Imagine walking up to your pricing board, changing the zero in “$10” to a two so the price is “$12”, and making 20% more profit.
That’s $2 more in your pocket. Free and clear. On every sale. Because price increases go straight to the bottom line.
Just by increasing the price of an item from $10 to $12. Of course, this relies on the assumption that customers buy the same amount when the price is $12 as they do when it’s $10. But this is often true for small businesses, customers will usually buy the same amount. But it’s important to test this (and we’ll show you how).
In this post I want to show you a method to help capture more of the value you are creating for customers and ultimately, make more money.
First, let’s explore how this works. It works because in most situations price changes drop straight to the bottom line. Check out this example Profit & Loss Statement to find out how:
|P&L||Result with Old Price||Result with New Price||Difference in Result|
|Cost of Goods||$500||$500||No change|
|Gross Profit||$500||$700||Increase 40%|
|Total Expenses||$300||$300||No change|
All we did here was change the price from $10 to $12, but made two important assumptions:
- Volume stays the same even at the higher price.
- The cost of goods sold and expenses required to deliver the same product and service, remained the same.
The second assumption is usually realistic. It’s the same coffee order, or birthday cake, or bottle of wine as before. When you change the price, your costs don’t automatically change (unless you have some variable costs tied to prices, which is true for very few small businesses).
- Sales revenue increased by 20%, the same as the price increase.
- Gross profit increased by 40%, double the price increase.
- Earnings increased by 100%, five times the price increase.
As you can see, price increases drop straight to the bottom line (profit). Revenue went up by $200, and earnings went up by $200. You get to keep all of the increase in revenue (not accounting for taxes). The best part is that for small businesses, most price changes cost nothing to implement, you just change the numbers on your price board, price sheet or website.
This brings up the key question again:
What if I increase prices and customers buy less of my product or service?
That’s a valid concern, and there’s a simple way to approach price changes to make sure you don’t lose business, only gain by capturing more value.
Usually there are three ways to approach pricing:
- Study past price changes.
- Survey customers in the present to ask them about prices.
- Change your prices in the future and study the impact.
However, most small businesses haven’t changed prices in the recent past (that’s why it’s such an untapped opportunity), and don’t want to give customers a survey on pricing (it’s a touchy subject).
Our solution: use price tests to change prices in the future to study the impact on volume, and reduce risk by starting with an experiment on one product first.
I’ll explain how in a moment.
WIIFM: What’s in it for me?
Which businesses is it for? This initiative can be adopted by any small business that sets their own prices and can freely change the price of their products and services. Excludes commodity businesses where price is set by the market.
What is the potential benefit? Effectively implementing this tactic can increase profits by 25% to 100% for the right small business. For a $500,000 business with a 20% profit margin this could mean from $25,000 to $100,000 more take home profit. But it’s important to get it right.
How much does it cost to implement? This initiative requires set-up time of 5-10 hours and may require an upfront investment to get started, depending on the business. There are no ongoing costs. Always assess the cost and benefits of any projects against the risk, and get professional advice before proceeding.
How often should I revisit this? You can look at pricing continuously, but we recommend doing a review at least yearly. I remind members of this every year.
Instructions for running this play
The goal of this project is twofold. First, to remind you to periodically review your prices and potentially reprice your products and services. Second, to provide an approach to changing prices that tests customer demand, and is less risky than just changing prices across the board.
Step 1: Pricing Review
While our approach is focused on running an experiment by making a price change on one product or service, it’s still important to see if there is any freely available information on your pricing that might help you make decisions.
Start with some research on the following questions:
- When was the last time prices were changed?
- What were the price changes made by each product or service?
- What impact did the price changes have on volume, and sales?
- Have customers or employees provided any feedback on prices? Do you typically hear feedback that they are too high or too low?
- How do your current prices compare to your competition? Do competitors have relatively higher or lower prices for the same products and services?
You can answer these questions based on your company accounts, historical price lists, desktop research, customer and employee interviews and using knowledge of your market and competition.
Step 2: Planning
If you believe based on Step #1 that there is the possibility to increase prices without impacting customers and the volume they demand, it’s time to start planning your pricing experiment.
Once you decide to proceed to the next step, you need to choose a product or service to run the experiment on. It’s better not to choose randomly, and try to pick a product or service that will provide a clean test of the price change.
You can identify candidates based on these characteristics:
- The product or service is not one of your best sellers.
- The product or service is similar to your best seller, or representative of the majority of the prices and services you sell.
- The product or service does not have low sales volume.
We chose these characteristics because:
- It’s too risky to experiment with your highest selling products or services.
- But you want the product or service you choose to provide information on what might happen to your highest selling products and services if you change prices.
- You need enough data to do a reliable pre- and post-price analysis of the price change.
Check all your products and services against these criteria and choose one that you believe will provide a good experiment.
Step 3: Experiment
It’s time to run your experiment. We’re assuming that you have a product or service where it is relatively simple to change the price. For example, if you run a coffee business you simply have to change the price of an item on your pricing board and in your point-of-sale system.
Here’s how you can run the experiment:
- Determine a timeframe for your investment. Based on your product and service, what is the appropriate period for a test? For some products that sell higher volume it might be just a week, for others you’ll want to compare two months against each other.
- Find a period of time that provides a clean experiment, so that you know what date you will make your price change. For example, you don’t want to compare periods during the holidays or public holidays.
- Once you have chosen your timeframe and starting date, make you record the starting price level and the volume sold in the period before you make the price change.
- Change the price of your chosen product, use your learnings from Step #1 to help decide on what the price change should be.
- Make sure your staff understand that the change is being made, and why, and can answer any customer questions or feedback about the change.
- After your chosen time period is over, record the volume sold and compare it to the previous period, and the same time period last year (to account for seasonality). You can use a simple table like the one below:
|P&L||Price last year||Price last month||Price this month||Difference|
What happened to volume after you changed prices, compared to your sample periods? Did it go up or down? What does the result tell you about your pricing?
As you can see in the example above, with sales only decreasing by two it doesn’t appear that the price change had a big impact on volume, and revenue went up by $176. This provides strong evidence that we can explore further price increases with our other products and services.
Step 4: Learn & Expand
Depending on the results of your first price experiment, you have some choices to make. If the experiment didn’t work out as planned, you can:
- Run the same experiment again on another product or service to collect more data and evidence.
- Park pricing as a project and revisit it again at some point in the future.
If the experiment did work, you can:
- Run the same experiment on another product or service to collect more data and evidence before you expand the price changes.
- Apply price changes to the rest of your products and services.
Charging higher prices simply means capturing more of the value you are creating for customers and putting the balance more on equal footing.
A lot of small business owners are leaving money on the table through untapped pricing power. It’s time to change that by using a careful and considered approach to pricing reviews.
Periodically reviewing and potentially repricing your products and services can make sure that you are capturing your fair share of the value that you are creating for your customers.
Yet so few small business owners do it.
Add it to your calendar to make sure you are completing the exercise at regular intervals, and if you do decide to change your prices, make sure you follow a considered approach.
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