Underpricing your product or service can be dangerous to your bottom line.
Nellie Akalp, entrepreneur and founder of CorpNet.com, explains that: “Even though you might land the sale, underpricing your products and services comes at a cost. … Entrepreneurship is challenging enough without feeling like you’re underpaid and overworked. Charging too little can not only put a damper on your revenue potential, but it can also douse your enthusiasm for your business.”
Raising prices, however, can cause anxiety. How will customers react? Will you still be able to find new business?
If you provide a valuable service, customers may be happy to pay more for what you do.
Contractors, including carpenters, plumbers, and remodelers, often wrestle with this pricing problem. The decision to raise prices requires careful thought, analysis, and a commitment to position your services in a more effective way.
If you sense that you should charge more, but you’re not sure how to proceed, read on.
Learn about how to manage your finances as a freelancer here.
Understanding customer perceptions
Your ability to charge more is closely tied to customer perceptions about your business.
As Wendy Maynard points out: “You may think that when your clients buy from you that it’s a rational process. The truth is, it’s not. No matter what you are selling, buying is actually an emotional decision.”
Maynard goes on to say that: “… the amount you can charge (and get people to pay) for your services is entirely based on your prospects’ perception of value.”
Business Directory defines perceived value as: “A customer’s opinion of a product’s value to him or her. It may have little or nothing to do with the product’s market price, and depends on the product’s ability to satisfy his or her needs or requirements.”
Think about your auto mechanic, for example.
Finding a repair shop that you can trust is a big deal. When you do find the right mechanic, you’ll probably stick with him or her, because maintaining a reliable car is critically important.
Now, you can easily Google the average cost of any repair that your car needs, and compare the total to your mechanic’s quote. If you need new spark plugs, and your local mechanic is charging 15% more than the price you find online, will you go somewhere else?
Probably not.
The fact that you know your mechanic, and that the repair shop has treated you fairly and fixed your car quickly in the past is worth 15% more to you. Reliability and convenience are important when it comes to car repairs, and for many other business transactions.
Consider your current book of business, and how customers interact with you. When you provide a quote for a service, do customers generally accept the price without complaint? Are you getting referrals? Do clients pay you quickly?
If you can answer, “yes” to these questions, you can probably charge more for your services.
Experiment with a price increase
If you decide that you should charge more, but you’re concerned about losing business, experiment with a limited price increase.
Keep in mind that a fear about raising prices is common among business owners.
As GrowthCast points out: “Many business owners think that if they raise their prices, it will scare-off their customers and they’ll look to your competitors.”
Consider this unexpected benefit
There is one benefit of increasing prices that you may not consider: Less-desired customers may leave, and that can be a good thing.
Another quote from GrowthCast: “Having the right customers is what matters most to a business. If you raise your prices, your low-quality customers will leave and go elsewhere – leaving those high-quality customers who see the value in what you charge.”
Low-quality customers take up too much time, complain, and push back on price increases. They act this way because they don’t believe that you offer a highly valued service.
Increasing your prices is the perfect opportunity to end the relationship, without creating a great deal of friction.
So, how do you handle the situation?
When a low-quality customer emails or calls to complain about your higher price, simply explain that the price increase was necessary, and that you understand if they go elsewhere. Thank them for their business, and move on.
This decision allows you to spend more time with better quality customers who value your service. You’ll generate higher profits, and get rid of some headaches.
Implementing a pricing experiment
To find out if customers are willing to pay more, increase the sales price on some of the products you offer, and analyze the impact on sales.
Assume, for example, that Sally owns a furniture company. She increases the price on dining room tables by 10% on March 1st, and notices that sales remain strong all through March. Since customers are willing to pay more, Sally keeps the higher price in place moving forward, and generates a higher profit on dining room tables.
If sales decline, Sally can reduce the sales price back to the original level.
Experiment with higher prices on all of your products to assess customer demand.
Deciding how much to increase prices
Once you decide to increase prices, and you’ve experimented with some price increases, the next step is to determine the amount of your price increase.
Consider these pricing factors
Pricing your product is an art, and not a science, and you must consider a number of factors to decide on an appropriate sales price. A key driver of your sales price is the amount of profit you hope to generate from each sale, and your should consider these factors related to profit:
- Profit margin: Profit margin is defined as (net income / sales), and this ratio explains the profit earned on each dollar of sales. This metric is a great tool to compare the profitability of products with different sales prices, and you should start your pricing analysis with this metric.
