The Savvy Entrepreneur
Setting realistic prices for your business: An interview with the woman who literally wrote the book.
Ellen Rohr President of Bare Bones Biz
NJSBJ: Why do so many businesses, particularly small businesses, struggle to stay profitable?
Rohr: They donít know how to keep score. The educational system has done a terrible job of preparing us for business. Even in business school, you are not taught what you need to know to compete in the real business world. If you think business school prepares you for entrepreneurship, think again!
Still, every year, thousands of people start businesses without a true understanding of the basics. This deficiency is most apparent in a companyís financials. Many donít fully understand financial statements; they donít understand the relationship between prices and gross profit or the relationship between gross margins and the companyís overall profitability.
Often, when a business starts to struggle, the owner will look to cut costs. But small businesses are already down to the bone. They are probably not paying themselves very well, if at all. Theyíre probably using their spouse and kids to help run the business. Youíre simply not going to find a lot of fat in these companies. Since there is no fat to cut, the way to increase profitability is to reevaluate your pricing structure.
NJSBJ: How important is setting an accurate price structure to the viability of a business?
Rohr: Itís vital! One of the biggest mistakes business owners make is to set up a flawed pricing structure. Again it goes back to understanding your financials and your business goals. If you fail to set up a proper pricing structure, you will quickly find yourself out of business or find yourself working extremely hard for very little. You must determine: how much it costs to deliver your service, what your time is worth, what your financial goals are for the company and how you want to live. These questions are important when trying to determine what to charge.
NJSBJ: So if a business owner is trying to evaluate why their company is not profitable or only marginally profitable, they have to look at the numbers to see where they stand?
Rohr: Absolutely! The truth is, most small business owners have no idea how money works or how to really make money. In the book we talk about the importance of the Known Financial Position or KFP. Basically KFP means understanding where your company stands financially.
As the business owner, you must take responsibility for understanding the financials of your company. If you donít know how to do it, take a course at a local college. Once you have an understanding of financial statements, I recommend you run and review the numbers every week. You should review your income statement and balance sheet. Conduct a cash flow analysis, look over sales figures and make sure youíre maintaining your gross margins. Once you have, and understand, this information you can determine what you need to do to make your business more profitable.
NJSBJ: On the other hand, you may learn that the business simply isnít viable, correct?
Rohr: Correct! But itís better to come to the realization that your business is not viable, so you can move on to something else, rather than waste time, talent and money on something that simply isnít financially feasible.
NJSBJ: With pricing being so important to a companyís very survival, why do so many business owners set their prices in an arbitrary way?
Rohr: Unfortunately, itís really just how things are done. I have a theory, if what youíre doing is what every other business in your market is doing; itís probably the wrong thing to do. Think about it. Most small businesses are swinging in the dark, most small businesses fail. So if you set your prices at the same level as everyone else because thatís the "going rate", then youíre going to fail too. Iíve rarely seen a "going rate" that supports a real business. Look at the most successful companies in this country. Most charge top dollar for their products and services. Look at FedExģ. They are undeniably the most expensive courier service. Look at Disneyģ. Whether youíre buying movie tickets, clothing, toys, videos or visiting one of their theme parks, youíre paying top dollar.
NJSBJ: In your book you cited that many service companies tend to miscalculate their overhead and set their prices too low. Can you tell us what types of expenses they overlook?
Rohr: First is the ownerís salary. Many business owners feel, if they commit themselves to their business the money will come. So many business owners donít plug in a salary for themselves. This is very ironic, since the idea is to make money come hell or high water, but many owners convince themselves that, "If I work hard enough the money will come." Unfortunately it doesnít work that way, building a successful business takes planning.
Another budget oversight is unexpected expenses. Owners are very optimistic. They tend to look on the bright side Ė where the business hums along a smooth road, free of bumps, potholes and detours. So, very few small business owners budget a contingency fund to cover unforeseen expenses. But in the real business world, computers breakdown and need to be repaired or replaced, vendors go out of business, companies have bad months and customers leave.
To keep down expenses, many service businesses are started in the ownerís home. But if you take a room in your home as an office, you still have expenses that are related to the business. Youíre still using utilities, heat, a telephone, a fax and possibly a computer. Whether youíre paying rent or a mortgage, the room youíre working in is costing you money. These expenses need to be reflected in your prices.
