A brief guide to pricing strategies for the new business owner.
Pricing your services is a complex subject and, as a result, few organizations price as accurately as they should. Determining a good and fair price for your services requires consideration of a number of different items, including your costs, the value perceived by your customers, alternatives available to customers, your regional cost of living and the effects of any competition.
Pricing is generally the most sensitive element in determining your net profit, with studies across a broad variety of industries showing that (assuming constant sales volume) a 1% increase in price will raise your net profit by 7%–20%, according to Morris Engelson, author of Pricing Strategy: An Interdisciplinary Approach (Joint Management Strategy 1995). Compare this to a 1% reduction in costs, which typically results in only a 1.3%–2% increase in net profit, says Engelson.
When setting your prices, you need to consider your original business objectives, which might be to maximize your profit, to maximize your market share or to earn a “reasonable profit” while still making your services affordable to a broad market.
Put simply, price is the value or worth of something or some service. To properly understand and set your “price,” you will need to answer, at a minimum, the following questions:
- Who is the buyer? Is the buyer the person using your services, or is it a spouse (or someone else)?
- How does the buyer decide on the worth or value of your services? Is it based on effectiveness of services; location; schedule convenience; staff qualifications and motivational capabilities; convenience of credit card processing; competitor prices; or (most likely) a combination of all of the above?
- What are your business objectives when setting prices? Do you want to maximize your profits or maximize your market share?
- Who are your competitors, and what do they offer? What are their prices, and who are their customers? Are you competing directly with another trainer or business that caters to your same clientele, or do your competitors target a different audience?
- Is the competitive environment a major, if not the primary, determinant in setting prices? Would you set your prices differently if there were no competition? How much differently?
- Who is the primary leader in establishing the customer’s perception of value? Is it you or the competition? What does this do to your pricing strategy and flexibility?
The economic value to your customers is determined first and foremost by what their alternatives are. Few people will pay $75 for a personal training session, even if they value it at $85, if they think the market offers alternatives at substantially lower prices. However, the reality is that only a small segment of customers insist on buying the lowest-priced alternative. By offering superior service plus years of experience and staying up-to-date on the latest research, you are providing a “differentiated product offering” worth more than the available alternatives.
How much more your services are worth compared with your competitors’ depends on the perceived value that your customers place on the differentiation between offerings. Some customers may place a high value on the differences, while others may not. The economic value of your services is your customer’s best alternative price plus the perceived value of whatever differentiates your services from the competition.
Although it is tempting to simply match the price of your lowest competitor or to price as the low-cost leader, low pricing is never a substitute for an adequate sales and marketing effort. While pricing your services lower than those of the competition is probably the quickest, most effective way to achieve sales objectives, it is usually a poor decision financially. Because low prices can be so easily matched, this strategy offers only a short-term competitive advantage at the expense of permanently lower margins. Unless you believe that your competitors cannot match your price cut, the long-term cost of using price as a competitive weapon usually exceeds any short-term benefits.
If you are tempted to cut pricing below what you think is reasonable for your services, do so with caution. Better yet, don’t do it at all, because your competitors may further cut their prices and you might end up in a local price war that significantly hurts your business and leaves you with no clear exit strategy.
1. Make Your Prices Simple and Easy to Understand. There is a well-known customer purchasing phenomenon known as “customer paralysis.” This occurs when a customer is presented with too many pricing options and she simply elects not to make a purchasing decision at all, preferring to look elsewhere.
2. Be as Fair as You Can Be. Most customers intuitively understand that vendors “reward” frequent customers with preferential terms. You can reinforce this concept by offering slightly lower prices for your services when clients make larger purchases or purchase commitments.
3. Stay Within Legal Boundaries. A number of states have enacted legislation governing health clubs. The main goal of this legislation is to protect health club members in the event that their club goes out of business or closes convenient locations in favor of opening locations farther away. The legislation also typically states that customers have the right to cancel their contracts in the event that the clients move and there is no location within a convenient distance of their home.
This legislation is state specific, so it may or may not apply to your business. If it does, you are generally not permitted to take a customer’s money for more than 31 days in advance of services rendered. However, if you do want to collect payment for 6–12 months of services upfront, you may be required to post what’s known as a “performance bond” with your state. The size of these performance bonds can be substantial, ranging from $25,000 to $200,000, depending on the state.
Slashing your prices to increase your revenue is not advisable in the long run. The perceived value of your services is what will initially help secure new clients and retain existing clients. Your ongoing commitment to those clients, coupled with your expertise, education and professionalism, is what will increase your bottom line in the long run. n
From a legal perspective, pricing regulation in the United States is governed by the Robinson-Patman Act, a 1936 statute that reads, “It shall be unlawful for any person engaged in commerce . . . to discriminate in price between purchasers of commodities of like grade and quality . . . where either or any of the purchases involved in such discrimination are in commerce . . . and where the effect of such discrimination may substantially lessen competition . . .”
Sounds confusing, no? The key thing to understand about this legislation is that it affects only business-to-business (B2B) pricing, not business to consumer (B2C) sales, so you are legally within your rights to charge different prices for the same services.
However, pricing is not only about the legal ramifications. To maintain customer satisfaction, you do want to set a pricing schedule that you can clearly explain to clients, one that is easily understood and considered fair.
Most business books offer in-depth pricing advice for large businesses, meaning the strategies covered are too time-consuming or not applicable for the average small-business owner. That notwithstanding, perhaps the most applicable pricing book is The Strategy and Tactics of Pricing: A Guide to Growing More Profitably (4th ed.) by Thomas Nagle and John Hogan (Prentice Hall 2005).
November–December 2008 IDEA Trainer Success