Understanding how a customer or prospect VALUES your service is critical to getting pricing correct. This article details an approach to understand the value and various other important factors to grow business profitability of your bottom line.
If you’re a Bruce Springsteen fan, you might enjoy his song “The Price You Pay” (also covered by country star Emmylou Harris). Roger Daltrey of the Who sings “The Price of Love” while Twisted Sister released “Pay the Price” in 1999. The Doobie Brothers contemplate life in “Too High a Price” while the Thompson Twins think back to their youth in “The Price.”
Get the idea? Price is important in song… and in life! But if you listen a little more closely, they are REALLY singing about VALUE, not price.
Price represents the VALUE we are willing to pay for something. Therefore, when setting a price, understanding value (along with other factors) is important for all businesses. As accountants, we often see that clients can greatly improve business performance through small adjustments in price. Here are some pointers:
1. Asking Questions to Establish Value
Think of some of your own purchases. Perhaps you engaged a marketing consultant in the hope of growing sales. You may have bought some software to reduce expenses. In both cases, the VALUE is measurable. There are also less tangible examples of value. Buying insurance, for example, may lead to risk reduction, more certainty, and peace of mind. Some purchases may bring value through improved well-being or lifestyle (like a gym membership). The value may take the form of a feeling of prestige, often enabled through purchases or luxury items. You need to understand how your customer VALUES your product. If you’re unsure, you may need to ask them. Once the value is established, you have the most powerful indicator of price.
2. Add Value to Reduce Price Sensitivity
Think about the price sensitivity in your market. Some markets are highly pricing sensitive, especially where you are selling a commoditized service. Why pay more for something that is readily available at a lower price? But if you are selling a highly customized, rare, sought-after product, price sensitivity will be lower. What can you do to increase the perceived value of your product or service? What can you add? What can you ‘bundle’ to create more value? How can you improve the client experience? The simple fact is that premium providers can charge more.
3. Think long-term
A ‘loss leader’ refers to a sale on which you are willing to lose money because of some advantage to be secured down the line. That advantage may be revenue from future sales, enhanced reputation, increased business valuation, acquisition of new skills, etc. The existence of these future opportunities will influence your view of price on the next sale. You may even consider a ‘freemium’ approach where you give something away in the hope of securing future revenue.
4. Consider Unique Aspects of the Market which Influence Demand
We are used to paying different amounts for flights depending on the season. Same with Broadway tickets. That’s because demand can change based on ‘surge pricing’, ‘demand pricing’, or ‘time-based pricing’. What factors influence demand among your customers? Gift-giving seasons? The strong performance of the economy?
5. Competitor Pricing/Benchmarking
Don’t think of value/pricing in isolation. Who would your customer buy from INSTEAD OF you? And what would those competitors charge? You are probably aware of suppliers who are considered to be ‘cheaper’ while some are considered ‘more expensive’. Consider the range of prices in the market and where you fit. Justify your position in this range.
6. Cost-Plus Method
This should not define your strategy… but it IS important to know what it costs you to provide your product/service. To get an accurate view, include ALL costs for this sale such as marketing, selling, preparing, and completing the work. Include the costs of personnel, materials used and any disbursements to third parties (e.g. contractors) you bring in. This helps to understand your breakeven cost and will influence the price, and thus your business profitability.
7. Consider Payment Terms
Payment terms form an important part of pricing and how your client VALUES your work. Would you rather receive $100 today or $120 in three months? More importantly, perhaps, would your customer rather PAY $100 today or $120 in three months? The value of cash in your business at any point in time will influence price strategy. Think also about performance-based payments where you are paid once certain milestones are achieved.
8. Keep it Simple
There may be a temptation to design complex price arrangements. An obvious example is to link price to future savings. But often it is difficult to track and measure future outcomes. Also, clients like transparency when it comes to payment/pricing, and anything that is difficult to follow will not be well-received.
For service providers, the most attractive way of pricing for clients is a project (or fixed) fee because they enjoy certainty and transparency. It also drives efficiency in your business because you strive to be more efficient resulting in a higher profit. Where the scope of work is extremely vague (because the project is exploratory or poorly defined), hourly rates may be the best way to go.
Some businesses will never offer discounts while for others, this will be a normal practice. An important question is what advantage you secure by offering a discount. Does this increase the chance of closing a deal? Does it result in a more loyal customer? The same can be said for promotions or ‘specials’ (such as buy-one, get-one-free).
10. Document Your Pricing Strategy
You don’t want to think through a pricing strategy every time you price a project. Create a document that you can refer to for future assignments and review it periodically because things will change.
Working out price may not get you ‘singing in the shower’ but shifting the discussion to value is an important start. Your industry, business goals, and costs of production will influence your approach to price.
Learn how to optimize your business profitability today by contacting our team at Fusion Legal & Tax.