How Will Right Pricing Make Your Business More Profitable? Post 3 of the series

Back again. In the previous post I showed how just placing a simple margin on your products and services may actually be leading you to a loss over the year. Simply because the money coming in wasn’t enough to cover the money going out – despite what many businesses would consider a good cash flow (in) situation.

The question I am often asked is which is better, cutting costs or increasing prices.

Let’s look at these.

Cutting fixed costs. Even major corporates often jump quickly to cutting costs as a means to raising profit margins. Every CFO seems to love less going out. Even stock holders think decreasing fixed costs as a bonus for a business. You only have to see how quickly stock prices jump whenever a company announces that they are “down-sizing”, “right-sizing”, “making redundant” or in simple terms, sacking people!

But this can be such a short sighted view of the world. Yes, where possible, decrease costs through efficiencies. But go beyond the point of efficiency and you could have a detrimental effect on your long-term business prospects.

Say you cut back on advertising. Will this reduce the number of people coming into your business? Will customers think you are going out or have gone out of business? Will you lose being “front-of-mind”, inadvertently raising the profile of your opposition?

Say you cut back on staff. What affect will this have on customer service? Will customers become frustrated and leave because they can never be served? Will staff turnover increase, adding extra costs to your business as you advertise for new staff? And with staff turnover will you suffer from the loss of ingrained knowledge and expertise – affecting your customers even more?

Or, you turn off 10% of the lights in your store as you try to reduce your electricity costs. Suddenly you become that little bit dingy and unattractive and customers no longer enjoy the experience.
Yes, it’s easy to cut back on fixed expenses. But will it cost you more than it’s worth? Simply think and ask yourself this question, “What impact will this have on my customers, on my sales, on my service delivery, on my long-term bottom line?”

A simple cut beyond efficiency could be the biggest mistake you could make.

Reducing variable expenses. If you can reduce the cost to you of purchasing the products you do, great! But what if this means you buy a “cheaper” product that is almost the same as your current quality product, will this lead to loss of customers as they now perceive your products to be below the quality they expect from you?

Does it mean you cut back on the size of your product or extend the time it takes to deliver a service? And, if so, what impact will this have on customer satisfaction and referrals?

You may be able to negotiate with your suppliers about bulk rates or loyalty discounts or supply-on-demand or direct-to-customer (where products are sent by the manufacturer direct to the customer – reducing the overall costs while maintaining margins) pricing structures.

Overall, while cutting back on costs can have a positive effect, cutting back on the fundamental essentials may have a greater negative effect, especially if it means you lose the segment of your market you shouldn’t be losing.

Often in business we refer to the 80/20 rule; 80% of your income will come from just 20% of your customers. Conversely, businesses will generally spend 80% of their time chasing the 80% of the customers who give them just 20% of their income.

So, before considering any major change in products, services and “brand”, consider first what impact those changes will have on your 80% income customers? Losing 5% of your top customers will have a greater effect on your business than losing 10% of your low-end customers.

Using our example in first post, to break even this business has a turnover of 73,000 items at $15 which equals $1,095,000.

80% of that turnover from 20% of your customers equals 58,400 items or $876,000. That leaves the 14,600 items or $219,000 from the 80%.

A 5% loss of sales at the top end equates to $43,800 decrease while a 10% loss of sales at the bottom end equates to just $21,900 decrease. Sure, neither is pleasant outcome, it is just that one is less pleasant than the other. Besides, what if you were able to increase your top-end sales by just 2.5%? Revenue neutral!

As a business owner you have the choice of what customers you attract to your business. The question comes down to exactly what will you do to attract those right customers to buy from you?

And that’s a story for another day.

Suffice to say, if you look at who your opposition are attracting to their business, ask yourself this question, “Are they the customers you want in your business and will they pay the prices you set for the products, service and customer service you deliver?”

Sometimes the best thing a business can do is lose customers that cost them more in the long run.

After all, your opposition may have the right customers for their business, not yours!

All success.

Colin

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