Nominal versus Real
In recent time inflation in Australia and most parts of the western developed economies has been low. However it has been the case particularly here in Australia that some years ago we had high levels of inflation. Inflation has a role to play in marketing of our products and services.
Many marketers say that if you have a product that is for sale at $50, don’t sell it for $50, sell it for $75 discounted to $50. As time goes by inflation could eat into your profit and you’ll have to raise the price, but if you have it advertised as a reduced figure you can reduce the discount. So the price would still be $75, discounted now instead of $50 to say $55 or $60.
This technique is often done by a lot of the retailers and as consumers we look at the top line price, even though the reality is that top line price was never probably a real price. The issue of understanding the power of inflation in pricing is important to consider.
Photo by:- Alan Cleaver
The Decisions We Make About Price
The decisions we make about price have some important lessons for us in selling our products and services, so lets consider a survey question that was asked by two researchers in determining how people make decisions about price.
“Imagine that you were about to purchase a jacket for $125 and a calculator for $15. The calculator salesman informs you that the calculator you wish to buy is on sale for $10 at the other branch of the store located 20 minutes away. Would you make the trip to the other store?”
This question was asked in 1981 when $125 and $10 was appropriate, so accordingly we could rephrase the question to maybe say a jacket worth $300 and a calculator or some computer device worth $150. Now the calculator/computer salesman informs you that the item that you wish to buy is on sale for $120 at another store, would you make the trip?
When this question was asked the majority of people said they would. The question was slightly varied and another group of people was asked. In the different version the jacket was only $15 and the calculator $125 and now the calculator was on sale for $120 at the other store and the question was, “Was that worth the trip?” and most said no.
In both versions of the question the buyer is planning to spend $140 total and the drive saves exactly $5 so why are we more willing to drive across town to save money on a small purchase than a large one? It is this understanding of the behaviour that is driving these pricing decisions that is important for us to understand in pricing the products and services of our business.
Photo by:- Andres Rueda
Unnecessary Fees And Processes
Invoice
Recently I have been noticing a rise in fees that have been added to various accounts with some amusing names (handling or processing fee). Telstra last year tried to implement a fee where you had to pay extra to pay over the counter your bill. This fortunately was removed by the public pressure.
Some banks charge you more to use the over the counter services than the electronic services. Other organisations also have fees and charges that appear on the bill and they don’t have to be the large public companies that are mentioned earlier.
These fees and charges are possibly being seen by some of the internal accountants and financial officers as ways of raising additional revenue without increasing the price of the good or the service.
But the impact from the customer point of view, far out weighs any benefit that these unnecessary fees and charges incur. It is not just the large companies that are doing this practice. Many small businesses seem to be adopting the practice but be careful.
Recently I had my car serviced and when you look through the bill there was four separate little fees, none of which exceeded $5, that were added on after the labour component and the parts component, etc. It leaves a sour taste in your mouth as a customer. The additional revenue that the business has charged adds up across all customers, but what is the impact on the customer.
Instead of the service or the experience being remembered, the little fees and charges take a bigger significance. It is always the little things in business that have a big impact and unfortunately these little fees are having a far bigger impact than most businesses are crediting.
So have you gone down the path of imposing some little fees, service charges or levies on your clients? If so I would seriously reconsider these and just consider increasing the price and accordingly, increasing the experience the customer has.
Margin and Markup – Does your team know the difference?
There is a lot of focus in business on net profit, ebit, roi, or other similar measures. However before all that a business needs margin. It is imperative that all in the team understand margin and what affects margin.
Margin is the sale price of the good or service less the costs incurred directly in making/purchasing the goods or services available for sale(also known as variable costs). Margin is also known as gross profit. This gross profit is what covers overheads, fixed costs and hopefully there is net profit.
Each type of business will have different norms for what variable costs and gross margin are. For example in a retail business it could be as follows:-
Sales 100
Variable Costs 70
Gross Profit 30
Overheads / Fixed Costs 25
Net Profit 5
In a retail business the majority of the variable costs are usually tied up in stock / inventory. Other sectors would have different standards.
From this we need to explore margin and markup which are often confused. Markup is the sum applied to the cost of goods sold to determine the sales price. Margin is the sales less cost of goods sold. In percentage terms margin can only be between 1 to 100% whereas markup range from 1 to over 5000% percent. At 50% margin the markup is 100% but after this as margin increase the markup increase exponentially.
One of the biggest item that impacts on margin is discounting. This seems to be the first tool to increase volume of sales. But before any discounting is entered we must consider the impact of the discount on the margin and calculate exactly much extra sales the business will need to recover the discount. Volume sales is not the only way to make profit. Smaller volume sold at a better margin can lead to more profit.
Another issue is adjusting prices to reflect the change in the cost of goods. When you import goods the currency changes can significantly affect the margin. So if the costs have increased and the margin is declined by 10% points, how much does the prices need to increase? No the answer is not 10%. If you put the prices up 10% then you would only increase margin by 9% points not 10. Now if you were turning over $30 million per annum then this could cost the business $300,000 in profit.
In setting the price of goods ensure that you know whether the software you are using is using markup or margin. If you put 30% into the program and it is set as markup when you wanted 30% margin then you have just lost 6.9% of your profit. If the desired margin was 80% and instead the goods were priced at 80% markup this would mean you have lost 22.8% profit.
Now none of this is necessarily sophisticated analysis but does your team understand these issues. What happens if the sales person in negotiating with a buyer applies 40% markup instead of 40% margin which the business wants. The buyer would have got a bargain. This message is applicable to a small business as it is a large business. GM in the States went under because it could not sell enough cars at high enough margin.
Photo courtesy of agentakit
A few points on the pricing emotions.
