Jay Holmes, The Daily Record Newswire
I am often asked to help businesses analyze the cost of their products or services.
Most of these inquiries end as quickly as they start. I always ask why the business owner wants to know this information. Often, it is because they are trying to price their products. Knowing the true cost of a product can be helpful in plenty of situations, but it only creates an artificial ceiling for your pricing. Cost is not the main concern; value is.
Think back to the time you were in the grocery store looking at cereal. You might have been trying to decide whether to buy the name brand cereal or the off-brand. The cost difference can be as much as 40 percent which is enough to make that decision substantial. I generally go with the name brand cereal. I have never rationalized that it must cost twice as much as the off-brand cereal to produce when making that decision. Not once. I buy the name-brand cereal because I think it tastes better, it is healthier and is overall a superior product - thanks to great marketing. I buy the name-brand cereal because I think the extra value I receive is equal to the increased price.
How is value determined? Value can be increased by focusing on your customer’s wants while delivering their needs. To explain this, let’s look at a coffee drinker. This person needs a cup of coffee, but what do they really want? Some people want the cheapest cup of joe they can get their hands on, others want great tasting coffee, exceptional service and consistency, or even the luxury of “getting a treat.” That’s why Starbucks can charge 25-50 percent more for a cup of coffee than McDonald’s. It isn’t that their coffee costs that much more to make. Starbucks identifies the wants of its customers and delivers them on a consistent basis and extremely well.
McDonald’s does the same by being the lowest priced option. These represent two totally different pricing strategies.
The scary thing about following McDonald’s pricing strategy is that there can be only one low price in any one market. This generally creates extremely price-sensitive customers without much loyalty who will divert easily at the next low price. Because of this, it is advisable to search out a customer group’s wants and deliver those exceptionally well. This removes the price from the main conversation and allows your business’s key qualities to surface: in other words, your value.
If you want to find out what your customers really want, simply ask them and sit back and listen. Focus on your customers’ wants that align best with your company’s strengths.
How do you know that you are in the right ballpark with your price? You actually want some people to turn down your product or service based on the price you offer. While the exact amount will be different for each individual business, a range from 10-25 percent is healthy. If you never have anyone turning down your products or services, you know that your prices are too low. You are leaving money on the table and you could be a lot more profitable if you raised prices. If customers balk at your prices frequently, you are either charging too much or not communicating value properly. No matter which side you are on, there is always room for improvement in communicating value. The better you become at this, the more you can charge. The more you can charge for doing the same amount of work means more cash in the bank at the end of the day.
Analyzing costs can be useful for many things, such as efficiency, effectiveness and benchmarking. But when it comes to pricing your product, you need to focus on the value you are creating and how effectively you are communicating that value to your customers. If you focus on value, your customers will reward you.
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Jay Holmes is a CPA @ Blueback Accounting. He focuses on the operational side of business, including bookkeeping, accounting processes and business consulting. He can be reached at 208-629-8141 or Jay@bluebackaccounting.com
