Stop Underpricing and Improve Your Profitability
One of the fastest ways for small businesses to dramatically improve their profitability is to stop underpricing their products and services and price them to get the profit margin that they deserve.
Small businesses tend to underprice their products and services. They also tend to price products and services erratically and haphazardly.
By needlessly underpricing products, small businesses reduce their profit flow, reduce the available capital for future expansion, and, in some extreme cases, even risk the business’s very survival.
Why Do Small Businesses Underprice Their Products and Services?
Why don’t small businesses just go out and try raising their prices today and charge what a larger corporation might charge for the same product or service?
I’ve been there myself, and I know what other small business owners are thinking and feeling. They are afraid that if they raise their prices their competition might swoop in like a bird of prey and their customer base might shrivel overnight.
Well, it is possible they are right. But it’s not likely.
Too Often, Businesses Don’t Have a Differentiated Product
As I have often emphasized, a critical factor in building a successful business is having a strategy, products, and services that are differentiated from competitors. Not a strategy, products, and/or services that are simply better than competitors, but different. Different in a way that really matters to customers. If a business has a truly differentiated product they can charge a higher price for it.
Too often, small business people don’t have a differentiated product or service, making it difficult to price their products as high as competitors. But sometimes the entrepreneur doesn’t appreciate that their customers may already see their products and services as differentiated and are willing to pay more for them.
Irrational Fear, Bad Habits, and Too Much Empathy
Another important reason small businesses don’t charge enough for their products and services is an irrational fear. They are fearful of charging too much when they start their business and they are even fearful of raising prices to keep up with inflation. Sometimes this fear may have more to do with their inner self-confidence and their hesitancy to take risks than the economics of the marketplace.
Small businesses may also fail to charge enough for their products or services because of habit. They just hate making the decision to raise prices every year. But each year they see their larger competitors increase prices like clockwork.
Finally, small businesses may not charge enough for their products and services because they become overly empathetic with their customers. Particularly when working one on one with clients or performing services for friends or relatives, small business people feel they want to do something extra for them, such as giving them a discount or not charging the full rate. This is a huge mistake.
You should charge everyone full price for your services, even your mother. If they are a special person and you want to give them a gift, fine, give them a gift or a present on their birthday. But don’t give away your services.
I have a good friend who is a very skilled professional and is now well into his middle-aged years. He is one of the nicest people I have ever met. But, tragically, he is flat broke. Why? The main culprit is his tendency to continually give away his time, including his professional services, to others.
Some business people hate to charge what they view as too high a mark-up for their products or services. They might think, for example, that 30 or 50 percent over their direct costs is plenty. This is not how you should think about pricing.
How to Price Your Products and Services
There are a lot of theories out there on pricing, but I believe there is only one you should follow: you should charge the price that allows you to maximize your profit over time.
Simply put, you should charge what the market will bear. But it is a little more complicated than this because typically you need more than one customer to succeed and each customer may be willing to pay a different price. So you basically want to charge the price that maximizes your overall profit.
You also want to maximize your profits over time. And you want to have some ethics. So, for example, if you have a water stand in the desert and a person whose car has broken down walks up the highway and desperately needs water, you should not charge 10 times as much as your usual price. But this is an extreme case. Generally, you want to charge what the market will bear.
How can you figure out what the market will bear? The first place to start is by looking at what your competitors are charging. Do you really need to charge less than them?
One of the best examples of an industry in which companies closely monitors the pricing of their competitors is the hotel industry. I know of single independent motels that pay a subscription fee to a service that continually monitors the pricing of all motels and hotels and provides them with constant updates. Using this information, the motels adjust their prices daily. This is common industry practice.
How Much Energy and Time Should You Put into Pricing?
Probably a lot more time than you are currently. I remember when I wrote an extensive marketing paper in business school. The one part of the paper I was most soundly criticized on was not giving enough attention to pricing.
I wish that in my past businesses I had given more attention to pricing. I can tell you now that with what I know today, I would have charged a lot more for my products and services in virtually every business I owned.
What If You’re Not Sure about Pricing?
Then you test. But don’t just test low prices and sale prices – have some guts and take a chance. Test higher prices as well and see what happens. It’s perfectly OK to announce higher prices and, if they don’t work, roll them back at some later date. You don’t want to constantly change your business strategy, the quality of your products, or your products themselves. But changing the prices is a lot more acceptable.
