Instituting value-based pricing over other common methods, like cost-led and positioning (pricing yourself against your competition), generally has a positive impact on business profits. Why? Because most businesses tend to underestimate their own value, thereby pricing below what they are truly worth. So, making the proper price adjustments can quickly increase the profits of the business.
Hopefully, you conducted the exercise from last month to determine what value your product (and service) brings to the market. If so, what did you find out? Is your product worth 10, 20, or 50% more than you initially priced it?
Once you’ve established the appropriate price for your products based on their true value, calculate the impact on profits the new pricing will have. The example below is a before and after look at an actual business scenario. I just changed some of the numbers to protect the innocent, but the principles are the same.
- On the above spreadsheet, we gathered the price, sales volume and cost of goods (cost of goods were verified and not based on past assumptions) of the product lines that made up 80% of the company’s revenue. In this case, we choose four products. Products A, B, C, and D.
- Next, we calculated the gross profit of each product line in order to analyze the gross profit contribution that each had on the business (and also calculated total gross profit based on the four product lines).
- Next, we duplicated spreadsheet A to create spreadsheet B, but inserted the new value-based prices for products A – D.
- After inserting the new prices, we saw that product A had a 14% increase in price, there was no change in product B, there was a 10% increase in price for both products C and D.
As you would expect, after inserting the new prices, the gross profits for the business changed for the better.
Overall, the business experienced an average of a 7.7% price increase for the four product lines, with an 18% increase in total gross profit totaling $2,875 per month.
Also, as we analyzed the profit contribution by product line, we had to ask if the business was spending the appropriate amount of time marketing the products that drove profitability, or was it spending too much time focusing on the product line that had the least contribution to the overall profit of the business.
For example, product C shows the second highest profit margin but yielded the lowest gross profit in pure dollars. Whereas product B has the lowest profit margin but gives the highest gross profit in pure dollars. So as the business owner, you might want to evaluate whether your marketing strategy is focusing on the right product lines that will drive your profits.
Go through this exercise of making the proper price adjustments and see how it will impact your profits.
Next, just like I did in this case study, determine which product or service line(s) drives your profits and see if your marketing strategy is focusing on the right items.
You may find that you are spending too much time, money and energy on products that are bringing in little profits, but with a small shift in focus, you can increase sales volume to the correct product mix, which will lead to even greater profits. In other words, you will start to work smarter not harder.
Lastly, determine if you can also lower any cost of goods or fixed expenses. If you are able to lower any of these costs and/or expenses, that will increase your profits even more.
What if I lose customers?
The first reaction out of most business owners’ mouths when they are challenged to increase prices is, “I will lose customers.” In my experience, one of two things happens when prices are increased to what they are truly worth:
- Customers actually increase. It may seem counterintuitive, but we make value judgements based on price, don’t we? If the price is low, the perception is that the quality isn’t as good as another product. If the price is higher, the perception is that it must be good. Many times, a fair increase in price will actually increase customers (which is what happened in the case presented).
- Any loss of customers will be more than offset by the increased profits due to the price adjustments.
The key here is to make sure your price increase is based on the value of your product and not simply to increase profits.
If you go through the pricing exercises I illustrated both last month and this, you will be on your way to increased profits in very little time. Once you are achieving sustained profits, make sure you reinvest them into your business in order to increase the value of your business further.
Continuing this cycle of profit and reinvestment will validate your current and future price increases, creating strong brand loyalty and insulating you from competitors who try to use price as a marketing tool.
Now go increase your profits!