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Tim Berry on business planning, starting and growing your business, and having a life in the meantime.

The Three Most Common Pricing Mistakes 6

(Note: This was first posted last week on the Amex OPEN Forum. I’m reposting it here, with permission, for the convenience of my readers here. Tim.)

All the years I’ve been following business, strategy and small business—from the late 1970s through today—I’ve always wished for a magic formula for proper pricing. What’s the right price for this service? How should you price a new product? In teaching, writing and answering emails, this question comes up all the time. And, much as I’ve looked for the right answers, they aren’t at the back of the book.

Pricing is magic. There is no formula that works for you, or me, or any generalized group. You set your pricing as a matter of situation, strategy, costs, competition, weather, instinct and all of the above.

While I can’t really tell you how to set your pricing right, I can at least share something that I’ve learned—in classrooms, in making mistakes, in growing my own company—about how NOT to set your pricing.

Here are the three most common pricing mistakes that I see. And, just to be clear, while I wish I could drum up some rigorous research to back me, this is based on anecdotal evidence, common sense, and three decades of dealing with business problems.

1.  Trying to be the lowest price provider

One of the most damaging cliches in business is the idea that the lower price gets the highest volume.  The whole lower price equals higher volume idea, a fundamental law of economics, is for undifferentiated commodities, not your business or mine.

Successful lowest-price strategies are unusual. They usually take a lot of capital, resources and visibility. What works for Costco and Walmart doesn’t work for the corner store, some discount airlines and gasoline stations, but those strategies usually require a lot of capital and very large scale implementation.

2.   Mixing your pricing message

We forget way too often—and too soon—that price is the most powerful marketing message you have. Do you think people don’t buy your work because it’s too expensive? But isn’t it worth it? Don’t you believe in it? It’s about positioning. How are you different from the others? Is what you sell better than the one across the street? Does your price say so?

Would you get a root canal from the cheapest dentist in town? Would you save money by buying two-day-old sushi? And why isn’t the cheapest car made the most popular?

I lost a consulting job I really wanted once when I bid $25k for it and a competitor bid $75k. The guy who gave me the bad news told me everybody liked my proposal, but they wanted the best, so they went for the higher price.

What would you rather have for dinner: a $1 hamburger or a $20 steak? We used to go to a restaurant that had really good food and surprisingly low prices. But I often wished they’d raise their prices so we didn’t have to wait 45 minutes or more to get a table. And guess what: they no longer exist. They went out of business. Do you think pricing had something to do with that? I do.

3.  Underestimating real costs

Businesses go under when they run out of money. The research on how they run out of money is confusing and ambiguous, and there are rarely single identifiable causes. Still, just betting on what I’ve seen with my own eyes through a lot of years, I think businesses frequently run out of money because they underestimated real costs.

We talk a lot about gross margin in business analysis. That’s your selling price minus your direct costs. So if you buy that widget for $2 and sell it for $6, then the gross margin is $4, and your gross margin percent is 67 percent.

Unfortunately, focusing just on gross margin isn’t enough. Aside from the $2 you paid for that widget, there are all those other expenditures, including your rent, your payroll, your insurance, your electric and water bill, all of your marketing costs, and lots of hidden costs, like the computers and software you’ll need to buy next year. We call that overhead and tend to forget it. Which is a shame, because a lot of businesses forget about it all the way to the business grave. You run out of money.

  • http://www.pricingstrategies.ca Andrew Gregson

    Well worded. Finding the right price is like herding cats. Plenty of options but only one thing matters at the end – being above cost. in 100+ consulting engagemnts, I met only 3 business owners who grasped the full extent of their costs and applied them to a pricing strategy.

  • Pingback: Come decidere il prezzo: errori da evitare « maxferrari

  • http://www.packagemachinery.com Kate Putnam

    What is clear to me both from the article and the comments is that it is crucial to state and restate frequently your value proposition: Why do people buy your product or service and why they should. One of my customers told me once he buys our wrapping machines because he does not have to seen us again until eh wants another machine: no service or parts needs in between. Since we lose any ongoing stream of revenue from the machines we need to have a high up front cost. Our competitors do not. It is our job to communicate that.

  • Helvin

    I guess its about selling at the value it is to the customer, and about why the customer is visiting. For regular spending like food (e.g restaurant mentioned by Charles above), people don’t want to spend so much. But places like Disney is an occasional leisure activity that people don’t mind spending a few more bucks on generally.

  • http://www.mondaymorningva.com Dawn Martinello | Monday Morning VA

    pricing is something that I discuss with all my clients in my guide sessions. Even the best laid plans can come crashing down when you’re faced with the realization of how much it really costs to do business, or when you haven’t thought about if a client doesn’t pay you on time.

    There was a discussion in a VA forum (VAnetworking.com) that deals with rate setting that goes along with what you’re saying. People talk about the low price providers and wonder how they can survive charging such a low price when they have so many things to pay for. Check it out even though it’s a different industry.

    http://www.VAnetworking.com/forum/index.php?showtopic=826

  • http://theRotater.com Chris Melton

    Love it. People seldom realize the complexity involved in setting up a pricing schedule. Many variables plus a little intuition.

  • http://www.cubert.net Charles Robinson

    There is a fine line to walk, and I think businesses need to be cognizant of the fact that their fans can walk away at a moment’s notice. Give me a good product at a fair price and I’ll stick with it. If I see you trying to gouge me, I’ll find another place to go.

    Disney controls crowds at their theme parks by increasing ticket prices. They could choose to limit tickets, but instead they choose to let their customers be self-selecting. During the recent recession this came back to bite them and they had to offer steep discounts on tickets to get people to come.

    One of my favorite local restaurants suddenly exploded in popularity after a write up in a national magazine. I have been going since the day they opened four years ago, and after the media attention I noticed prices creeping up. The last time I was there I spoke with the owner about that, voicing concern that some of the prices now seemed a little steep. I used to go at least once a week, and sometimes I was there four nights in a row. Since their prices started going up I have only been eating there once or twice a month. I heard a couple of weeks ago that they are struggling. Price had something to do with that, too.