Even if you are working out of your home, you should have a market rent plugged into your budget. Otherwise, when you decide itís time to move to a commercial space, youíll be forced to dramatically increase your prices to maintain your margins. Advance planning is equally important when considering capital expenses such as the purchase of new equipment. If youíve already budgeted for these items, you can handle these expenses without jeopardizing the companyís profitability.
NJSBJ: Many new businesses try to offer cut-rate prices to establish a customer base; does this method work?
Rohr: Yes, it absolutely works! Using this method youíre guaranteed to attract the worst, least loyal and least profitable customers in your market area. Youíll be busy before you know it and youíll be losing money on every sale. Remember, getting busy is easy; being profitable is a little harder. Your goal is to make money.
NJSBJ: What are the drawbacks of being viewed simply as a low cost provider?
Rohr: As a general piece of advice to anyone who may read this article, If you are considering going to market as the low cost provider in your industry or market, I anticipate your business will sink. I just donít see how anyone can make money as a low cost provider. If thatís your unique selling position, if thatís the big advantage or benefit of doing business with your company, youíre in real trouble. Hereís why: tomorrow any idiot can offer a lower price than yours and rob you of your competitive advantage and your customers.
Second, youíll attract the worst type of customer. The price customer! The price customer always wants to beat you up on price, and is perfectly willing to lock you into a win-lose position. And once someone else comes along with a lower price, they will drop you. On the other hand, quality conscious customers expect to and are willing to pay more. They also tend to jump ship less frequently.
NJSBJ: Do you agree with the adage itís better to set your prices too high than to set them too low?í
Rohr: Yes, absolutely.
NJSBJ: Why is that?
Rohr: I know it may take more time to build a customer base when charging a higher price, but if you are losing too many sales because of price, itís time to work on your marketing program. People will spend money. Look at what they will spend on a car. One car sells for a few thousand dollars while another car sells for a few hundred thousand dollars. They both have four wheels and an engine, but they are positioned differently and are sold to different segments of the same market. If you are charging a higher price than the competition, you have to provide superior service to justify that price. You must also target that segment of the market that is willing to pay your price.
NJSBJ: A company canít set prices in a vacuum. How do you go about finding out if the market will support your price?
Rohr: Actually, when you first start running the numbers, you want to do it in a bit of a vacuum, because at this point itís all about you. Where you want to take your business, what your expenses are, what your resources are and what your financial goals are. Then you can establish, or reestablish, a price structure based on your situation and goals.
NJSBJ: Should you research the competition before or after you determine how much you need to charge?
Rohr: Definitely after. One of the biggest mistakes entrepreneurs make is to simply charge what everyone else is charging. But you should not do that because you usually donít have enough information about your competitorís financial situation. Even if you do, it has little bearing on your financial situation.
After you run your numbers, create a budget and set a price structure, you can look at whatís going on in your market area. You may see that you want to charge $250 an hour when the going rate is $125. Your first impulse may be to reduce your price, but because you ran the numbers before hand, youíll know your price is not an arbitrary figure. Then you can look at other ways of dealing with it.
You may decide to increase the value of your offering by rendering more extensive service; you may narrow your market focus; or you may become a specialist in a specific area of your industry. But the point is you can resist the immediate compulsion to cut your prices.
NJSBJ: If your prices are higher than a competitorís, what can you do to justify your price?
Rohr: This is where self-esteem comes into play. You must believe that you are worth your asking price. Find out what value your companyís products or services bring to your customers and articulate those points in your marketing.
Another point is, chances are most of your competitors are not very sophisticated and they are not doing a great job of servicing the customer. If you want to charge a customer more than the competition, you have to be better than the competition. The good news is, itís easy to be better. Most companies offer terrible customer service. Offering better or more extensive service than the competition will help justify your price. The best part is, youíre not offering anything the competition canít offer. Youíre simply offering something the competition wonít offer.
NJSBJ: You have set your prices as high as competitively possible in your market, but you still fall short of your financial goals. What can you do to increase annual sales without raising prices?
Rohr: First, I would challenge that assumption. Weíve all seen people spend hundreds of dollars on Beanie Babiesô. Many people spend hundreds of dollars a year on their pets - some people spend thousands. Again, if you are charging more than your competitors, you have to look at how youíre packaging your offering and reevaluate your target market. Markets donít set prices, marketers do.
Ellen Rohr is President of Bare Bones Biz, Rogersville, MO. She is also author of two business books "How Much Should I Charge?" and "Where Did The Money Go?" Both are available at bookstores everywhere. Her web site is www.barebonesbiz.com.
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”2001 The New Jersey Small Business Journal