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The Impact of Pricing on Profits

2005 | Nov 21 in Money

By E-Myth Business Coach,

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How do you decide what to charge for your product or service? The specifics will be different for every business, but it comes down to one thing: VALUE. If your customers can see the value of buying your product or service, they'll happily pay the price. If they don't see that value, it makes little difference how low you set your price, the customer will look somewhere else for the perceived value, even if "somewhere else" costs more than your product or service!

Too many small business owners are working far too hard and charging far too little for their product or service. In most cases, they have no idea what sets them apart from their competition. They don't know what they do better or what their competitors do better. And they are more afraid of losing a customer than they are focused on making sure each sale is PROFITABLE. So the only basis on which they think to compete is price. They think, "If I'm able to beat my competitor's price, I'll attract more customers and make more money."

But is that really true? Not usually. First, it helps to understand that customers are not actually buying a product or service. They are buying a SOLUTION to a perceived problem or need. Fill that need at a price they can afford and you'll have no shortage of potential buyers for your product or service.

Notice we said, "at a price they can afford." Not "the lowest possible price." Not "cheaper than our competitors." A price they can afford. A price that is less than or equal to the perceived value of the product or service.

First of all, the business needs to know if the price they're charging allows them to make the desired level of profit. How do you find that out? Add up all of the costs associated with producing your product or service. Then, add in a percentage for overhead (rent, utilities, payroll, taxes, etc.). The percentage will be different for every business, but make sure you build in enough mark-up to cover overhead. Finally, add in your desired percentage of profit. You need to charge at least this much to cover your costs and generate a profit.

Does that mean you set your price there? Not necessarily. If you can show your customers that your product or service will save them lots of time, money, and/or aggravation, you may be able to charge more. How much more? That depends on how much time, money, or aggravation you can alleviate for each customer. Depending on your customers and your product/service, you may be able to charge a LOT more.

Hopefully, we've almost convinced you to look at increasing your prices. How will your customers react? If you already provide them good service at a fair price, most will have very little objection to a modest price increase. Will you lose customers? You'll probably lose a few. But which ones? The ones for whom price is an overriding concern, or the ones who haven't seen the different ways in which your business adds value to the product or service. Usually, these are the same customers who complain loudly at every perceived error or slight. You probably won't miss their complaints. And you most likely won't miss their dollars, either. Your increased profitability should offset the few sales you may lose to the "price shoppers."

If you still aren't convinced, here's an example of the way discounts and reduced prices may impact your profitability.

If you sell your product or service at a gross profit of 40%:

  • Offering a 5% discount means you need to sell 14% more volume to make the same dollar amount of gross profit.
  • Offering a 10% discount means you need to sell 33% more volume.
  • Offering a 20% discount means you need to sell twice as much!
  • Offering a 30% discount means you need to sell four times as much!
  • Offering a 40% discount means you don't break even no matter how much you sell!

These numbers also work in reverse. The higher your price, the less volume you have to produce for a given dollar amount of profit! Even a small price increase can generate significant additional profit.

We know what you're thinking: What if I increase my price so much that I drive away most of my customers? If you've done your homework and are providing more perceived value for your customers than you are charging, this won't be a problem. Even companies that have a monopoly in the marketplace are limited by that perception of value. When a business comes out with a new product or service and they are the first to market, they may be able to charge high prices initially. But those higher prices can't be sustained for very long. Other businesses will see those prices and develop their own lower-cost alternatives. Examples throughout history abound. And the higher the initial price and profit margin, the faster a competitor will come to market with a less expensive alternative. Don't let this possibility keep you from increasing your prices!

Instead, enjoy the additional profitability and reduced workload. Use that increased profit to BUY YOURSELF SOME TIME for the strategic work of reducing your costs, laying the foundation for growth, and researching new market opportunities. Reducing your costs ultimately allows you to reduce your prices while maintaining the same level of profitability, but you need time and money to create that value for your customers and for your business. Don't sell yourself short. You and your business are worth it!

Please share your expereinces with the changing prices, or offering discounts on your products and services? If the change worked well, how did you do it and what your tips for success. If it did not work well, what are the common pit-falls and how would you avoid them next time?

Comments

  1. .David M. says:

    I currently charge more than my competitors. Thanks to E-myth strategies, I have positioned myself as a specialist. I tell prospective customers, upfront, that if they are shopping around (yellow pages), they will find I am a little more expensive. I then tell them WHY I am more expensive. What I do and why in an effort to create the VALUE.

    Submitted Nov 21, 2005 6:48 PM

  2. .Randall R. says:

    what is the best way to take an existing buisiness which just has been doing year end reporting from Money and start to generate tge reoirts abd data from the financial module in embark? Is it to use quickbooks and a accountant who is quickbooks certified? Or are there other programs which are better? We are a small buisiness on the grow and are currently emything our whole process. Sales of 700,000 and revenues of 500,000 last year. randy

    Submitted Jun 16, 2007 1:34 PM

  3. .Louise A. says:

    Hi, do you have the formula for working out those % that you've listed above as I'd like to put my prices up a little bit, but can't workout what the impact will be.

    Submitted Mar 27, 2012 8:22 PM


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