Pricing is a sensitive game. Contrary to popular belief, winning does not always depend on the lowest price. In fact, I would caution heavily against simply pricing your product the lowest as low pricing is not a strategy. You might be thinking “that’s not true, what about Wal-Mart.” True, Wal-Mart does have low prices, but I would argue that Wal-Mart is pursuing a low cost strategy which is not the same as simply a low price. Small business, especially, should take note as they have competition from larger players with deeper pockets that can play the 'low price' game much better and longer.
To find the perfect price, it is important to find a price that is supported by the 3 pillars of pricing: economics, marketing and accounting.
Economics
It's as simple as supply and demand: raise the price, quantity demanded goes down; lower the price, quantity demanded goes up. The trick is finding the profit maximization point, the price and output that yield the highest profit. In pricing strategy it is important to take into consideration the price elasticity of demand (Ep). Price elasticity of demand is the percent change in quantity demanded of a product for a percent change in price (Formula: Ep= (▲Qd/Qd)/(▲P/P). To find out your price elasticity, set a price for your product for one week and see how much product you sell (that will be your P1 and Qd1), then for the next week chose a different price and see how much you sell then (P2 and Qd2). This is not a perfect science, as other factors are at play, but it will give you a good idea. Plug those values into the formula Ep= (▲Qd/Qd)/(▲P/P) = [(Qd2-Qd1 )/((Qd1+Qd2)/2)] /[(P2-P1)/((P1+P2)/2)] and you will get that product’s Ep. The value you get is referred to in absolute terms (>0). If the number is between 0 and 1, your product is “inelastic;” meaning, that a change in the price will likely not change quantity demanded all that much. This is characteristic of products with a low number of substitutes. If your calculated Ep is >1, your product is said to be “elastic;” meaning, a small change in price will likely drastically change the quantity demanded. Of course, if you don’t have the time to spend calculating your Ep for your product there are industry websites where you can find the Ep for specific products. This will help speed up the process. A good practice is to do both and compare answers, which will add more certainty to your calculations.
After you have calculated your Ep, it is now important to find your marginal cost. Marginal cost (MC) is the additional cost of producing one more unit of good. When you have your MC and your Ep you can calculate your Markup Price to maximize profit using the formula: (P - MC)/P = 1/ -Ep. Plug in your values of Ep and MC and solve for the Price, P.
This price will give you your profit maximizing price. But, of course, we aren’t finished. This is but one of the three pillars in pricing. Let’s move on to marketing.
Marketing
When you have found your profit maximizing price, it is important to compare that price in the marketplace. How does it align with your competition or industry trends? Performing an in depth market analysis is your next step.
Start with an industry analysis. There are tools to help you with this: PEST Analysis for industry trends as well as Porter’s Five Forces: Bargaining Power of Supplier, Bargaining Power of Buyers, Threat of new Entrants, Threat of Substitutes, and Rivalry Among Competitors. These tools will give you a good idea of what kind of industry in which you compete. If it is a saturated industry with negative trends, price may be an important factor. Or alternatively, if it is an industry with positive trends and a small number of competitors, price may not be an issue. Know your industry as it will help with your pricing strategy.
After you have figured out your industry, perform a competitive analysis. I would start by outlining the key success factors of the industry followed by creating a chart comparing how well you and competitors are performing those key success factors. Then, you should complete a SWOT Analysis to give you a good idea of how your company matches up. Knowing how well your competition performs is important when setting a price. For example, if post-purchase service is a key success factor in your industry and your company is beating all your competitors, then you might be able to charge a higher price for that service.
After completing a detailed analysis make a pricing chart comparing your profit maximization price with the prices of your competitors for the same product. Taking into consideration industry forces and trends, how competitive is your price? Can it go higher? Should it go higher? Do you need to lower it? However, before making any drastic changes let’s take a look at how accounting plays into the equation.
Accounting
Accounting is a crucial pillar in pricing strategy. Yes, pricing your product at the profit maximization point in addition to being aligned with your customers and competition is important, but maybe not as important as covering costs and making and accounting profit. This is were breakeven analysis and cost accounting come into play.
