Is the price right? Focus on your profits, not revenues.

I regularly see business owners putting huge amounts of effort into reducing their costs. This is a pursuit that inevitably provides diminishing returns, as a floor is reached of what costs can be cut without undermining performance, quality and service delivery.

This, however, is only one half of the profit formula… and the more difficult half at that. Much easier is to ensure that your pricing is optimised. Paradoxically for most businesses, pricing is a mere afterthought.

Particularly if you are in a low margin industry, such as construction or consumer goods, every bit that you lose from suboptimal pricing is a huge drop in your profits. For example, if your profit margin is 10%, a 5% price drop is a 50% drop in your profit margin. To make up for that 5% drop in your sale price, you would need to double your revenue - unless you are in a pure commodity situation this is a very unlikely situation. In reality, research has shown that often increases or decreases in pricing up to 3% have zero or negligible impact on sales volume, but a huge impact on profit margins.

The law of supply and demand also does not always hold true, particularly in luxury goods or industrial applications. Pricing is one of the most powerful marketing tools that you have at your disposal, as many customers use it as an indicator of quality and performance. It can be the case that by reducing your price, sales volumes fall, and when raising them, sales volumes rise. The customer assumption is that lower price = lower quality and higher price = higher quality. Take the case of Chivas Regal Scotch Whisky, for example. Amid stagnating product sales they made only two changes - a new, more appealing label and a 20% price increase. With no change to the actual product, sales volumes increased dramatically. If your product or service is in a category where prestige or quality are of high importance, by dropping your prices you may shoot yourself in the foot - twice.

Before considering dropping your prices, it is critical that you understand what your customers truly value. It should be intuitively true that a customer will only buy your product when the perceived value that they receive is greater than the money that they give you to acquire it. For you, pricing determines whether you have a viable business - for your customer it is just one of several competing factors (including quality, performance, status, taste, feel, alignment with their values among others).

I also see many businesses base their pricing on their costs plus a profit margin. This too is not optimal… if a customer values your product less than this amount they will not purchase, and if they value it more you are giving away potential profits. Pricing should be based on the value to your customer - they couldn’t care less about your costs.

The correct solution should be to critically assess what your customers truly care about, and this means talking to them. Find out what they want to achieve with your product or service, what frustrates and delights them, and if necessary tweak your offering to meet the most critical of these at the lowest possible cost to you.

A simple survey of your customers can help you to determine an optimal price, asking them about your product or service:

• At what price is it cheap?
• At what price is it good value?
• At what price is it expensive?
• At what price would you not purchase?

We are going through tough times right now, and there are more tough times to come. As you strategize your response, the optimal response will often be to leave your price alone even if it means sacrificing some revenue. Focus your energies on the things that your customers truly care about, and that are relatively low cost to your business and remember that it’s not revenues that keep your business afloat, but profit.