Pricing is a huge topic that spans far beyond just one post. I could write a whole book on the subject as I spend more time working on pricing with clients than any other area of finances. This post will be a high-level view of the issues and some solutions to the pricing problem, and then I can dive deep into some areas in future posts.
Pricing is often the root cause of problems many small businesses need help with. Getting your pricing wrong leads to a lack of profitability and, therefore, cash flow issues.
A lack of profit means the owner ends up working more hours because they can’t afford to hire the staff they need. They start to make mistakes and cut corners, the service or product suffers, and sales drop or churn increases.
You end up in a death spiral until you are finally shaken out of it and forced to take the drastic step of increasing your prices or folding the business - dreading the huge number of clients that will suddenly leave when the increase kicks in and the fact that nobody will ever buy from you again at this high price….
But, what actually happens is that one or two clients grumble a little about the pricing but stay on, 90% accept the increase without blinking, and you lose 1 or 2 clients (these would be your lowest payers and probably the biggest pain in your backside).
So you end up with fewer clients, less work for you but a much higher revenue, with no extra costs - ALL bottom line profit!
How do I know this? I have seen it play out time and time again. This happened in my own business at one point, so I can talk from personal experience too!
Pricing is the quickest way to destroy your profit margin but also the quickest way to fix it.
Ok, so a quick caveat, the above doesn’t play out like that for everyone, but it does for most businesses, especially service-based businesses.
Why is that?
- Pricing takes a lot of work to get right. It is a delicate balance between the science and the art form of pricing. There is a huge psychological aspect of pricing that is not black and white.
- Business owners constantly undervalue themselves and the service they provide - therefore, they fear higher prices.
The Science of Pricing
First and foremost, your pricing has to deliver a decent profit margin for your business.
I always start by working out what pricing works for the business as a first step and then look at how we can position this pricing and the value the product or service delivers - the two are not mutually exclusive.
You can’t just set sky-high prices because it gives you an excellent profit margin if you aren’t delivering the value or the market can’t sustain those prices.
On the flip side, it’s all well and good having a price that looks great value for money and stands out in the market but not at the expense of not making any profit!
I spoke with a business owner last week and immediately spotted that they needed to increase their price. They deliver an excellent service, were over maximum capacity and had a long waiting list of clients - yet they were not making enough profit - A prime candidate for a price increase to fix many of their problems!
Let’s take a look at a few of the common pricing methods.
Cost-Plus Pricing
Start with your Cost of Goods Sold (COGS - all the direct expenses related to making the product or delivering the service) and add a markup for the profit you want to make.
For example, COGS are £50, and you want to make £50 Gross Profit from each sale, so you sell for £100.
Note that markup is different to Gross profit. Gross Profit in this example is 50% (£100-£50 = £50. 50/100 = 50%
Markup starts from the COGS, not the profit. In the above example, the markup is 100% as you are starting with £50 and adding £50 on top (100%) to get to the price.
This is one of the simplest and most basic pricing methods and works well for product-based businesses like e-commerce but terrible for Saas, who typically have very little COGS.
It also ignores everything else going on in the market or the selling conversations if used in isolation.
Competition-Based Pricing
The opposite of Cost-Based Pricing in that it ignores the COGS and focuses on what others are doing in the market. This might typically be to undercut the market and price cheaper than others but can also be used to place your price mid or top-tier.
It keeps your pricing dynamic and should make it easier to sell (if being price compared), but as it ignores COGS, you could be pricing at an unprofitable level.
It is used in combination with other methods in most sectors, but be wary of relying on this if going for a premium product or service - A Ferrari seems expensive to most but still sells like hotcakes. Get in front of the right people!
Value-Based Pricing
Value-Based buying is one of the most customer-centric methods around. Focus on the perceived value you bring the client rather than the time or cost to deliver the service.
This can work well in service-based businesses, but it can be hard to identify the perceived value to the client in some situations.
If you run marketing ads for a business and bring in £100k of sales and charge £5k to do so, most owners would feel like they got a good deal, but it’s also likely to be very profitable for the marketing agency.
Other Pricing Methods
This could be a very long list. Others worth mentioning are:
- Dynamic pricing - price changes constantly; think airlines or Uber.
- Freemium Pricing - Basic free version of produce (typical in SaaS) with chargeable upgrades.
- Penetration Pricing - Be the lowest in the market to gain a share.
- Price Skimming - Start as high as possible and keep lowering the price over time (common in tech hardware).
The truth is, focussing too much on a particular pricing strategy probably isn’t going to work for most. It’s best to look at a combination of different methods.
The Art of Pricing
No matter what pricing strategies you use, it essentially boils down to a choice of two options.
Beat your competitor’s price or beat your competitor’s value.
I know what I would choose, but for some, competing on price might be right.
The tricky thing with value is it can be impossible to measure. The value we talk about here is the perceived value from the customer’s viewpoint. For this reason, it can be more about how the service or product is “packaged” and positioned rather than the functionality.
Communicating maximum value is very much an art form!
The psychological aspect of pricing can (and does) fill whole books.
Everything from including a 7 or 9 in your price to make it more appealing, positioning your price between a lower and higher one for psychological positioning or listing your prices in high to low (think of a wine list in a restaurant).
It’s helpful to understand how the human brain interprets numbers and prices but use this with caution. You do not want to manipulate buyers into making decisions they regret. I am a keen believer in ethical selling - delivering far more value than the cost I charge.
Ultimately you will need to experiment, track results and be willing to make changes until you find a price that strikes the right balance.
Pricing forms the bedrock of your business’s financial health, profitability, and growth. It’s a fine balance between art and science, where you navigate the numbers to ensure profitability while also tuning into the psychological elements that influence how your customers perceive value. Crafting a pricing strategy that safeguards your bottom line, resonates with your customers, and propels your business forward is a skill not many founders possess, so consider bringing in help. I will delve deeper into specific pricing aspects in future posts. Until then, keep pricing with purpose and courage, and remember that the value you bring to your customers is worth every penny!
About the author
Luke Desmond
Fractional CFO for Tech, eCommerce & SaaS. CEO @Crisp_Acc provides virtual finance functions. Co-Founder @getvaulta SaaS Startup for accountants.