Pricing Strategies for Small Business - Andrew Gregson 101 for Small Business Series

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the membership and show line by line the costs for staffing, commissions, rent, overheads, and even owner remuneration expressed as a percentage of total sales. Even a year-old survey is a wonderful source of information to benchmark your business.

      All of the sales in Table 8 are expressed as percentages of the gross sales. If your financial statements do not currently show each line as a percentage of sales and last year’s figures (year-on-year or month-on-month) then ask your bookkeeper.

      Risk and Return

      Very often businesses will attach a tariff to flow through charges to cover the costs of paperwork and gain a little profit. It seems like a good idea that if you provide an outside contractor for a job that you should add 10 percent onto the bill. Many times it works. All of the time there is a risk of the job going sideways. There is a risk attached to these returns and it needs to be considered carefully and wisely.

      Suppose that you had the chance to cut a check for $1,000 that represented your entire out-of-pocket expenses. For the $1,000 you might have an option to purchase a house for $270,000 but the house is really worth $340,000. Would you do it?

      The ratio of risk-to-reward is low. The risk is the non-refundable $1,000 deposit taken from your bank account. The house will never evaporate and in most cases not depreciate. Moreover, you are buying the house at less than list value. The reward factor is measurable.

      Let us suppose on the other hand that you had a chance to cut a similar check for $1,000, in return for the chance to buy stocks in a company about which you knew nothing except that the promoter told you it would hit the heavens.

      The risk-to-reward ratio is high and without doing a little bit of homework, you should probably feel queasy about signing that check.

       Table 8: Profitability Ratios

      How does this apply to pricing? Having a keen perception of the downside of a contract may help you make shrewd business decisions rather than fatal ones. At the beginning of my career I was told that a bad business decision is one you cannot back away from gracefully. An appreciation of the risk may persuade you not to change the overall value of the package of goods and services but rather to unbundle them to reflect your risk and rewards.

      In other words, how can you legitimately give value to your customer in providing services or products outside your normal course of business and see some of the profit for doing so hit your bank account? At the same time, how can you place a wall between you and the outside provider so that his or her poor performance or bad luck does not have a disastrous impact on your business?

      Example

      During the hot property market years in British Columbia, a kitchen design company employed the standard business model of selling an entire kitchen design, buying the cabinets, installing the cabinets, and putting a markup of a few points on the cabinets and the installation. The cabinet manufacturer demanded 100 percent of the cabinet price up front and was frequently late, especially for small customers like my client.

      On first examination, it appears that the designer would have a $6,000 job profit on a $35,000 job — a 17 percent profit margin. On a job sheet or a profit and loss statement, it would be difficult to find fault with this model. However, when you considered the cash flow and the market circumstances the picture changed horribly.

      First, the dollars paid to the manufacturer for the cabinets — $20,000 — came from the customer’s initial deposit. The entire customer deposit had been used to buy the cabinets.

      In order to complete the job, the company had to use its own cash reserves to cover the cost of installation and design. This was a cash flow nightmare for my client. When the cabinet manufacturers did not deliver on time (a frequent occurrence); or delivered only a portion of the cabinets ordered — almost 90 percent of the time — the customers were understandably unhappy. If the customers demanded their money back — and they did — the company did not have the cash reserves to comply.

      The company fought to get around this difficulty; upon completion a significant number of customers refused to pay the 10 percent holdback on the entire job — $3,500 or 58 percent of the entire anticipated profit.

      The risk-return ratio was wrong for the market circumstances due to the unreliability of the cabinet makers.

      In remedying this problem, the business model had to be turned on its head by unbundling the transaction and getting the profit paid first.

      Initially, the customer paid the company for a kitchen design. This translated into $8,000 in revenue that paid for the design and overheads. All of the profit to be expected from this transaction was therefore paid up front, plus $2,000 for future costs.

      Then the customer was introduced to the manufacturer from whom they bought the cabinets directly. Blame for late or incomplete deliveries came home to roost with the manufacturer and the designer could commiserate but never had to take the blame.

      When the time came for the installation, it was paid by the customer to the company and the company paid the installer.

      Even better, the design company got a sales commission from the manufacturer.

      From a price point of view, the cost to the customer did not change. However, perception of added value did change. In the first place, they believed the designer was getting them the manufacturer’s best price and since they paid the manufacturer directly, they were not being “taxed” by the designer. The customer paid for performance and the designer that designed the kitchen and was paid. When the cabinets arrived, the installer was paid. Even with a normal holdback, the risk to actual profit was minor.

       Table 9: Kitchen Design Examples

      So, in your business, are you risking large amounts of cash on deals that stand a chance of going sideways? What is the realistic risk? And how do you avoid it?

      Five Business Wreckers

      In the interests of exploding all the pricing myths I could find, the following carefully places dynamite under some people that can distract an owner from making the best decisions for his or her business.

      • Business wreckers imagine all business rumors to be true. They believe that all competitors are undercutting them and believe every customer who tells them they are too expensive.

      • Business wreckers believe that if sales go down, it is the fault of high prices. They fail to look at the total industry numbers or share of the market the company is taking.

      • Business wreckers always concentrate upon some prices only, to the exclusion of others. They also believe that costs are the only factor influencing prices.

      • Business wreckers hide in a crisis. They believe that the crisis will blow over without them doing anything about it and that the price they have is the fair price.

      • Business wreckers are often honorable people who believe that there is a moral price and a moral profit. As such they are willing to forgo large profits but have no recovery plan against awful losses.

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