First thing to do is to allocate all the costs that go into the production of the product: (i) Direct Material, (ii) Direct Labour, (iii) Overhead (indirect material, indirect labour: like the foreman’s time spent overseeing the product’s production). Break down those costs for the product into per unit costs (based on actual unit production), then add them together. You might be thinking to yourself: why would I include the foreman’s time on the product? When selling your product it is very important to cover all the costs; so, in cost accounting we allocate all costs directly to the product itself to ensure that each product covers its own costs. Once you have you’re per unit cost, decide how large of a mark-up you can have (taking into consideration marketing and economics) and add that to the price.
Now you might be thinking: wait a minute, hold on! The profit maximization and marketing price I calculated is lower than the per unit cost. Don’t worry there is another way to look at it. Instead of a breakeven based on per unit costs you can perform a volume breakeven based on total costs. What I mean is, if you found out a profit maximization price that fits well with the industry and against competitors you can take that price and calculate how many units you will need to sell to breakeven. Once you breakeven, based on volume, every unit you sell above that specified volume is profit.
What is important is to find a price that is supported by all three pillars. This price will be more sustainable for your company than an arbitrarily low price. If you find you need to raise your price to cover costs, you can rearrange your Ep formula to see how that affects quantity demanded. If you need to lower your price based on market trends and competitive pressures then you can solve for your new volume and increase sales support and marketing to ensure you hit your new volume target. The idea is to change your price until you find the perfect price that is supported by all pillars.
Finding a price which is supported by all three pillars is pivotal in your company's success!
Monday, February 28, 2011
Tuesday, February 22, 2011
Expansion Strategy: Know Your Options
Expansion: an exciting, yet stressful, time for a business. Expansion is great! It means you did something right and the next logical step is to grow. But before you go ahead, there are a few options to consider: franchising, licensing, or a new location entirely. It is important to know not only the difference but also, which one is right for you.
Franchising
Franchising is the practice of using another firm's successful business model. To franchise your business there are few factors that you need to be an attractive franchisor:
1. High Profitability
No one wants to buy a franchise, pay royalties and never have anything left. Franchisees are looking for a high profit margin and a short payback period. Can you offer this?
2. Easily Duplicated Business Model
Do you run a business where the number one asset is you? Since cloning is yet to be perfected, if you are the reason your business succeeds then franchising is not a feasible option. Does your business have sound policies and procedure? This is a must if you want to franchise, because your brand is going to be run by someone else. To protect your brand you have to ensure that your franchisee knows what to do and when. Are you set up to supply your franchisees? The majority of successful franchises supply their franchisees. This way they can make money off the supplies and it helps with consistency. Remember, your brand is in someone else's hands, so consistency is important. Finally, are you able to provide training to the new owner? Again for consistency, it is crucial that the franchisee receive the proper training.
3. Financial Resources
Many franchisees look for financing help. Do you have a close relationship with a lending institution that is willing to lend to your franchisees? Many franchisors offer this, because their franchises are such proven successes. To compete, it is important that you offer some type of financial assistance.
4. Know your Stuff
Potential franchisees are going to want to know everything from who your customers and competitors are to industry changes to profitability to payback and ROI. Make sure you know your business inside and out. Nothing scares away franchisees more than a franchisor that doesn't know their own business.
Licensing
Licensing comes in a few different forms: intellectual property licensing, trademark/brand licensing, artwork/character licensing. But, they are all essentially the same thing. Licensing is granting permission to another to use your licensed material.
To license here are some things you should know:
1. Brand, Brand, BRAND!
Brand is usually everything. Do you have a recognizable brand and, more importantly, is it recognizable in the area in which you plan to license your product? This is very important. People are only willing to pay for brand if there is already brand awareness. Be sure.
2. Watch out for copycats!
Especially when going across borders. It can become very pricey defending license infringements. Be sure the company to whom you are licensing is reputable. Be careful not to give away plans or processes without the proper contracts in place first. Finally, be aware of the country’s intellectual property laws; make sure they defend the owner.
