The 4 Evils of Margin-Based Pricing Strategy

Margin-based pricing sounds great in theory — it predetermines profit for a specific product by setting a definitive goal for the difference between price and cost.

Unfortunately, the reality is that margin-based pricing creates a host of potential issues for the simple reason that determining price involves many more factors than just cost. Margin-based pricing ignores these other variables, simplifying the process but weakening your results.

To give you an idea of how margin-based pricing can negatively affect your bottom line, we’ve outlined its four biggest evils.

  1. Emphasizes Costs, not Value

Margin-based pricing relies on two major variables—cost and desired markup. It disregards a third variable—the value you create for the customer. This third factor determines what your customer is willing to pay, so margin-based pricing risks one of two undesirable outcomes:

  1. You arrive at a price higher than the value you create for the customer and lose the transaction and any associated profit
  2. You arrive at a price lower than the value you create for the customer and win the transaction, but leave profit on the table

Moreover, margin-based pricing, by ultimately depending on costs, means your prices may change even when the value you deliver the customer does not change or, alternatively, keep your prices flat even when the value you create for the customer changes. Either results can produce a disconnect between your price and the value you create for the customer, ultimately putting your profits at risk.

Take a step back for a moment and consider why your customers chose your company as a vendor in the first place. Most likely, it isn’t because you’re consistently the least expensive option out there (which is a difficult position to maintain anyway). What else are you offering them? Bundle these benefits into a value communication to your customers consistently and often. Weave them into your brand’s message, and make sure customers understand they are included in the price, in addition to the tangible product-based elements of your offering.

  1. Assumes Your Customers Are Clones

Are you treating your customers like the exact same person? You shouldn’t be. When you assume the same price fits all of your customers through margin-based price management, you create three major pricing potential issues for your company:

  1. Tailored Value Propositions are impossible to create, creating a crater-sized hole in your pricing strategy.
  2. You sacrifice increased margins from customers willing to pay more due to incremental value you create for them.
  3. You run the risk of losing customers who draw the line at a specific price point.

A more profitable pricing strategy takes these scenarios into account and plans for each of them. For example, when you outline value proposition to your customers across their various buying situations, you understand that one size doesn’t fit all. Your customers exist in different markets, seek different products, and find different things appealing in different situations. Do a little research to determine what matters most to specific customers, and use this data analysis to properly segment them into groups (“pricing segments”), each with their own designated pricing strategy.

Also consider segmenting your customers into groups defined by price responsiveness. We all have customers who don’t balk at incremental price increases either out of loyalty or an accommodating budget. And we all have those customers who pinch pennies and demand answers at every tiny price increase. This is not taking advantage of the customer – it’s a practicing a subtle yet powerful form of value-based pricing.

Instead of having pricing for all customers ebb and flow with input costs, set a profitable price for each customer segment and then do your best to hold it there. Most customers will appreciate the consistency, and your team will most likely save on the resources and time that accompany negotiation around constantly-changing prices. Of course, if there are massive changes in input costs, customers will likely be aware of this and you should temper your approach in these situations accordingly.

  1. Assumes Your Products Are Clones

Margin-based pricing also has the evil tendency to lump all of your products together as it does with your customers. Many companies employing this strategy set a margin goal for huge groups or — gasp — every single one of their products.

For example, if your company carries a standard 5 pound bucket as well as a non-standard 4 pound bucket, it wouldn’t make sense for you to charge the same price for those products, even if the costs for them might basically be the same. A non-standard product in inventory immediately gives it a higher value than other similar products, and you should be passing on this premium to your customers in the form of a higher price. After all, the 4 pound bucket has a slower product velocity, and you’re creating value for your customers by keeping it on your shelves.

For effective product segmentation, start with taking stock of all of your products and their implied value to your customers. Then segment these into smaller groups and price them accordingly. To enhance your price performance for even better profits, build upon this and a customer segmentation strategy to determine effective pricing for specific products within distinctive customer groups. This can get complicated quickly, so having an intuitive and effective business analytics solution to help you juggle, organize, and properly analyze all of your data is key.