- Industry: Your profit margins will be affected, in part, by your company’s industry. If your curious about your particular industry, review the annual report of any public company, you’ll find a discussion of the firm’s profit margin by product, or by company division. Some industries, such as grocery stores, have profit margins of 1-2%, while other industries generate profit margins of 20% or more.
- Competition: If you operate in an industry with a large number of competitors, you may be forced to keep your prices lower than you prefer. Think about two gas stations that are across the street from each other, for example. Station A must keep its gas prices at or below Station B’s, in order to drive sales. Firms with less competition have more flexibility when pricing a product.
- Perceptions of value: As discussed above, the biggest profit factor is the customer’s perception of the value of your product or service. If clients strongly believe that your product solves a problem, they may be willing to pay more. On the other hand, if your product is viewed as commodity that a client can buy from many different companies, it will be difficult to increase your prices.
Take each of these factors into account when you price a particular service. All of these factors impact the profit you can generate, and the sales price you can charge.
Evaluating your sales mix
Most companies sell more than one product or service, which is why you should consider your sales mix when you price a particular item.
Each product or service may have a different profit margin, and a business can change the sales mix of products to generate a higher overall profit.
For example, assume that the hardware store earns $4 on a garden hose priced at $20, and $45 on a $300 lawn mower. The profit margin on the garden hose is ($4 / $20), or 20%, while the lawn mower profit margin is only 15% ($45 / $300).
The lawn mower generates far more revenue, but less profit per dollar of sales. The hardware store can increase the company-wide profit margin by selling more garden hoses and fewer lawn mowers.
Take the time to analyze your firm’s sales mix.
Ask for referrals
Ask your best customers for referrals, and you may see a huge increase in sales.
Every successful business has high-quality customers, and some even have brand advocates, those highly satisfied customers who recommend your product or service without being paid to do so.
To increase your sales, put a formal process in place to ask for referrals.
Now, many companies are hesitant to ask the referral question, because they don’t want to make clients uncomfortable. However, there are many ways to ask for referrals, and many don’t require a one-on-one conversation.
Entrepreneur.com suggests asking your clients using an email, webpage, or by adding a note to your customer invoices. Say something like this: “I find most of my best new customers from client referrals. If you’ve had a good experience with my company and know someone who needs our services, please let me know. Thanks!”
Ask for referrals to find more high-quality customers, and you can grow sales without increasing your marketing and advertising budget.
Meet Julie, a contractor who wants to increase profits
Julie owns and operates Sterling Remodeling, a firm that provides kitchen and bath remodeling services.
In recent years, Julie’s business has grown, and her customers rave about her work quality. She gets very little customer resistance on her pricing, and Julie suspects that her prices could be higher.
To find out, Julie increases her pricing on two smaller jobs she quotes during May, and both clients quickly accept her terms. Next, Julie researches remodeling prices on the web, and asks some of her better customers if they are willing to share bid information from any competitors.
Based on the results of her research, customer feedback, and the price increase experiment; Julie increases her kitchen remodeling prices by 10 percent, and bath remodeling work by 12%.
Finally, Julie adds a paragraph of information to each invoice to ask for referrals, and she adds referral requests to her website’s home page.
Action steps to take
You’re a serious professional who provides a quality service, and you shouldn’t hesitate to increase your prices and ask for referrals.
Here’s how:
Now
Consider the satisfaction level of your current book of clients, and research your market to find out what competitors are charging the similar work. Your former customers are a great resource, because most people get multiple bids for contracting work.
Analyze the profit margin you earn, on average, and compare the ratio to your competitor’s results (if possible), and to the average for your industry.
Create a plan to formally ask your best customers for referrals.
Periodically during each year
Successful business owners analyze pricing, track cost continually, and should try some pricing experiments during each year. Use the information, along with your research to consider price increases. Keep in mind that your profits may be different, depending on the type of service a customer needs.
As you move through this process, you may find that your competitors quote much higher prices, which is additional validation that you’re on the right track. Also, pricing can play a critical role in customer perceptions, because increasing your prices communicates to the client that you’re offering more value.
To get your business results to the next level, you need to have the confidence to increase your prices. You work hard and offer a quality service, and you should be fairly compensated.
Increase your prices to grow your business- you deserve it!
This article originally appeared on the QuickBooks Resource Center and was syndicated by MediaFeed.org.
Featured Image Credit: Ridofranz / iStock.
