just under) the levels set by your competitors and thereby earning an above-average margin. Alternatively, you could price lower and go for more market share. Whichever way you go, don’t make this decision solely on a predetermined margin over your cost. On products with short life spans, what-the-market-will-bear-pricing can be very effective.
  5. Prepare to be imitated. Do you anticipate copies or knockoffs? If so, how much time do you have before they enter the fray? You may want to start with a higher margin, and then either lower your margin when competition enters the field or knock yourself off with a lower cost version.
  6. Think longer term. Will the success of this product lead to successful spin-offs or follow-up sales? If so, you may want to consider selling this original product at minimal or no profit in order to build and capture the after-market or add-on sales.

The classic example is Gillette pricing low for easy razor sales to capture the ongoing blade business, but there are many others. You can forego short-term profits to break into a new channel of distribution with good long-term growth potential, to help your company’s image, to gain market share, or to send a strong message to your competitors.

  1. Think strategically. This is an obvious follow-on to the previous point. Is there some strategy aside from profit that this particular product may help advance? Is this a case where you know you have lots of good (and profitable) follow-up products to put into the pipeline? Will it help you break into a new channel of distribution? Will it help you get a new sought after customer?


Cost of Product

  1.  Determine all your true costs.
  2. Establish what it takes to be successful in your key markets and with key  customers.Then put a cost on each of these factors. For example:
    • Will you need consumer or trade advertising? If so, to what extent?
    • Will your product require co-op advertising, and if so, what are the standard arrangements in the various markets and customers you’re pursuing?
    • Do distributors play a role? If so, what are their margin requirements?
    • What are the margin requirements of target customers in target markets?
    • Is servicing important, and if so, what is your service strategy?
    • Will you be using specialty reps? If so, what commission will you have to pay?
    • What inventory risks will you have to take? How will you handle guaranteed sales, stock balancing, backup stocks, and reorders?
    • What type of packaging will be required?
    • What display (if any) will be needed?
    • What are the standard payment terms in this market?
    • What’s the integrity level of this market and of your target customers? (Are you comfortable with those levels?)
  3. Determine the up-front, one-time costs involved in coming to market. What volume level will be required to recoup these costs at what price?
  4. Examine your cost to acquire a new customer.
  5. Understand your legal rights and what they may cost you. For example: if your patent or copyright is infringed upon, will you have the resources needed to start and (if necessary) sustain litigation?
  6. Identify your costs at various volume levels. Are there dramatic cost savings that come with volume? If so, what strategies and associated costs can you employ to achieve these volume levels?
  7. Examine the “spread.” What are your payments terms from suppliers as opposed to those you give your customers? The cost of money on the spread should be included in your overall costs and prices.
  8. Keep your eye on that license. If your product is licensed, you probably have both guarantees and royalties to worry about. If the guarantee is high, you may come up short, and you may want to price in light of this potential shortfall.


Strategic

  1. Determine and prioritize the channel of distribution into which you plan to sell.
  1. Think competition. You’re likely to have competitors and maybe even skilled ones. Will you compete on the basis of product superiority, price, service, quality, advertising, sales coverage, delivery time, or some combination? What costs are associated with this strategy?
  2. Understand the implications of your (limited) finances. If available finances limit your ability to produce and sell your product, then maybe you should opt for smaller, higher-margin markets. (Yes, there are bragging rights associated with “selling Wal-Mart,” but you shouldn’t wind up paying for those bragging rights!)
  3. Understand the implications of your (limited) resources. Again, if selling Target means you’ll sell out your limited run at a relatively low margin, think twice. Shouldn’t you look again at those smaller, higher-margin markets?

It has been my observation over the years that not enough time and brain power go into the establishing of your selling price. Maximum profits are good for you and your company’s health.

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