  1. Relies on Volume for Profit Improvement

The last evil on our list is narrowing focus on growth to volume alone.Businesses have five levers to improve profitability: price, cost, customer mix, product mix, and volume. Margin based pricing takes the first four out of play completely. Prices are dictated based on a set margin percent, and costs gains are immediately passed through to customers, eliminating those levers. Margins for all customers and products are set to a single rate, so you have no ability to improve customer or product mix. This leaves you with volume as the only lever to improve profitability. Why would you want to adopt a strategy that limits you to only one lever to improve performance when you could have five levers?

Moreover, businesses that focus heavily on volume to drive growth usually end up having to cut prices to reach their goal. This, in turn, often triggers price wars and put companies on a downward spiral that’s difficult to stop. By focusing solely on volume, your company relinquishes control over your profits.

Change direction by using all five profit levers — price, cost, customer mix shift, product mix shift, and volume — in tandem to find the quickest and most sustainable path to profit.

Brilliant oroginal by : Chris Sorrow June 2, 2015

CHASING DUCKS

CHASING DUCKSWhen businessmen tell me that being low priced is the only way to stay in business, I am sceptical. Price is the simplest way for a consumer to compare and is overused as the basis for a decision to buy. Price noise is the screaming toddler in the room- demanding excessive attention relative to importance. And most businessmen pay excessive attention.

In the July 2015 edition of the Business Examiner, the owners of Command Industries admit their shock after quizzing their customers. A mentor had suggested that they speak directly with their top customers and ask them, why do you buy from Command? “I was sure the answers were going to be pricing related and focused on comparing costs with our competitors. “said Rob Woudwijk. “But the results of those conversations shocked me. It was never about the money. Instead they talked about the way we communicated with them, the level of transparency and honesty we have as a company and our problem solving mentality”.

Would price have figured in the equation at any time? Of course, but it looks like price was further down the list than they believed. In a study reported by Right Technologies by Bob Thompson called the Loyalty Connection, price features lowest as the reason that customers stop dealing with a company. In his analysis, customers leave almost 75% of the time due to customer service problems while owners see that as being important in only 22% of the cases. Quality is seen by customers as an issue fully 32% of the time while owners rank quality as the suspect only 18% of the time. It appears that staff indifference is a greater cause of losing customers than doing a bad job.

Similarly, price was ranked by owners as the number one issue at 45% of the time while customers felt price was important only 25% of the time.

And what about employees? Do they value their pay cheque more than a great boss or satisfying work?

Does Money Really Affect Motivation? A Review of the Research

In “Does Money Really Affect Motivation? A Review of the Research” by T. Chamorro-Premuzic published in the Harvard Business Review, the authors reviewed 120 years of research to synthesize the findings from 92 quantitative studies. The combined dataset included over 15,000 individuals and 115 correlation coefficients. In the study there is a weak, almost negligible correlation between pay and happiness and so they conclude that money is a weak motivator.

 

So, where does this leave the average business owner? To focus exclusively on price differentiators is evidently NOT the answer. My dog swims with determination after ducks, but she never catches one. Being cheapest in the market place leads in only one direction – the dumbest competitor will win. And after the ducks have flown, those left standing.. er, swimming.. will have the best employees, happiest bankers, most motivated bosses and HIGHER prices. Where do you want to be?

SQUARING THE CIRCLE

SQUARING THE CIRCLE: Consumer Choice and Consumer Segments

square peg

I have been reading about market segmentation and choice. Howard Moskowitz’s research into tomato sauce as retold by Malcom Gladwell on the TED talks led to a big increase in sales by Prego.The company added new varieties to its lineup of sauces – chunky, garlicky, mushroom, and saw a big jump in sales.(http://www.ted.com/talks/malcolm_gladwell_on_spaghetti_sauce?language=en  Moskowitz’s conclusion was that consumers are not one great monolithic entity with one taste in tomato sauce. Therefore, the company needed to offer more varieties and in so doing dug deep into the market.

