Dear Readers, For many years we have focused on cost based pricing and making sure your margins are right from a reporting and record keeping perspective. But in all honesty we have ignored looking at margin management from a pure business psychology viewpoint, well not today. In part 3 of our series in margin management we look at the sins of laziness and cowardice in pricing policies and we add a Part 4 to the series.
FAILURE TO PRICE BASED ON VALUE PROVIDED
Your products and services have a perceived value to your customers, it is the amount that they are willing to pay. The job of sales is to increase this perceived value to the highest level possible so your customers are willing and satisfied to pay a higher price. The job of your pricing policy is to establish an "acceptable" profit range (based on accurately padded costs). The job of your company as a whole is to balance the "risk" of higher margins against the "profitability" high margins generate.
The sins against value based pricing:
- Cowardice - The first sin is an unwillingness to take the risks needed to make profit. Evaluate the products you sell to each customer and determine which products are more or less price sensitive. Products that are less price sensitive and are being sold below the perceived value are opportunities for you to make a higher margin.
"Too often the fear of losing a customer stops sales representatives from charging a price with an associated high margin" - Advenous
There is a clear cut difference between "You're charging too much." and "You're ripping me off." You know the difference and your customer knows the difference. One is a negotiation tactic, the other is a lost sale. On products with low price sensitivity you should be running close to the limit of perceived value. If the customer ever becomes more sensitive to price on that particular product you have the opportunity to build additional value or to reduce price, but in the meantime you've made a fair profit. - Misplaced Guilt - The second sin is a lack of confidence or understanding of the value a company provides to it's customers. Even when a salesperson understands the costs and net profits they may still feel bad about charging one customer ten percent more than another for a particular item or for asking for a 30 percent margin on one item when most other items go for a 15 percent margin.
"Simply put, even the most effective salespeople at times feel guilty about making a profit." - Advenous
What a salesperson must realize is they are not selling a product based on the cost they bought it for, they are selling a product based on the value the customer finds in it. To be blunt, if you were truly asking for a price higher than the value you provided, your customer wouldn't buy. - Laziness - This can come in many forms. You could be putting off making pricing changes because "its too time consuming" or ignoring the margin of low volume items "because you only sell a few of them" but one of the worst offenses is flat or direct cost-based pricing. Let me present it to you this way:
If you have a star performer as a buyer/purchaser who routinely buys for 3% under the market average cost, does the product have less value to your customers?
If your buyer/purchaser is performing poorly and buys above the market average cost, does the product become more valuable to your customers?
Most likely you've answered "no" to both questions, it doesn't matter to your customers what your costs are, the price they are willing to pay is the value the product has to them. Cost based reporting is key to accurately evaluating your pricing policy and a market cost based pricing system can be an excellent tool to keep your prices in line with the perceived values on price sensitive items in a volatile market. But you should never fall into the "just divide what we paid by 0.85 to get the price" trap. Doing so completely negates the value of having skilled purchasers and salespeople in your company (all you've got at that point are order takers and placers...welcome to McDonalds).
So what can you do?
First, take a good look at yourself in the mirror, recognize that you deserve to make a fair profit. Accept that your customers do NOT care whether you make a fair profit and do not feel you are entitled to one, they will pay you a price based on the value of the products and services you provide.
If you doubt this fact I encourage you to go buy a $1 candy bar for $100 and try to sell it to a customer for $125 because you deserve to make a fair profit even though they could buy a candy bar for $1 elsewhere. If you have trouble finding somewhere selling $1 candy bars for $100 please feel free to contact me and I would be happy to sell you one.
Next, set your pricing based on value and drive for high margins. We looked at price elasticity (or volume vs margin) back in Issue 209. The food industry as a whole is very price inelastic simply put you are more likely to see an increase in profit by concentrating on raising your margins at the risk of decreased volume than you are to see an increase in profit by raising volume at the cost of margin.
Finally, balance risk versus profitability by identify price sensitivity in products and customers. We're going to focus on this topic for our next newsletter where we identify the earmarks for items that customers frequently are more or less price sensitive on. These items are your opportunity to recover margin you had to "give-up" on high price sensitivity items.
The last sin for part three of the newsletter series is pride. Remember a few paragraphs back where you recognized that you deserved to make a fair profit, and that customers will only pay you based on the value the product has for them? This means that there will be some items and customers that at the end of the day are profit losers. The value they see in the product will be less than the costs you incur and you will not make the profit you deserve. We looked at this when we talked about the 80/20 rule in Issue 207. When you see this situation develop you need to choke down the bitter pill, swallow your pride, and recognize that you have a negative risk opportunity. Target these items and customers for margin management immediately with the understanding that even if you lose the account or stop carrying the product you are improving your net profitability.
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