by Dr Greg Chapman
An interview with Dr Greg Chapman by the Sydney Morning Herald
SMH: What are the key considerations when businesses set prices?
Dr Chapman: The starting point is that you must understand your margins – and the gross profit you need to cover your overheads to generate a target net profit, after you have paid yourself a decent wage. This analysis helps set targets to stay profitable. For many businesses, they find that they are not charging enough to stay in business.
Then you must understand the competitive environment and your own Points of Difference without which you will only sell on price. This is about the value you provide the purchaser – you want the purchaser to focus on the value you provide rather than how much it costs to provide it. If you don’t know the true value of your product or service- will the buyer?
SMH: Why do businesses seem to get this wrong?
Dr Chapman: The steps I mention require some analysis, and businesses think if they just charge what their competitors do they will be ok – without consideration of the value they offer- so they end up being too expensive or cheap. Neither is good.
They also don’t realise they have it wrong until they have lost a lot of money. They have no measurement system. And when they realise they have a problem, they can’t afford to pay for help. The school of hard knocks has far higher fees than any good consultant, but they think they are saving money.
SMH: What are the different ways to set prices?
Cost plus : Adding a standard mark up to the cost of the product or service
Value based : Determine what the buyer perceives as the value of the product
Relative Value : Set prices relative to related products that you sell
Going rate : Charge the same as your competitors
SMH: How should they discount?
Dr Chapman: Discounting can be fast way to go out of business. There can be good reasons to discount –like getting rid of old stock. But even small discounts can destroy your gross profit.
The best way to discount is by discounting your scope. So you might offer a happy meal, but if that is too expensive, offer to take out the drink. You may find the customer says, actually I do want the drink, and they talk themselves back into the more expensive product. But even if they don’t, you haven’t compromised your margin.
SMH: What's the best way to increase prices?
Dr Chapman: It really depends on the type of business you are in. In my book, I give 57 ways you can do it, and I am sure there are others I haven’t thought of.
But here is a simple example – You can increase your prices by putting less in the box, and only partially reducing your prices to compensate. Cereal manufacturers do this all the time. You can do the same with services.
Branding is also a common way of doing this. The biggest reason that a person will buy a product is that they have confidence that it will meet their needs. Branding builds confidence- so people are prepared to pay more for a product they have heard of than one they have never heard of.
SMH: How should they communicate this with customers?
Dr Chapman: You must be clear about your points of difference and the value you provide to the customer. Without these two factors in your communications, people will just buy on price. So your marketing must defend your prices.
SMH: What are the risks involved with raising prices?
Dr Chapman: If you don’t properly communicate as we discussed, you will lose sales and ultimately go out of business. It doesn’t matter how clever your pricing tactics, you have to defend your margins. Otherwise it is like trying to fly by running off a cliff, like Wylie E Coyote. At some point gravity will win.
SMH: Is it better to aim high rather than low?
Dr Chapman: It is best to be strategic, and to test your pricing. So do some experiments. Companies often trial new products outside their biggest markets to see whether they work. In the end the market is always right.
SMH: Any tips?
Dr Chapman: Business are often scared to raise their prices, but understand that you may actually be slowly going out of business today at your current prices, so you may have no choice but to lift them. So you must do the analysis. Finally, your pricing strategy must be supported by your marketing. The bigger the price rise you seek, the more radical the changes you need to make.
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Dr Greg Chapman is the Director of Empower Business Solutions and is Australia's Leading Advisor on Emerging Businesses and provides Coaching and Consulting advice to Australian Small Business Owners in Marketing & Business Strategies Planning & Systems. He is also the author of The Five Pillars of Guaranteed Business Success and Price: How You Can Charge More Without Losing Sales.
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