But merely offering lots of choice leads to lower sales. In Terry O’Reilly’s CBC Radio programme, Under the Influence, (http://www.cbc.ca/radio/undertheinfluence/limited-edition-brands-1.3021076) Terry recounted a test marketing of jam. When consumers were offered dozens of varieties and even inducements, like coupons, sales were still less than where consumers were offered limited choice. It seems that our human brain cannot cope with too much choice. Too much choice causes us to walk away shaking our heads.

How can we square the circle of too much choice simultaneously increasing sales and killing sales?

The companies that have been successful in adding choice already have a market presence. Reebok introduced its soft leather dance shoe in 1982, but gradually offered tennis shoes, basketball and then children’s shoes. There was a time lag as Reebok built its brand and consumer awareness of the benefits of supple leather footwear. Introduced all at once to the market, it could have been hard to sell a monolithic idea to a splintered group of people with altogether different needs and tastes. We are not all the same and so we all do not need the same product.

So how is it done? First create a presence in the market for 1 product or service that is the best or suits your target market the best. Dominate your market. Like the pub in the sitcom, Cheers, Everyone Knows Your Name. This is brand creation. Offer limited choice in that product or service. If you are offering more than 3 or 4 choices, trim. Only when you have some significant market share (you are measuring your market penetration, right?) can you start slowly adding other related versions to the original idea. Even after marketing leather shoes to dancers, Reebok is still best known for…  running shoes.

What every business person wants to know: How to Tell if Your Marketing is Working

white board

If you’re not getting results after 4 months, it’s time to ask some serious questions—including whether the problem falls with you

Because marketing is not something with which many B2B companies—especially manufacturers and technical firms—are overly familiar, many leaders of these businesses have a lot of questions about how it all works. The first question most CEOs ask when they launch a marketing effort is, naturally, “How long does it take to get results?” But a close second is this: “How do we know if we’re marketing the right way?”

(This question is sometimes phrased more bluntly: ‘How will I know if it’s time to fire my marketer?”)

As I’ve outlined before, marketing does take time to show results, so impatience can seriously threaten to success. But at the same time, you shouldn’t have to wait six months to know whether your efforts are making any progress.

And as I’ve also written before, the first 100 days are the most crucial for setting your marketing efforts on the right path. That’s when your marketing team should be creating a strategy, defining your target market and value proposition and creating collateral to help the sales team to sell with confidence. A new website could fall in there too, depending on complexity of the job. If your marketer can accomplish all these tasks in the first four months of working with you, it’s safe to deduce that your firm on the right track.

But it’s important to note that if a marketer hasn’t accomplished those things, it doesn’t necessarily mean they’re failing—especially if your company has never done any real marketing before. As long as you see that progress is being made on coming to decisions and building the marketing foundation (that is, your messaging, website and collateral), you can probably stay the course.

But if after four months you have seen no tangible results at all from your marketer—no signs of a new strategy, no road map to new collateral, no talk of a new online presence—consider it a red flag. An inability to get anything accomplished in the early days is a harbinger for more of the same in the future. Either your marketer is incompetent (what many leaders tend to think), or your company is unable to make decisions. I’ve seen both. And while many CEOs like to think that their companies are perfect, if you’ve had a string of marketers who haven’t been able to achieve results, you need to consider the possibility that the problem lies with you.

With thanks to Profit Magazine; Lisa Shepherd || November 14, 2014

Lisa Shepherd is author of Market Smart: How to Gain Customers and Increase Profits with B2B Marketing and president of The Mezzanine Group, a business-to-business strategy and marketing company based in Toronto. She was the youngest female CEO of a company on PROFIT’s ranking of Canada’s Fastest-Growing Companies in 2007 and 2008 and is a frequent public speaker on B2B marketing strategy and execution.