A Chinese restaurant where I often eat at has rolled the price of its lunch buffet back and forth like a Ping-Pong ball, between $5.95 and $6.25, four times over a two-year period.
How Do I Determine a Rational Price Point?
This Chinese restaurant example brings me to another point. I believe consumers don’t think rationally about pricing. For starters, I believe pricing that is different or unusual from industry standards just seems weird and unprofessional, and is one more reason to avoid the product. So if everyone in your industry prices at $5.95, $6.95, $7.95, etc., I would be reluctant to come in and price at, let’s say, $6.38.
Similarly I would tend to round prices up. I think consumers tend to simplify pricing in their unconscious mind. For example, I think if they see a price of, let’s say, $6.78, they really don’t differentiate that price with, let’s say, $6.95. So you should charge the $6.95 price.
Pricing Our Resume Book: Example No. 1
For years we credited much of the success of our best-selling resume book, Resumes That Knock ’em Dead, to its relatively low price of $7.95. But my sales manager insisted we could charge more. He had managed a bookstore chain and had lots of experience in the industry, much more than I did. But I was the entrepreneur and had that entrepreneurial self-sabotaging fear that if I raised prices, sales would collapse. Stores would return our books unsold and, before you know it, I’d be closing the doors of my business, donning an apron and serving up hamburgers at McDonalds.
But eventually I agreed to increase the price. I even thought to myself, “Why just increase the price to $8.95? That’s an odd price and to most people sounds kind of like $10 anyway.” So, I very, very, very nervously increased the price by approximately 20 percent to $9.95.
What happened to sales? Unit sales, not just dollar sales, surged by more than 20 percent. Total revenue soared by 50 percent, and profits skyrocketed.
Pricing The National Job Bank: Example No. 2
In the early years of my book publishing business, we focused on creating employment guides for major employers in local markets. After I had launched these books for a number of major U.S. cities, I decided to publish one book that would cover all major employers throughout the entire USA – The National Job Bank. It would be a big, fat, and expensive library book – more than 1,000 pages long. I was considering pricing it around $150 per copy, relatively cheap for the library reference market. But coming from the trade book publishing field, I was surprised by how expensive library reference books could be and what libraries were willing to pay.
Later, I found out that the huge commercial data company Dun & Bradstreet was planning to launch a book that would directly compete with mine, or at least that’s how I viewed it. Their book would cover fewer employers but have more information on each one. All told, each of our books would have roughly the same amount of information. But Dun & Bradstreet was going to price their book at more than $300. Furthermore, they weren’t even going to sell the book, they would only lease it to libraries who would have to send it back to them at the end of the year. The libraries would then have to pay an additional $300 to get the new edition for the following year.
Dun & Bradstreet’s pricing example should have been a clear lesson to me that I was severely underpricing my book. But amazingly, in hindsight, I took the wrong lesson. Instead, I focused on the fear that Dun & Bradstreet would control the market and my books wouldn’t sell. As it turned out, almost all of the target customers bought both our book and Dun & Bradstreet’s. Which is another lesson: in the eyes of your customer, your product may be more differentiated than you think.
Pricing the Auto Service Firm: Example No. 3
I have a friend who runs a franchise system in the specialized service auto market and who is a very astute businessman. He spent a lot of time negotiating to buy a similar firm located in California. It was a difficult process because despite being the market leader, the California firm was losing money. Eventually they agreed on a price and my friend took over.
Immediately, my friend raised prices dramatically and sales plunged. Fewer customers bought the service. Even total dollar sales went down. However, for the first time in several years, the California firm has started to make money. I suspect that some of its competitors will sooner or later raise prices, which are currently much lower than in other major markets, and sales and profits will really pick up.
Are You Really Charging as Much as You Can For Your Products?
So ask yourself today if you are really charging as much as you can for your products and services. And if you are not sure, go out and investigate the competition, or test raising prices.
You’ve worked hard to be in business. You deserve to make a good profit.
Bob Adams is a Harvard MBA serial entrepreneur. He has started over a dozen businesses including one that he launched with $1500 and sold for $40 million. He has written 17 books and created 52 online courses for entrepreneurs. Bob also founded BusinessTown, the go-to learning platform for starting and running a business.
