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The third law (of nine) in the HYPERGROW system encourages business owners to “refine toward perfect pricing.” Of all the laws, the mere mention (and the strategic wording) of this law seems to elicit the most noticeable reaction. Eyes bug out. Brows raise. Head’s tilt. Sometimes, I even get speechless mutterings from the client I am working with.
Yes, perfect pricing would be great, but I am certain I am not there yet!
Never fear if your reaction was similar. Pricing is not a “perfect” science and does require a certain amount of refinement toward that goal. However, when you study the pricing part of your business, rarely will you find a business concept that has as wide a reaching impact. Pricing has a huge influence on the customer and our marketing efforts (and thus our ability to hypergrow), as well as having monumental weight on the financial side of the business. Shooting for a great approach to pricing is a super-smart thing to do!
Here’s the trouble as I see it. Pricing is a multifaceted management issue (see below). However, we tend to treat pricing decisions as one single decision. In reality there are many factors which should be studied when selecting our prices. This is why the process seems to confuse a large percentage of businesses. To solve this, I suggest considering six individual, narrow approaches to pricing instead of a single, convoluted, and complex one.
How does this work? When looking at pricing, look at the following six things on their own first. Put the blinders on. Do not consider the other factors until later. Initially, study each of the six by themselves. After completing that exercise pull the six different approaches together to see how the different methods relate to each other. For me, only after you have done this, are you making an informed, intelligent, and growth-based approach to pricing.
Here are the six methods and a brief overview of each:
· The Margin Method – simply, in most companies there is a relationship between the cost of an item and what it is sold for. Margins look at the unit profit per item in relation to the selling price. (How much of the selling price is profit after we pull out the direct product costs?) A related concept (though slightly different) is markup. Using standard markups or margin targets is a common way to study pricing. In most industries, margin standards for the industry can be identified and used the pricing equation.
· The Income Method – Your prices have an impact on your bottom line, and if you are the business owner, also your personal compensation. If you don’t believe me on this, take the financial model for your business and run it through with everything else being equal, but change the pricing approach. You will be amazed. Set your prices with an understanding of how this impacts the bottom line of the company.
· The Competitive Method – Of course, what others are charging for comparable products and services should be considered. The goal is not to be higher or lower than the competition, necessarily, but to (a) solidly understand where the competition is, and (b) make a conscious decision where you want to fit in relation to the market.
· The Volume Method – Economic theory tells us that as the price of an item changes the quantity we sell should change, as well. In some industries this is more pronounced than in others. You want to study the market and make some estimates based on how unit volumes may change if you modified your prices. Yes, this is guessing at something where you do not have perfect information, but a “wild guess” is still better than doing nothing.
· The Image Method – The price of an item, by itself says something to your customers. For instance, a $0.99 hamburger says something very different than one which costs $15. Just the price tells us a lot about what you expect of that hamburger and your perceptions of what it will be like. Your price – by itself – also makes a statement about your product, your company, and sets the tone for how people will react to you. Again, the key is to study this and consciously select the way you want the market to look at you and what you do based just on the price.
· Lastly, The Testing Method – Like many things in business, pricing is an inexact science. You will try some things that work, and some others that don’t. Important is to seek to learn and modify your prices based on how the market actually reacts to your offering and price, not just on how you think they will. I often tell clients it does not matter what I think or what they think. Ultimately what matters is what their customers believe and act upon.
Is that complex? Well, probably. But it reflects the many things which have a significant impact on pricing. Ignoring any of them simply means you are making decisions with a blind eye to important elements in the business. By looking at the six methods separately, we are able to isolate the variables, do a real analysis without feeling overwhelmed, and make a decision with more comprehensive information.
Your pricing decision is not one, but six!
Curt Clinkinbeard is the Director of the Kansas University Small Business Development Center and is the author of HYPERGROW YOUR BUSINESS. He can be reached at curt@hypergrow.com.
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