How Small Business Handle Their Money

Canada’s SMEs prefer to manage their finances in-house, according to our survey of 727 companies

Canadian business owners have a do-it-yourself approach to financial management, according to the latest instalment of the American Express Small Business Monitor.

Fully 92% of the 727 owners surveyed (each of whom employs fewer than 100 people) believed they could speak adequately to their businesses’ finances. While 71% said they handle their own bookkeeping, 95% deal with budgeting and forecasting in-house, and 79% handle their own payroll work.

Managing finances internally is not necessarily a drain on employees’ time, with 50% of respondents saying they spend less than five hours a week on it and only 9% taking more than 15 hours weekly.

The one area that remains tricky for many Canadian firms is taxation—only 55% of the businesses polled do their own taxes in-house. At the same time, taxes were ranked the most challenging aspect of business finance by nearly one-fifth of respondents, with the same number rating cash-flow management as most difficult.

Technology is key to respondents’ financial management: 33% use software that makes the process simple; 11% turn to websites to learn the basics.

Small businesses are remaining positive, despite the slow economic recovery. Sixty-three percent are “hopeful” about their firms’ financial future, and 52% said they saw a slight or significant improvement during the last quarter. However, companies are continuing to take a cautious approach, with 66% willing to take only moderate risks, versus just 6% prepared to attempt significant risks.

Here are other key findings of the AMEX Monitor, co-produced by PROFIT and Canadian Business.

with thanks to Canadian Business and Profit

 

WHY DON’T SCHOOLS TEACH BUSINESS HOPEFULS TO USE CASH FLOW TOOLS?

Gallery

This gallery contains 1 photo.

Imagine a business, if you would, that shows decent margins, low debt, and slowly growing sales. Bankers examine the financial statements declare that the company is in good shape. “Carry on and keep up the good work,” they say. But … Continue reading

6 easy steps to emptying your business wallet

In the early 1980’s, when I began operational work with businesses, there was a conventional attitude to inventory control. This wisdom measured inventory control by looking at the relative cost of money and the interest charged against having that inventory on the shelf. That attitude saw the creation of robust ERP systems to help managers like me.

Because the recent price of money is so cheap, that business calculation has taken a knock; but the curtain is now drawn back revealing another way to measure the effectiveness of inventory control.

Consider that you have $10,000 per year with which to purchase housewares inventory. And let us suppose that 90% of that inventory sells during the year. At the end of the year 10% of the original $10,000 is still on the shelf. $1000. Theoretically, that means that in the coming year, only $9000 is available to purchase inventory. At the end of that year, assuming 90% sells, the will be $1900 worth of unsold inventory on the shelves. It does not take long to realise that all the cash will shortly be locked up in unsold inventory. The table and chart show how that works.

The result will be, of course, that the company finds itself less and less able to purchase new goods. There may not even be the room on the shelves or in the warehouse to store more purchases. From the customer point of view, the company will be stuffed with dust covered inventory. The company has ground to a halt.

If the dead inventory is converted to cash at even 20 cents on the dollar, you can use that cash to buy goods that will sell and buildup the cash available for further purchases.

Does this ever happen in real life? Yes is the simple answer. A decade ago, the company I managed had $600,000 of inventory of which 30% had no sales in 6 years. This strapped the company for cash. There were items on the shelf due to ordering errors and for which there was not even a market for more than 150 miles.

Recently, an office furniture company called me about their cash problems. They badly needed $100,000. But in their showroom and warehouse they had inventory totalling almost double that. The solution was to have a huge sale and convert everything to cash.

Remember that cash is king and being without it leaves you at the mercy of creditors, suppliers, and landlords. With cash, you have a chance. Even selling goods below cost and converting those goods to cash is better than sitting on mountains of unsold inventory. 

Written by Andrew Gregson, Senior Partner at Floodlight Business Solutions and author of Pricing Strategies for Small Business (2008).  1-888-959-0752  www.floodlight.ca. Floodlight Business Solutions, where we help you drive profits.

