How to set a price point for profit
The Power of Pricing
Watch the full pre-recorded webinar on small business pricing strategy with financial expert Dawn Fotopulos hosted by SCORE. Learn real-world tips on setting your prices, discount strategy for your business, and tips to improve your profitability immediately.
Our audience asked some amazing questions that we didn’t have time to answer on the webinar. A few of our most popular questions are answered here.
Q: How does the discount strategy work for service-oriented businesses?
A: Always remember your primary job when you’re running a business is to protect profit and cash flow. For service-oriented businesses, whatever you charge, it must be enough to cover your direct labor expenses four times, according to Greg Crabtree, CPA. That means if the direct labor for a job is $100, your gross profit, or the profit your business makes after subtracting expenses, must be $400. That means the minimum you should charge is $500. If you can get a $400 gross margin after the discount, then that should help the business remain sound financially.
Q: What are ways you can better communicate your true economic value to customers?
A: The evidence of true economic value will always come from customers who have benefitted by the product or service they have bought from you. It is the perceived value of your product or service. Again, customers are not paying you for what you do but what you deliver. True economic value is also about how you do what you do and how that is better and different than the competition. Your customers who have purchased from the competition and bought from you will best answer this question. Consider using surveys to ask your customers why your product or service outshines the competition. Use their testimonials as third-party evidence of your business’s value and push them out (with permission of your customers) over your marketing channels, like your website and social media. Just remember, true economic value is not what you think it is, it’s what the customer says it is.
"Just remember, true economic value is not what you think it is, it’s what the customer says it is."
Q: Should you provide discounts for referrals?
A: Behind this question is the idea that a referral has real value and you want to reward the person or business that referred new business to you. That makes total sense. The real question is, can you reward the referrer without putting your gross profit on life support? Yes! Instead of providing a discount, give the referrer free product or extend a free service. Think about it; you’re giving something at cost to you that a customer would otherwise have to purchase at retail. Let’s take an example: A photographer friend of mine offered a $50 referral discount for photography sittings. That’s discounting money right off the top line, lowering her revenue. I asked her how she priced a 9-by-12 photograph. She said $50. I then asked her how much the final photograph, framed and all, cost her. She said $20. So, if she gave away a free 9-by-12 photo it would cost her business $20, instead of the $50 she loses with her discount, yet the customer gets $50 worth of value. And remember, a discount lives in the mind and quickly is forgotten. A gift lives in the heart and stays there forever.
Q: How often can you raise prices? Should you gradually raise prices?
A: This is a great question and difficult to answer for all situations. There are certain times of the year when it’s easier to raise prices; the turn of a new year is an obvious one. Look at your product or service line item by item or service by service. In our “Pricing for Profit” webinar, we set a goal profit margin of at least 30 percent. Identify which items or services don’t meet our 30 percent gross margin hurdle rate. These are the products that need refinement, a new market, lower cost structure, or higher pricing. Don’t feel compelled to raise prices on every product at the same time. Test the market. Raise prices on key items by 5 percent and see what happens to demand. A 5 percent increase could increase gross margin twice that depending on your cost structure. Price increases should be gradual. You don’t want to scare off customers. Just remember, as we covered in the webinar, you have to charge a price that covers your cost plus a 45 percent profit premium or else you won’t be able to offer your wonderful product or service to the world.
To learn how a real small business brought this pricing strategy to life read about FedEx Small Business Grant Contest winner Dream Beard, and how owners Ryan and Brittany Lane saved their business by pricing for profit.
Dawn Fotopulos is associate professor of business at King’s College. A “recovering banker” with more than 20 years of experience in the banking industry, Dawn is an expert in entrepreneurship and has guided hundreds of struggling small businesses to recovery. She is also the award-winning author of Accounting for the Numberphobic: A Survival Guide for Small Business Owners.