Pricing & Margins

Are You Undermining Your Pricing Strategy?

The pandemic caused almost everything to go off the rails. It’s time to get your Profit Train back on track.

The old way to measure profitability was to look at job revenue, subtract expenses, and mark the remainder as gross profit. These days it’s more complicated. Making good decisions about pricing and margins relies on being acutely aware of the changing trends in supply and demand.

Repackaging the Fundamentals

The basics of pricing haven’t changed: cost + margin = profit. But that doesn’t mean you can continue quoting jobs the same way you did pre-pandemic.

Scarcity, limited supply chains, and an increase in demand cause prices to increase. Everybody knows prices are rising, but they might not be clear on why. Sometimes a refresher on the fundamentals is necessary when so much is changing.

That Was Then

Back in the 70s, I had a friend who owned an independent gas station/garage. Due to scarcity, gas prices were high. Consumers were acutely aware of this. If your per-gallon price was even one cent higher than a corporate competitor’s, you were going to lose a lot of business.

Because my friend wasn’t in a position to purchase large quantities of gas, he had to pay a higher wholesale price than his corporate competitors. Out of necessity, he kept his gas prices in line with the competition, even though it meant he was not making a single penny of profit on gas.

Why? Because if he raised his gas prices, people wouldn’t stop at his station. He’d lose out on selling oil changes, candy bars, sodas, and everything in between. He went so far as to discourage customers from purchasing fuel unless their car was empty, while encouraging them to do things like get their oil changed.

Smart guy.

Now and Then

The motel/hotel business is another good example of understanding how to set up the profitability equation.

If you’re Motel 6, your goal is to fill as many rooms as possible each night. To meet that goal, you set your prices at a low per-room rate and hope to reach full capacity as often as possible.

If you’re running Ritz Carlton, on the other hand, you keep prices high. You’re in the business of attracting customers who value the luxury and prestige the Ritz is known for, and you’re better off booking 50% capacity at luxury prices than being fully booked at discount rates. Those customers will make up the difference in the restaurants, shops, and spa.

In other words, know thy customer. But that’s not all. Timing matters, too. If it’s a high-demand time of year — say spring break at Disneyland — both Motel 6 and the Ritz are going to raise prices as high as they can and remain at full capacity.

This Is Now

In the post-pandemic entertainment industry, both supply and demand have changed.?

As far as demand goes, it’s there, but customers aren’t sure what they really want. Maybe a customer starts out wanting a live event, but then realizes it isn’t feasible and switches to something virtual. This isn’t because customers have gotten more fickle. It’s because their needs are changing, even though their tastes remain the same.

To put it another way, say you and a friend stop at a Cheesecake Factory to have an appetizer before going elsewhere for dinner. When the “appetizer” plate comes out and is the size of a main course, you realize you no longer need to leave for the entrée. So you change your plans.

The demand changed because the need changed.

When it comes to supply, there’s a labor shortage that has led to an increase in labor costs and availability. This has hit the trucking industry very hard, which also disrupts the rest of our supply chain. Not surprisingly, we’re seeing an increase in the cost of sub-rental equipment, tied directly to the labor and logistics shortage.

In other words, there’s a lot of volatility in the industry right now — with both supply and demand — that you’ll need to account for in your pricing. So how can you maintain healthy margins in your particular marketplace?

Revisit the Strategy Grid

Let’s go back to the strategy grid I discussed in a previous blog post. When you determine where your business falls in the grid, your pricing strategy becomes clearer. (We’ll again ignore the enterprise quadrant.)

Maximum Capacity (Capacity-Driven)

If your company falls into the capacity-driven quadrant, your job is to optimize the use of your resources — maximum return for minimum effort. This is the quadrant of Motel 6, where supply and demand have less impact. You just pick the highest price that sells out your capacity, or if you have more capacity you can reduce the price.

Top Price (Client-Driven)

In the bottom right quadrant, you provide solutions for clients with a broad range of needs. This is the Ritz Carlton quadrant, where supply and demand allow you to be pickier about whom you do business with. Instead of dropping prices to fill up your client list, you hold out for top-paying customers who value the full range of premium services you offer.

Timing (Project-Driven)

If you operate in the project-driven quadrant, your pricing will be more about time. The customer wants you to do something for them on a certain date or in a given time frame, so you’ll price that period of time. Supply and demand here allow you to set how busy you want to be at any given point.

Is it a busy season? The price will go up. The customer will decide whether certain timing is worth paying a premium. Don’t panic. If you’re busy, then so is your competitor. Customers do not have the upper hand right now.

Resale Strategy

Believe it or not, you’re in the resale business. A gas station resells commodities, a motel resells real estate, and the entertainment industry resells equipment and labor.

Successful resale businesses locate a source, calculate the cost, assess the demand, volatility, and margin to mitigate risk, and deliver a reliable profit. Keeping these three points in mind will help you navigate the process:

• The more stable the source and cost (less volatility), the less demand affects price.
• The less stable the supply source, the more demand affects price.
• The more volatile the demand, the more value there is in the supply chain itself.

If both demand and source are volatile (as they are now), either choose to sell maximum capacity or hold out for top price (see chart above).

If demand is high and the source is unreliable, the ability to reliably deliver increases the value of what you do. Be sure to take it into account.

Keeping your Profit Train on the tracks is all about making good decisions concerning pricing and margins. You can do this by being acutely aware of the changing trends in supply and demand. Optimize for these changes according to the appropriate quadrant on the strategy grid, and you’ll find your business running smoothly into the future.