 

Exiting your Business with a Barrelful of Money

 

How to Super-Size the Cheque the Buyer will give you.

With the baby boomers reaching retirement age, a large number of companies will likely change hands in the coming years. Right now, 20% of small businesses are for sale. Within 10 years that percentage will double to 40% and within 15 years that number will rise again to 70%. Kelowna and the Okanagan, being an older demographic are at least 5 years ahead of that supply curve.

soldWhat will be the fate of small businesses when the owners retire?

According to TD Waterhouse’s early October Business Succession Poll of 609 small business owners, only 24 per cent of small business owners surveyed said they had a succession plan worked out for retirement.

Of those polled, whether they had a formal plan or not, 23 per cent said they would simply close their business when it came time to retire; 20 per cent planned to sell their business to a third party; 18 per cent expected to transfer it to a family member; 12 per cent said they’d sell to a partner or employee; and 27 per cent said they were not yet sure what they’d do with their business.

td waterhouse survey

 

 

 

 

And what will be the likely impact on personal wealth?

When you sell to a family member or employee, there are typically fewer dollars on the table, because the company will be heavily discounted.

Closing the doors means zero return for years of business building.

The people answering “not sure” are likely faced with a Freedom 85 Plan, wherein the owner works until he/she can no longer work- and not by choice.

Of course, if the owners salted money away and used the cash flow diligently to build personal assets, then the owners may have enough for a comfortable retirement, allowing them simply to close the doors.

This article, however, is about those who are relying on the sale of their business to fund their retirement and how to find the retirement money they need.

Simple economics dictate that in forthcoming years, supply will exceed demand and many companies will just be left on the shelf as buyers cherry pick the best. But since the beginning of the recession in 2008 many businesses have faced falling sales and increasing debt. This situation has eroded value in many businesses.

So how can an owner stand out from the rest in a crowded bidding war for a buyer? What will buyers pay top dollar for? Investors look for a return on their investment and will not buy indebted companies with falling market share and paper thin margins. Most of all, they will not buy a business that depends entirely upon the owner to make it work.

  1. Is there good return on equity – today, not some hypothetical future?
  2. Does the company have high profit margins?
  3. What fixable factors mean that the business will be purchased at a significant discount to its value?
  4. Are there systems in place for the owner not to have to work 12 hours per day?
  5. What factors will help a buyer get financing from his financial Institution?

If an owner answers NO to any of these questions, then something needs to be done, starting today.

What to do?

  1. Pay for a third party valuation and ask what factors are holding back the value.
  2. Pay down debt, starting with the most dangerous debts
  3. Build tangible assets that hold their value and are essential to the business
  4. Increase profits and cash flow with a better pricing strategy
  5. Increase sales with a modern marketing plan
  6. Create a credible exit plan that identifies to whom you will sell the company and at what price and when.
  7. Talk to a good accountant about the tax implications of your plan
  8. Build a solid 3 year plan to make this happen
  9. Work the plan
  10. Do something, do anything. Remember that even a dead fish can float downstream.

By Andrew Gregson, Senior Partner at Floodlight Business Solutions LLP, a consultancy focusing on rebuilding sales, rebuilding finances and creating value. call today if you need a guest speaker on this topic www.floodlight.ca.

Email: agregson@floodlight.ca                        Ph: 888-959-0752

Innovate, Don’t Ape – How to Survive the Recession

Aside

apeThirty years ago, according to a recent article in the Economist, the bosses of America’s car industry were shocked to discover that Japan had overtaken them to become the largest car manufacturers on the planet. The bosses blamed this success on cheap labour and government subsidies.

But the progressive bosses went to Japan and discovered that Honda and Toyota had raced ahead of them by virtue of a combination of innovation and inspiration. The American manufacturers quickly dubbed the methods of production “lean manufacturing”. This approach to manufacturing was in fact an American idea that was fully developed in Japan and ignored in America. The inspiration was to listen to customers who – echoing today’s demands- were looking for cars that were cheap on gas but still a quality product.

