You’ve seen it many times. A business owner sees a competitor lower their price on a product or service and they then decide to lower theirs to the same or slightly lower price. Little thought is given to what exactly has occurred beyond, “I have to meet or better the prices my competitors charge.” In simple words, this is usually the wrong approach.
Price always equals value. Further, when pricing a product or service your goal is to not only make a profit but even before that profit, it is to communicate what you offer to the marketplace while also identifying your business’s brand. Lowering your price sends a message many do not consider, “if you can sell it for that lower price, why have you been selling it at the higher price?”
Pricing a product or service correctly isn’t that difficult. Further, if you follow a logical process it can identify inefficiencies in your business or business processes. Inefficiencies that cost you money and ultimately lowers your profits. Pricing your product or service means nothing more than understanding your business’s value stream.
A value stream is every single step in the complete process of creating a product or completing a service. These steps involve:
- Order entry by customer service
- Ordering and receipt of supplies and materials
- The end-to-end cycle time to make or complete the project or product.
- Packaging, labeling, and delivery to the customer.
Everything you make or sell has a value stream.
The biggest challenge you will have is “How much should you sell it for?” In reality, you should be asking yourself how much will it cost to do this?” Let’s look at one value stream.
How many individual steps must be performed, and completed, to fill the entire order? What quality issues, standard instructions, consistency, accountability, and information is needed for each of these steps? How long (time) does it take for each step and all steps combined? Never forget that regardless of what you are selling, the time involved is also being sold.
When you consider the time spent in producing or providing your product or service you must remember that this time includes not only the labor costs of those directly involved in the work (Cost of Goods Sold people) but also the labor costs of those who are in your office that you pay regardless of available work (Indirect labor). This even includes paid breaks and meal periods. You must simply remember that every employee’s time is billable, no one is non-billable. You also must include other business expenses from rent to utilities and more. In other words, your total time inventory, plus your Cost of Goods and services, plus information costs is your profitable price for one product or service project.
To do this, you add the following:
- Your Time costs. (To determine this take your company Margin (some call this Gross Profit) divide it by the number of employees directly working and then divide that by the total number of available work minutes in a month for your business.)
- Your Indirect Labor Costs – the people you pay anyway
- Your Business expenses – rent, utilities, vehicles, etc.
- Your information management costs at each step in your process
All of that combined will automatically include your profit. That number will show your COST to produce 1 product or service profitably. Your marketing efforts will then tell you if the price is competitive or not. If your cost is too high you must go back to your value stream process and determine where you can eliminate waste and error to reduce your cost. In other words, if your costs are high and your benefit high, will this make you profitable in the marketplace. If your costs are low and the value is low, what will be the benefit of that, medium costs to medium benefit, low cost to high benefit etc? You have to evaluate your cost in relation to the market benefit.
You can also look at the product or service (and its value stream) to determine whether or not you can add something, or take away something, to allow you to charge even more or less. This strategy, often called a Good-Better-Best approach to pricing, allows to you not only price your product appropriately but to also meet the needs, wants, and desires of different buyers.
This is a critical step for your business success. By focusing on cost instead of the price you will always know that you can make or provide one profitably. Managing those costs effectively will always lead to greater profitability.