Every entrepreneur makes the same mistake. They think they need to be the cheapest to get the market share,” says Ed Challinor, one of the founders of Liverpool cosmetic dentistry business Smileworks. “We started out cheap, but customers just kept asking for even more discounts. It’s a race to the bottom.”
So after reading Pricing for Profit by Peter Hill, Mr Challinor looked more closely at how the company pitched its services. “We found that we could afford to lose 80 per cent of our patients if we raised our prices by 30 per cent,” he says. “It’s a myth that putting prices up makes you lose customers.”
Smileworks has achieved £1.5 million in revenues in less than three years and has doubled its profit margin, so the approach has clearly worked.
For many businesses, especially when they’re starting out, pricing can seem like a dark art – based either on gut feel or on undercutting your competitors. But setting prices at the right level can be one of the most important decisions you make in your business, and determine whether you reach your revenue, profit or expansion ambitions.
FSB member Darren Wells, founder of the consultancy Excel in Pricing, says: “Pricing is not something that most business people ever study. Unusually, there’s little popular wisdom beyond ‘add X per cent to your costs’ and ‘charge what the market will bear’. Intuition and experience of your market are great assets if you have them, but to maximise the perceived value of what you offer, opinion is irrelevant.”
Mr Wells argues that it’s vital to research how customers perceive the value of what you offer, rather than just adding a premium on top of the cost of what you produce. “Just because one of your competitors is pricing their product at £17.50 doesn’t mean you have to match them,” he says. “Ask yourself what differentiates your product from theirs and justifies a higher price, and then work out how to show that differentiation to customers.”
Lisa Forde, Director of event stationery company Dotty About Paper, builds pricing into her future business plans. “We look at the market, what others are offering, and where we can pitch our products at a price that’s affordable but good-quality,” she says. “Knowing how price points affect our ability to reach our goals helps, and we discuss this with suppliers so they know where we’re coming from.”
In her business, paper and materials prices can go up, so it can be a case of looking at how processes can be made more efficient behind the scenes so these costs don’t affect the customer. “We would look at whether there’s a means of achieving that price another way, such as ordering bigger quantities from a supplier so they can reduce price, or arranging labour in a more efficient way,” says Ms Forde.
One route Dotty About Paper does not go down is mega-discounting, she says. She sometimes offers a small discount of 5 per cent or free delivery, but avoids holding sales or slashing prices. If prices do have to go up because of external factors such as mailing costs, she always gives customers due warning. “We’ll tell them ‘last chance to buy at X price’, or raise prices in advance of costs increasing, so the cost is absorbed,” she says.
David Johnson, Head of Programme at Cause4, advises small businesses and charities on growth strategies. He agrees that setting prices is not as simple as factoring in your costs. “Think about how niche your offer is, and focus on your social purpose as part of your strategy,” he advises. “Make sure you ‘mystery shop’ before you go to market.”
Mr Johnson also suggests bundling items such as consultancy or training alongside core products, to give the customer a perception of added value. And he reminds businesses that price is only one part of what they do. “Ask for feedback if you don’t win a contract – it might have nothing to do with the price,” he advises.
Nick Healy, Managing Director of Suresite, which provides card-processing services, uses a strategy common to many businesses: setting prices on the size of the customer and the volume of business they can provide.
“Customers expect that the more they buy, the lower the unit cost will fall,” he says. “This works in favour of both the buyer and the seller, as once the buyer has seen the unit cost drop, they are likely to commit to working with one provider at an agreed price rather than spreading their budget. By looking at the competition’s pricing, adding in a fixed margin and taking into account our overheads, we can produce a price curve.”
The company also offers a choice of pricing options – “the service business equivalent of Tesco Finest or no-frills ranges” – whereby customers are invoiced based on the level of service they require.
Get pricing wrong, however, and doing business could end up costing you money, warns Rick Smith from business turnaround specialist Forbes Burton. “There’s a misconception that because you’re selling more, you’re making more money,” he says. “But you might need more staff, or a bigger space for storage, so the cost of sales can be greater, and this needs to be factored into your pricing strategy.”
Companies should make projections based on how things have sold in the last six months or year,” adds Mr Burton. “What did things cost, and will this increase or decrease? Can you get a better margin from your supplier if you give them more business? Doing this will show you where you can squeeze prices and where you can’t.”
Simply keeping prices low to gain market share means you may end up working harder for less money, he says. “You have to work quicker to make the margins to continue, and you still need the same resources to keep fulfilling those requirements.”
Mr Challinor from Smileworks tired of chasing the lowest prices and has never looked back from raising them, while lower-priced competitors have gone out of business. “We’ve worked out just how much profit margin we get if our revenue is at a certain level, and I’ve shared this with everyone in the business,” he says.
It’s all proof that knowing the value of your products and services, and what customers are prepared to pay for them, can lead to greater rewards in the long term.
Darren Wells, founder of business consultancy Excel in Pricing, offers an example of how a small price rise can make all the difference:
“You sell 1,000 units per month at £20 (£20,000/month), and each has a variable cost of £5. This means a gross margin of 75 per cent, or £15,000/month. You have fixed costs (such as labour and rent) of £10,000 per month – leaving profit of £5,000 per month.
“If you increased your unit price by 5 per cent, even allowing for a 1 per cent reduction in sales, this would generate an additional 17 per cent profit overall.
“To match that improvement, you’d have to sell an additional 56 units (6 per cent) a month, cut your variable costs by 17 per cent, or cut your fixed costs by 8 per cent.”
As with many entrepreneurs, Nathan Cable started out his business after feeling frustration with what was available on the market. He and co-founder Barry Moore had enjoyed clubbing holidays while at university, and were shocked by the prices being charged by bigger operators. So when it began, Party Hard Travel priced its holiday services on the basis of making them accessible to students.
However, they soon realised this approach wasn’t sustainable in the long term, so they considered how they could add value to their offer. “Now our holidays might cost a similar amount to the larger travel brands, but the key difference is that all the biggest and best [clubbing] events are included,” says Mr Cable. “Our pricing strategy is about being competitive while providing the best possible experience for our customers.”
There have been challenges, such as the exchange rate since the Brexit vote, and often having to set prices based on hotel capacity.
Mr Cable sums up the firm’s current approach to pricing: “Promotions and offers are great to drive sales for a particular product, but our pricing is now firmly aligned to meeting customer needs, and through this to our business goals.”