The moral of the story is that if Japan had merely aped American car manufacturers, their car industry would not have thrived. Today’s emerging economies are growing in part on cheap labour but mostly because they have innovated faster than rich countries. Kenya, for example, is the world leader in money-transfer by cell phone. Frugal innovation in the emerging world has created the $3000 car and the $300 laptop. These products were re-designed to eliminate costly steps in the manufacturing process.

The lesson for today’s businesses is an old one. Innovate don’t ape. If everyone else is offering sale priced goods on senior’s Tuesdays, and they are not making any money, why would you want to copy them? If everyone else offers the same burgers, the same landscaping service, the same financial solutions, the same furniture, then, to compete you must drop your prices in order to gain customers.

 In a conversation last week with a manufacturer in Vancouver, the owner told me that his approach during this recession had been a total reversal of the approach in the recession 10 years ago. A decade ago, the company chose to ride the storm and drop prices. This time they cut costs and left prices intact. The result: fewer sales but more cash in the bank.

 So, the question is how to innovate. Can you make your product or service better in some way than is currently offered? Will the change be a gimmick and easily copied by your competitors or can you offer something your competitors cannot?

 Overwhelmed by the thought of what to do? Do you think your business has no room to innovate? Consider this. Water and flour are commodities traded on the world markets on price alone. When mixed together, they ought to produce another commodity. However, this product has over 1000 market niches with prices that reflect not the cost of materials or the taste of this food product, but the shape of the food. I am speaking, of course, about pasta.

This is brilliant marketing to create a market based upon the shape of a food product while everyone else focused on flavour or fast food.

5 keys to profitability – part 1

keysA profitable business is a saleable business. A profitable business is easier to manage and to operate. Everyone loves to do business with probable businesses because they all know the invoices will get paid. The best employees want to work for profitable companies because they know their paycheques will not bounce or get delayed.

Profit is the reason entrepreneurs get into business in the first instance; but how to keep a company profitable is sometimes a trial. Here is how, with the first of our 5 keys to profitability.

Attention to cash flow

Most business owners focus on price and margins forgetting an important element in running a successful business – cash flow. What does this mean and how does it work?

Let us consider for a moment that you are selling loose tea. You pay 1 dollar per kilo for the tea. You sell the tea for $1.50 per kilo giving you a margin of 33%. Monthly you can sell 100 kilos to 100 different customers. So every time you sell one kilo of tea you profit by 50 cents.

At $1.50 per kilo you can sell 100 kilos per month but experiments have shown that by dropping the price to $1.29 per kilo you sell 150 kilos per month to 150 different customers. That generates a margin of 22%.  So every time you sell one kilo of tea you profit by 29 cents.

Most business owners will focus on sales and price believing that dropping the price will increase sales and the sun will shine. But will that reasoning help your profits?

In the first example the cash flow is $50 per month. In the second the cash flow is $43.50. So dropping the price and selling even more tea has damaged the bottom line. In terms of cash flow, increasing the sales with a lower price has not been a good decision.

But if you focus on the cash flow figure, you can also improve profits, as follows. Suppose that you are now selling tea for the sale price of $1.29 per kilo. But instead of selling one kilo at a time, now the buyer must buy a minimum  of 2 kilos. As before, 150 customers come in and buy tea and the margin remains the same at 29 cents per kilo. But this time the contribution to the bottom line is $87. And you did not have to work any harder for that profit.

What this example tells us, is to focus on the dollar contribution and not margins or even the price. Dollars pay the rent, employees and taxes.

Written by Andrew Gregson, Senior Partner at Floodlight Business Solutions and author of Pricing Strategies for Small Business (2008).  1-888-959-0752  www.floodlight.ca. Floodlight Business Solutions, where we help you drive profits.