Any business’s survival depends on finding the ever-elusive right price — that magic number that will get people to buy from them in an online-discounts-dominated market while still allowing them to make a profit. No matter what you’re selling, the “right” price to ask for your goods is never clearly defined.
After all, the price at which profits disappear isn’t just the wholesale cost — you must also take into account the many individual expenses your business incurs.
Ultimately, the businesses that survive are the ones who correctly estimate the balance point and have the discipline to maintain it despite competitors’ miscalculations. If you want to be one of the businesses that “makes it,” read on for pricing advice.
Know the science…but realize that pricing in the real world is an art. Yes, you’re familiar with the price/demand curve — as prices go down, sales go up; as prices go up, sales go down. Theoretically, it’s possible to determine the point on the curve at which price and sales create maximum profit. But here’s the reality: Ideal conditions and time to experiment come true only in textbooks.
In the real world, you usually have to take your best guess. For instance: “I think customers will be willing to pay this much for this product.” Or, “Considering all of our costs, I don’t think we can sell it for less than this.” If you make a net profit, you can assume that your guesses were pretty close — but you can never know how close. Remember, only experience and feel for the market — not textbook knowledge! — will keep you within a profitable range.
The right price isn’t a multiple of wholesale. It’s tempting (some might even say “smart” or “all that’s necessary”) to price by simply using a fixed-percentage markup from wholesale. But the problem with that strategy is that it assumes that all of the expenses of a sale are determined by the product’s wholesale cost.
Sure, things like cost of capital and insurance are functions of wholesale cost —but many others, like labor, occupancy, and support, aren’t. To price correctly, you must do it individually and by feel, with consideration given to the total expenses of the sale, customers’ price sensitivity, competitive options, and the sale’s potential contribution to other business. Only occasionally and by coincidence should markup percentages match!
Understand your limits. Many rookie business owners totally overlook the price of their mistakes as they’re made. It’s only after a few dismal year-ends with miniscule or negative returns that these businesspeople begin to realize what went wrong.
When you’re too aggressive in your pricing, give unnecessary discounts, or make one of many potential mistakes in buying and selling, a sale can easily turn into a loss. Keep in mind that according to the U.S. Economic Census, the net profit of a business owner after everyone and everything have been paid is usually 1 to 3 percent of total sales. All too often, losses due to pricing mistakes aren’t limited to that 1 to 3 percent, and business owners are left digging deeply (and painfully!) into their back pockets.
Know the real definition of “wholesale.” Wholesale is the cost of the merchandise, not the cost of the sale. Think about it: The price paid to the manufacturer is only the first of many expenses in a transaction. Sales can’t be made without including expenses for rent, salaries, advertising, utilities, telephones, freight, maintenance, taxes…depending on the nature of your business, the list might go on. Just because a sale has a gross margin doesn’t mean it’s profitable. Unless the price covers all of the sale’s expenses, you will be taking money out of your own pockets to make it.
Know which sales should bear the operating expenses. (Hint: It’s all of them.) Some salesmen and managers subscribe to the following theory: “Our expenses are fixed, so we should accept every sale that has a positive gross margin.” Here’s the problem: When are expenses ever fixed, really?
Sales don’t happen in a vacuum. So increases in them require increases in personnel, space, inventory, handling, and virtually every other expense of doing business. Yes, it’s true that expense increases don’t always occur in a smooth progression, but they are depressingly reliable. The fact is, every sale incurs operating expenses, so its price should be sufficient to cover them plus a fair contribution to profit.
Don’t try to offer the lowest price — you probably won’t succeed. You’ve probably seen it before: Weaker competitors offer lower prices so that they’ll be customers’ first choice. At first glance, this might not seem like a bad strategy…until you realize that those companies are crossing their fingers and fervently hoping that when the dust settles, there’ll be a little profit left over.
It’s futile and suicidal to try to price below desperate competitors, because they’ll always drop their prices below yours. You might be tempted to sabotage another business by playing a game of who-can-offer-the-lowest-price, but even if you win, another business will spring up to fill the void. Differentiation is almost always a better strategy: Offer superior products and/or services that customers are willing to pay more for.
Reputations are made on price-sensitive items, margins on the rest. What are price-sensitive items? They’re those bought frequently and advertised often. In a grocery store, they’d include bread, milk, and soft drinks; in a musical instrument store, they’d be strings, reeds, and picks. Because customers buy them often, price differences between stores are more apparent.
Pricing these items low creates a value image for the store. Higher margins on other merchandise allow the store to cover its expenses, stay in business, and occasionally even make a profit. If you have trouble reconciling this idea with the idea that each sale should cover its own expenses, think of price-sensitive items as an advertising and promotion expense!
It won’t sell if it’s not on sale. The truth is, we live in a society that loves the thrill of a bargain. In fact, customers have become so accustomed to discounts that many won’t make a significant purchase unless the product is on sale. If you’re observant, you’ll notice that some furniture and clothing stores schedule only brief intervals between sales, which they use to catch up, restock, organize, and collect prospects for the next sale. Many department stores end one sale only as the next begins.
Before you get too clever, it’s important to note that consumer protection laws prohibit posting a “regular price” next to the sale price unless you can show that you actually sell the product at the regular price on occasion. But still, many companies’ strategies beg the question: If merchandise is always “on sale,” is a sale really a sale? Shoppers apparently don’t ponder the question. Use that to your advantage!
Don’t delude yourself when you make a buying mistake. Eventually, it will happen to every business: You’ll purchase inventory, only to find that technology or fashion has changed before your merchandise is sold. Many business owners hold on to these “mistakes,” irrationally hoping that customers will appear looking for this outdated, overpriced merchandise and bail them out of their problems.
The stark truth is, a product’s value is determined by the market, not by how much you paid for it or how much profit you want to make when you sell it. In the end, it’s almost always more profitable to move out your mistakes and put the floor space to more productive use. The mistake was in buying; trying to make up for it in selling only makes the error more costly. Learn your lesson and move forward!
Ultimately, there is no foolproof formula for finding the delicate balance between making sales and making a profit. However, there are numerous strategies that can help you to come to a profitable decision.
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