Quick: how do you come up with prices for your products or services?
If you’re like many entrepreneurs, there’s not much science to your pricing strategy. Maybe you choose a particular profit margin and apply it across the board. Or perhaps you simply match your competitors’ prices for similar products.
If any of these common tactics sound familiar, you’re likely leaving money on the table, according to Rafi Mohammed. Mohammed, the founder of Cambridge, Mass.-based pricing consultancy Culture of Profit LLC and the author of The 1% Windfall: How Companies Use Price to Profit and Grow, believes that most entrepreneurs do a lousy job of setting prices, largely because most have other things on their minds. “It’s hard to get a business going. If you get people in the door, you’re happy,” he says. “But once you’ve established your product, you’ve found people to buy it and you’re looking to grow, you should spend some time focusing on pricing.”
What entrepreneurs need to understand, says Mohammed, is that prices should reflect a diverse client base: different customers are willing to pay different amounts for different products in different settings. Often, they’re willing to pay more than you think — especially when the increase to your existing price is small. That’s great news for a lot of entrepreneurs, because, according to Mohammed, in many industries a 1% increase in price can spur an 11% increase in profitability. And the spoils come quickly: “For 90% of companies, there’s an opportunity to change pricing in such a way as to fast-track better profits,” he says. “It’s not like you have to invest something and hope that in six months it might pay off. You can literally change your price on Sunday night and start making more money on Monday.”
Want to know how to price for growth and profitability? In a recent conversation with PROFIT, Mohammed outlined the following strategies.
Understand your value: The core concept of effective pricing, according to Mohammed, is the relative nature of value; that is, the different reasons why people choose to buy from you. Smart firms understand what their offerings are really worth to customers — and attach a monetary value accordingly, he says.
Recently, Mohammed delivered a speech at a conference for leaders in Brazil’s grocery business. One delegate brought up a concern: since everyone there sold virtually the same products, the sense was that none of them had any pricing power. “I said to him, ‘Are you telling me that a litre of milk at a convenience store should be priced the same as a litre of milk at Walmart?’” Mohammed says. “Even if you’re selling the same product as someone else, the value you offer can be very different.”
Understanding where your offerings lie in the value continuum is key to getting pricing right. You can do this by looking at your company through the customer’s eyes, evaluating the strengths and weaknesses of what your company does relative to the competition. This value — not profit margin, not markup — should determine what you charge. “People don’t price their products based on their value, even though that’s what customers base their purchases on,” Mohammed says. “If your product or service is better, you have an opportunity to charge higher prices.”
Mohammed adds that it’s crucial to impart how you’ve set that value to your sales team. “Most salespeople just aren’t confident about what they’re selling, so the first thing they do to ingratiate themselves to potential customers is to offer price discounts,” he says. “When you point out the relationship between pricing and profitability, they’ll start curtailing discounts.”
Introduce differential pricing: That’s not to say that all discounts are bad. If you’re looking to expand your client base, one price doesn’t always fit all; it pays to accommodate differing perceptions of value. Many customers never want to pay full price for what you’re offering — but that doesn’t mean you should turn them away, Mohammed says. Instead, you might want to consider offering “differential pricing,” including offering lower prices for those willing to put forth extra effort — by purchasing on slow weekday mornings, for instance, or by clipping coupons. “These are ways that give price-sensitive people a discount,” he explains. “You may have a great product, but some customers are deterred because they think the price is too high. You should look for ways to strategically offer a lower price to these customers without cannibalizing your business.”
Offer several versions: Another effective way to address the different preferences of your customers is to segment your offering to meet their tastes. Mohammed believes every company should offer good, better and best options of whatever it’s selling — regardless of industry, product or service. Take the example of a gourmet restaurant, he says, which may offer early-bird, regular and chef’s table options. The early-bird special attracts price-sensitive people by offering a discount during an off-peak time. The regular menu appeals to the normal diner. And the chef’s table option offers the experience of tasting the chef’s latest creations — for a $50 premium. “This allows customers to choose how much they want to pay you. When you give customers choice, it makes them want to deal with you,” says Mohammed.
Why would you want to offer a “good” option when your stock-in-trade is “better” or “best?” Mohammed says lowering the barrier to entry secures customers whom you otherwise may not have been able to attract. It also gives you the opportunity to upsell them to your premium options — although Mohammed cautions that you shouldn’t count on this approach to work all the time, since some “good” customers will always be “good” customers.
Let your customers pay their way: Mohammed also recommends reviewing how customers pay you. People like to have options when it comes to the term and structure of payment plans — to the point that their preferred payment method can become a deciding factor in their purchases. Mohammed tells of an acquaintance who, when planning a family trip to a Caribbean sun spot to celebrate his birthday, said he didn’t care about the destination, as long as it was all inclusive, because it would kill him to see his grandkids drinking $5 Cokes all day. “The payment plan was the most important attribute affecting his decision about where to go,” says Mohammed.
How different payment plans resonate with consumers varies, he says; for example, dentists can race past competitors by offering financing for treatments, law firms by offering flat rates and vacation property companies by offering share ownerships.
For resource-strapped SMEs in particular, this approach can be tricky to implement — it takes a lot of back-end work to create, market and implement alternative pricing plans. But if you’re able to integrate them into your business, Mohammed says, you’ll likely see a spike in new customers.
Ultimately, Mohammed believes, entrepreneurs who take the time to tweak their pricing models stand to reap big benefits: “Small changes in how you price things can have a huge effect on your business growth and bottom line.”