When I ask my accountant, he tells me that Profit equals Revenue minus Costs. He then spoils this simple equation with two caveats:
- Revenue is the cash flowing into your bank - this is sales without the bad debts, returns or shrinkage.
- Costs include your materials, labour and energy bills as well as everything else needed for long-term trading such as your contingencies, investments, replacements, training, and insurances.
So how do you determine your price?
If you were my client and I was helping you to calculate your sales price, does that mean that can you simply take the cost of the goods or services that you are selling and add on the Profit you choose?
No - though you are in business for profit, your other goals might include growth, long term survival, avoiding competition or managing tax. So deciding your business objectives will change the price you set for your products and services.
As I work with small businesses, we often have to look at a range of pricing strategies to figure out which will allow them to reach their chosen goals:
1. Pricing low for market penetration
You may want to gain new customers quickly, perhaps when you are entering a new market. Therefore, you lead with a low-priced product to build your clientele and then in a separate sales cycle target these customers for sales of your more profitable products or services.
2. Pricing to be market competitive
You may want to compete for tenders, proposals, auctions or other situations where you are forced to offer similar products to your competitors so that the buyers can select on price. So set a competitive price to get selected and afterwards you can look for ways to adjust your costs - through volume discounts, payment schedules or value engineering.
3. Pricing high to maximise your profits
You may have a product or service that is unique or new, with no local competitors, giving a short-term opportunity to get high profits before copycat products dilute your market. Therefore, increase the profit per sales unit, keep your supply cycles tight and ensure you are not left with unsaleable goods when your monopoly runs out.
4. Pricing to make a transparent profit
You may want to set a price that your customers see as honest and reasonable, say with a key major customer or group of customers, where trust is important. So set a 'cost plus 15%' price to make an acceptable profit on top of the input costs that you allow your customers to audit.
5. Pricing for maximum profit and maximum sales
You may want to generate the maximum profit without losing customers along the way. This might follow your initial product launch as you start to emphasise how the benefits you offer differ from your competitors.
Choosing the right strategy
Using one of these five strategies helps my clients to move from a simple profit structure to using price in their marketing strategy to achieve specific business goals.
Of course, the chosen strategy is only good until your market conditions change. Then you need to reconsider your goals and re-apply the pricing strategies that will get you there profitably.
Adrian Pepper coaches people through business and personal difficulties, helping companies figure out what to do, how to move forward and what to get organised. You can contact him through Help4You Ltd, through his website at www.help4you.ltd.uk or by phone +44-7773-380133. At feeds.feedburner.com/help4you, you can listen to his podcast for small businesses.
Tags: monopoly, era, parent
