July 18, 2013, by Malvika Johal
My guide to starting your own business – Part 6 “Setting a pricing strategy”
Written by: R L (Bob) Hall (BSc, PhD; University Of Nottingham ) Owner & MD of Top & Jeffries Limited; Co-owner & Chairman of Fuel Additive Science Technologies Limited, Shropshire, UK
Welcome to the sixth in the series – “Starting your own business – what I wish someone had told me 25 years ago.”
Setting prices is more art form than science. Some courses advocate that you set your business strategy and pricing at either that higher end (small number of sales) or lower level (large number of sales) with little in between. This is utter rubbish I have already suggested you adopt a niche business start-up approach, but there are a whole range of things to consider before pricing policies can be set.
The usual start-up approach is to have smaller margins in order to get established and therefore set prices low. This is risky for several reasons, when you start up your best estimates for the cost of doing business is usually far too low. Throughout the life of your business you will observe that costs always increase and margins always decrease. If you start low, you have very little room to adjust or change tack.
The other opposite mistake is to believe your niche in the market is truly unique (as it must be for you to start-up) and you set the prices far too high. This may work fine for a while, but high prices and margins attract competition. Setting prices is a complete balancing act with an eye on the company costs, factoring in increases, competitor activity and adjusting as you learn much more about the market.
Think about your company as a money making machine, because that is what it needs to be. The first thing to note is that money is made from repeat customers not one-off sales. Satisfied customers not only come back, but they both recommend you to others and resist advances from your competition. Customers generally need a compelling reason to change supplier if the product/service they receive meets their requirements at a fair price. The company starts to make real money when the “smoothly running delivery machine” keeps cranking out again and again…….and again, with no hitches. The increased profit comes from spreading the cost of overheads over higher sales.
For the early years your focus needs to be on growing the business with reducing costs as a second priority. It is much easier to cut costs that it is to grow sales. The rate limiting steps to growing a business are usually nothing to do with the macro market opportunities if you have done a thorough job of selecting your niche product/service and started to build a good value for money reputation. The factors constraining growth are usually internal resources to facilitate getting in front of the customer to understand their situation and converting suggested solutions into orders.
Small improvements maximize profit. We have already discussed that setting product/service prices requires a tricky balance, costs tend to naturally increase and margins decrease. In order to win sales costs can be minimized by engineering in the lowest cost approaches right from the start. A prime example is fast food restaurants. Look how the buildings are constructed, the menu designed and how the work flows. Everything is the same all over the country allowing maximum buying power and implementing the best efficient practices of how things are done.
To give one example where we have been smarter with manufacturing processes; the judicious introduction of a bottle filling machine and pre-cut “peel off” labels increased the “comfortable” daily production capacity from 1,000 to 3,000 units per pair for each 2 person team. With careful thought these modest investments have tripled productivity. In general, standardising both purchases and practices minimises costs. Next in the series discusses Reputation and Integrity.