In this post I outline just a few points on the psychology of pricing. People tend to buy emotionally and justify intellectually. How many houses have been bought for emotional reasons? Then afterwards intellectually we say it’s a good investment.
There are three pricing emotions:
1. Price resistance.
2. Price anxiety or buyers remorse.
3. Payment resistance.
In educating our clients during the sale process we need to be able to address these pricing emotions. The mere obtaining of sticker shock is not necessarily a negative as once a client is educated to the value then they will often be your best customers. It’s a known fact that the luxury car ads are aimed at existing customers more than potential owners. These companies understand that after making such a large purchase, customers want reassurance that they have made a good decision. People don’t go out and buy a BMW because they saw the ad on the TV. But those who have bought the latest and greatest BMW or Mercedes or what other marquee brand and have spent a significant amount of money need to be assured. These companies understand that they need to address these buying emotions. It does not mean that they are addressing it by reducing the price, it means addressing it by educating their customers.
Prices need to be set at the beginning or as early as practical so that we get the pain out of the way and then deal with the pleasure. We get the ability to educate the client on the value at they are receiving but of course, we need to understand the value equation to be able to do this.
Pricing is a marketing issue. Pricing by itself as has been countlessly realised in the dust heap of business will not lead you to business success but pricing coupled with great service, understanding what the customers expectations are and delivering value can lead to increased net profit, increased revenue to the business and increased loyalty of your customers which in the long run will be the best growth strategy for your business. Don’t neglect pricing.
The 5 C’s of Value
In my previous post I discussed that pricing is a marketing strategy. In this post I discuss the need to look at the value being delivered to the customer.
So let’s look at the 5 C’s of value:
1. Comprehend the value being delivered to the customer.
2. Create value for customers.
3. Communicate the value you create.
4. Convince customers they must pay for value.
5. Capture value with strategic pricing based on value, not costs and effort.
So many businesses look at the services and products that they offer from their perspective. But to be able to determine the appropriate price, you need to firstly comprehend the value to the customer. Why are they buying that service, what problem is it solving, what pleasure is it obtaining or pain is it avoiding and then what is that worth to them?
In business, we need to be able to create the value. We need to be able to create this value so that we are actually delivering the value to the customer. We could create value by the experience in dealing with you. It could be by the result of using or delivering the product or service. Value must be created.
The customers don’t always comprehend exactly the value that is being delivered to them and accordingly an important part of any service strategy of a business is educating the clients of the value being delivered. Often time the customer may think of an aspect of the value but have not thought through every aspect of the value. Alternatively it may be that they have not quantified the real value being delivered. Never assume – educate your customers on the value being delivered.
The fourth aspect of convincing people that they must pay for value is also very much tied up with the education of the customers. Now remember that not all customers are going to want to pay full value. Those customers, you don’t want to deal with. We only want the good customers who are willing to pay for the value. There are plenty of these paying customers once they have been educated because these are the ones that we can earn a profit from and have a far more enjoyable business.
Finally, once we have understood the value equation, we then can determine the pricing strategy.
Pricing is a marketing strategy.
Too often in business, particularly service businesses, pricing is not seen as an important business tool to develop the business. Pricing is often seen as something that is set by the market. From accountants, engineers, financial planners to physiotherapists often the answer to the question of how you set your prices is usually one of two answers. The first option is have a look around at what everybody is charging. The second option is, work out my costs and add a margin that I want to achieve as profit. These two approaches are not a determined appropriate pricing strategy to ensure that the price being charged for the service is in any way reflective of the value being delivered. Unfortunately too many businesses do not look at price as an important element of their marketing strategy
So what do customers buy? We are all familiar with the old, they don’t buy the drill bit they buy the hole, they don’t buy the sausage they buy the sizzle. Theodore Levitt of Harvard Business School put it best when he said that customers buy expectations. They expect a certain result, a certain outcome, a certain problem be solved, pleasure to obtain or pain avoided and that is what they are buying. They are not buying time, they are not buying effort, they are not buying the cost structure of the business – they are buying an expectation, an expectation of a result. Being mindful of this fact, why on earth would any business therefore price its services on a time basis or some other anachronistic tool that is not focused on the value being delivered to the customer?
We need to ensure that as a business that we are meeting our customers expectations because that is what they are buying, that is what they are going to pay for.
In the United States it has become known amongst management literature an effect called the “Starbucks effect”. Approximately 12 to 13 years ago, 3% of coffee sold in the United States was premium. Today, more than 40% of coffee sold in the United States is premium. This is primarily due to the development of Starbucks. They selected a customer base, delivered an experience that that customer base wanted.
Who would have ever thought that we would be paying the money that we are for bottled water. Something that we can get for free, it is not scarce in reality There is a plentiful supply of drinking water in the western world yet we are buying bottled water. To make this even more of interest is to have a look at the company Evian who sell premium bottled water. They make an experience out of bottled water. Maybe it is not coincidental that Evian is naïve spelt backwards.
Evian, Starbucks – they have loyal delighted customers. This wasn’t done by charging a fair price or catering to discount shoppers. It was done by delivering an experience to a particular customer base that wants that experience and charging appropriate for it.
Pricing can assist in the development of a business in so many ways as it transmits so much information. Take a minute and look at the lead pencil that you may have on your desk. Think of all the businesses that have been involved in putting that pencil together from the tree – the logger, all the way through to the end salesman from which you purchased that pencil from. Every which point, a price was charged. A price that was transmitted value to the next stage. Even in the humble pencil, the price mechanism is at work.
So the question is – how is the price mechanism at work in your business and is it being looked at properly.
The first point in determining what is the price is to look at the value side. Customers are only going to deal with your business if they see some value from doing so.
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