Pricing is not a maths problem. It’s a judgement problem

…X being their flagship product or brand-new service.

I think they expect me to peer into their accounts – almost like looking into a crystal ball – and come up with the “correct” answer.

I hate to disappoint them…

There is no formula that can tell you what to charge and no objective, right answer.

You have to weigh up lots of different factors, then take your best educated guess – and test to see how that lands with your customers.

As Michael Dearing, who ran pricing at eBay for many years, once put it, “Pricing is not a math problem. It’s a judgment problem.”

It’s important to realise this because right now, we’re in an extremely unstable economic environment, with galloping inflation, interest rates, taxes and costs. To protect their profit margins, many companies have no choice but to raise their prices.

If that’s a move you’re contemplating too, the difficult part is always: “How much by?”

I see it as a puzzle with three parts.

Last week, I explored one of them – your customers. You can only charge what the market will bear, so if you misjudge how much your best customers are willing to pay, you’ll end up in trouble.

This can be really hard to judge in advance, especially as surveys asking people how much they’ll pay for a particular product or service are notoriously unreliable. People are terrible judges of their own future behaviour!

The next component is your own costs. You really need to know your numbers inside out, so that you understand exactly how much it costs you to run your own business…

…And how that’s changing in the current turbulent economy.

After all, there’s no point raising your prices only to discover in a couple of months that you’re running a loss again!

Again, it’s difficult to foresee what might happen a few months down the line. But a good finance director will look at your entire supply chain and play with different scenarios so you can see both best-case and worst-case circumstances.

Finally, there’s your competition.

How much are they charging, and by how much are they raising their prices?

I’m not suggesting you should automatically match them, undercut them or do exactly what they’re doing.

But you must be aware of what’s going on in your own market. It affects the way your customers might react when you change your prices. If they have other options, they’ll be less likely to stick with you.

And if you want to charge more than the competition, it could also change how you position your product or service to make it appear more attractive.

Again, you need real numbers and real information, not guesswork and “Last year they charged X…”

So give an intern or a junior the job of listing all your key competitors, and researching what they charge. They should also map out exactly what the alternate products or services consists of, so you know whether you’re comparing apples to apples.

The answer to the question, “How much should you charge,” lies somewhere in the information you gather from these 3 C’s – your Customers, Costs and Competition.

Like I said, there’s no formula you can apply. But I find that when you gain as much clarity as possible on your situation and weight it all up, an educated guess usually emerges. You can then test it to see if you’re right.

Yes, your new price is still a guess, so intuition does come into it.

But there’s an enormous between difference raising your prices by 12% “because it feels right”…

…and doing it because you’ve looked closely at the numbers and concluded that this will leave you with a 23% profit margin even if things go horribly wrong, and that you’ll still be competitive – because you’ve looked at what others in the marketplace are doing.

The former is a reckless gamble, and will probably feel like it!

The latter is an informed judgement call, which is much safer and much more likely to pan out. Your numbers are there to help you make better decisions.

And won’t you sleep better at night knowing you’ve mapped out your options and understand them before acting?

That’s the kind of thorough, responsible process that mature companies with well-run finance departments go through when they need to raise their prices.

And it’s the kind of process we take our clients through too. It’s all part of our work to help you grow faster and maximise your profit, by managing your money smoothly and professionally, like corporates take for granted.

If that’s the kind of financial management you’d like for your company, hit ‘reply’ to this email or call me on 01279 647 447 to get in touch today for a no-obligation chat about your situation – and how we can help you.

Warmly,

Garry