New Location
If you like to keep total control, maybe franchising and licensing aren’t the best fit. If you don’t mind dishing out a few extra $$ because you know, you create success, then a new location is probably your best option.
Adding a new location to your company’s repertoire is possibly the most time consuming and expensive route. But, you get to stay in total control. Of course, a new location doesn't expressly mean physical, it could be a new place you supply, advertise or offer your services. A new location is simply a new place that you currently have no operations.
Here are a few things to consider:
1. Money: Not only do you need the funds for expansion but it’s also crucial that you have working capital to run your new location’s operations. Now I'm not saying that franchising and licensing are free, but, this option can really drain funds. Think about when you opened your current location and how much it cost.
2. Location is key: Does the new area fit with your strategy? Is your customer in the region? Can your suppliers easily access the new spot? It is important to reflect on these questions before you spend money on expansion.
3. Competition? For some businesses it does not matter, for others, you may not want any competition for miles. Know your business and how competition affects it. Then, figure out your new location.
4. Consider building, accessibility, traffic etc. If you’re looking at a physical location: Has the electrical been updated lately? Renovations? Maintenance? How is the traffic in the area? All valid questions. Again, it is imperative that you know your business and what affects it. If you are an internet business, building might not matter at all, whereas with a restaurant location is usually very important. Know what is important for your business.
5. Balance cost/benefits: Is that location downtown really going to increase revenues enough to cover the added cost? Make sure you forecast, survey, and conservatively estimate. There is no sense paying the big bucks if you can’t match it in revenues.
Obviously, there is more to it than a few points, but this is a good start. It should give you an idea of which expansion option is the best for your business.
Remember, above all else: know your business.
Franchising
Franchising is the practice of using another firm's successful business model. To franchise your business there are few factors that you need to be an attractive franchisor:
1. High Profitability
No one wants to buy a franchise, pay royalties and never have anything left. Franchisees are looking for a high profit margin and a short payback period. Can you offer this?
2. Easily Duplicated Business Model
Do you run a business where the number one asset is you? Since cloning is yet to be perfected, if you are the reason your business succeeds then franchising is not a feasible option. Does your business have sound policies and procedure? This is a must if you want to franchise, because your brand is going to be run by someone else. To protect your brand you have to ensure that your franchisee knows what to do and when. Are you set up to supply your franchisees? The majority of successful franchises supply their franchisees. This way they can make money off the supplies and it helps with consistency. Remember, your brand is in someone else's hands, so consistency is important. Finally, are you able to provide training to the new owner? Again for consistency, it is crucial that the franchisee receive the proper training.
3. Financial Resources
Many franchisees look for financing help. Do you have a close relationship with a lending institution that is willing to lend to your franchisees? Many franchisors offer this, because their franchises are such proven successes. To compete, it is important that you offer some type of financial assistance.
4. Know your Stuff
Potential franchisees are going to want to know everything from who your customers and competitors are to industry changes to profitability to payback and ROI. Make sure you know your business inside and out. Nothing scares away franchisees more than a franchisor that doesn't know their own business.
Licensing
Licensing comes in a few different forms: intellectual property licensing, trademark/brand licensing, artwork/character licensing. But, they are all essentially the same thing. Licensing is granting permission to another to use your licensed material.
To license here are some things you should know:
1. Brand, Brand, BRAND!
Brand is usually everything. Do you have a recognizable brand and, more importantly, is it recognizable in the area in which you plan to license your product? This is very important. People are only willing to pay for brand if there is already brand awareness. Be sure.
2. Watch out for copycats!
Especially when going across borders. It can become very pricey defending license infringements. Be sure the company to whom you are licensing is reputable. Be careful not to give away plans or processes without the proper contracts in place first. Finally, be aware of the country’s intellectual property laws; make sure they defend the owner.
