Blue Elevator Blog

Proper Pricing Principles

Say “proper pricing principles” five times.  And as tough as that is, applying proper pricing principles is equally difficult.  Let’s get right to it.  Here is an overview of the proper pricing principles.

Proper Pricing Principles – Qualitative

1. You must have a clear Deliverable.  Your Deliverable should be something you are good at.  Your Deliverable should be something the market needs.  More information can be found in this article: Build a Deliverable for Business Success. You could be great at building abacuses; but unless they are works of art, it is doubtful they are what the market needs.
2. Your market price, relative to your Deliverable, should be perceived as a good value.  Let’s say you make the world’s best donuts.  You might want the price to be $20 per donut.  But at that price, it might be hard to sell a dozen at a time.  What is the right price range for a donut?  This is where you need to be.
3. Your price must be both profitable and scalable.  We’ll cover this in a bit more detail later on.

Proper Pricing Principles – Tenets

1. You should create a process for establishing pricing.  Using a systematic approach will help you when it comes to evaluating and updating your pricing.  Don’t just wing it.
2. Whenever possible, you should create different levels of pricing to create choice.  There may be some exceptions to this rule, but generally, it will help to provide your customers with options.  For example: If you have one size of popcorn, it becomes a “yes” or “no” proposition.  On the other hand, if you offer three sizes, you increase your chances of a sale.  In simplistic terms, not everyone will want the ginormous-sized popcorn.  Some people will want a medium.  Some people will want a small.
3. How you price your options will influence decision-making.  This could be a separate article in and of itself.  Whereas pricing will influence decision-making, make sure that your commission structures are decision-neutral.  In other words, a customer should be influenced to make the best decision for himself or herself – not a decision that is best for the sales person.

Proper Pricing Principles – Mechanics

As mentioned earlier, your pricing must be profitable and scalable.  Here are some additional details:

1. Cost of Services (or Cost of Goods Sold).  Your pricing must cover your direct costs for production.  There must be an allowance to cover your direct costs and labor.  Here are some examples: Construction (labor and materials), Food (the time to prep & cook and the related food costs), Photography (the time and cost to shoot pictures and process the raw images for delivery), and Service (the time and labor to provide & perform the service plus any incidental costs).
2. Gross Margin (Contribution Margin).  Your pricing should make a contribution towards overhead and profit.  The concept here is that every sale should make some contribution towards indirect costs (e.g., supervision, rent, utilities, etc.).  And, every sale should also make a contribution towards profit margin.
3. Selling Costs (Spiffs or Commissions).  Your pricing should also have a provision for selling costs.  Ideally, you should have some provision for compensating sales people (e.g., a commission on the sale).  As mentioned earlier, make sure that the commission doesn’t influence sales activity.  That is, customers should be informed and assisted so that they buy the best product or service for them – not the product or service best for the sales person.

The difference between your hard costs (or direct costs) and your sales price is margin (or contribution margin).  Obviously, the higher the margin the better.  But, like in the donut example, your price has to be in line with the market.

If your price is too high, sales may lag.  However, too low of a price can prove to be problematic as well.  Experience has shown that poor financial performance can often be traced back to pricing and margin.  Specifically, when the margin is too low, the prospect of scaling and taking the “business to the next level” is elusive.

The Pricing Model

The embodiment of proper pricing principles should be formalized into a custom pricing model.  This can take on various forms.  Every company, product, and service will be different.  Be encouraged to build it systematically using proper mechanics and mathematics.  It should cover all of the various components: direct costs, overhead and profit, sales commissions, etc.  The pricing model is your secret playbook.  It is something you will build, measure, and continuously refine over time.

The “One Sheet”

When all is said and done, be encouraged to publish your pricing.  This can be done via a “One Sheet.”  This One Sheet will clearly outline options and related pricing.  Whereas your pricing model is secret, the end result (e.g., your final prices) are not.

Even though your customers will buy from you relationally speaking, your customers will want to see the price and associated features and benefits.  Having published pricing will help your customers relax.  Take the pressure off of them by making your Deliverable clear.  Not having set pricing tends to push people into a negotiation stance which is part of a transactional (not a relational) approach.

Having published pricing doesn’t mean you have to post it on the Internet.  You just need to have your One Sheet readily available.  You will need to clearly and concisely answer the question: “How much is it?”  Absent a clear answer, you will likely create angst and uncertainty with your customer.

Conclusion

There are a lot of moving parts when it comes to pricing your goods and services.  Employing proper pricing principles is critical.  At Blue Elevator™, we can help.  Contact us today!