New Location
If you like to keep total control, maybe franchising and licensing aren’t the best fit. If you don’t mind dishing out a few extra $$ because you know, you create success, then a new location is probably your best option.
Adding a new location to your company’s repertoire is possibly the most time consuming and expensive route. But, you get to stay in total control. Of course, a new location doesn't expressly mean physical, it could be a new place you supply, advertise or offer your services. A new location is simply a new place that you currently have no operations.
Here are a few things to consider:
1. Money: Not only do you need the funds for expansion but it’s also crucial that you have working capital to run your new location’s operations. Now I'm not saying that franchising and licensing are free, but, this option can really drain funds. Think about when you opened your current location and how much it cost.
2. Location is key: Does the new area fit with your strategy? Is your customer in the region? Can your suppliers easily access the new spot? It is important to reflect on these questions before you spend money on expansion.
3. Competition? For some businesses it does not matter, for others, you may not want any competition for miles. Know your business and how competition affects it. Then, figure out your new location.
4. Consider building, accessibility, traffic etc. If you’re looking at a physical location: Has the electrical been updated lately? Renovations? Maintenance? How is the traffic in the area? All valid questions. Again, it is imperative that you know your business and what affects it. If you are an internet business, building might not matter at all, whereas with a restaurant location is usually very important. Know what is important for your business.
5. Balance cost/benefits: Is that location downtown really going to increase revenues enough to cover the added cost? Make sure you forecast, survey, and conservatively estimate. There is no sense paying the big bucks if you can’t match it in revenues.
Obviously, there is more to it than a few points, but this is a good start. It should give you an idea of which expansion option is the best for your business.
Remember, above all else: know your business.
Thursday, February 17, 2011
Technology and your business: Why Before When
In today’s eWorld technology is everything and everywhere. But how can you make it work for you? You: the business owner. I know, technology promises to make things easier, faster, and more profitable – but will it really? It depends. It comes down to your business strategy. What I mean, is your business strategy needs to be outlined well before you incorporate technology into the mix. Don’t go spending money on technology hoping a strategy will fall into place, hoping your business will grow and become more profitable.
Technology should be applied to a strong business strategy – not, be the strategy itself. Technology can be a godsend but only if it fits within your value proposition.
Let me illustrate:
You own a small but successful coffee shop. For years you have enjoyed a virtual monopoly because you are the only coffee shop in the area. But the real reason you are successful is that your customers enjoy the experience of going to your shop. You have managed to pay off all your debts and saved a good amount of money over the years. One day, across the street, Starbucks opens up. You a terrified because you think that all your customers will flock to Starbucks. Without too much thought you decide to diversify your business thinking that the losses you incur from the lost customers can be made up from the new business. So you buy an internet business. Having been selling coffee for the past 15 years you know little to nothing about running an online business, but that doesn’t discourage you, you know that technology is the new way to go, so you invest many hours and dollars learning the trade. Meanwhile, your customers from the coffee shop start to feel neglected and wonder where you are. Slowly they actually begin to go to Starbucks because the value they once saw from your coffee shop (the great customer service you offered) is now gone.
This story outlines a common mistake in business. A threat appears or a new technology pops up and every company gets antsy. The first thing you should do when a threat appears or a new technology comes around is to first take a step back and analyze your value proposition.
The way you analyze your value proposition is to outline:
1. Your Goals: what you want your business to achieve;
2. Your Product Market Focus: what are the products/services you sell (or plan to) and to what markets; and
3. Your Core Activities: What are the value-adding activities your business does (or will do)
From these three components formulate your value proposition: what your business does to attract customers and add value to the market place. After you have outlined your value proposition, take a step back and try to see how technology can improve or help build momentum to your value proposition.
Never (and I mean never) add technology as a way to create a breakthrough. Think back to the story. If the owner had taken a step back and seen his/her value proposition he could have invested in technology that would have enhanced it as opposed to crippling it.
Remember, technology can be very beneficial to your business but it has to mesh well with your strategy.
Technology should be applied to a strong business strategy – not, be the strategy itself. Technology can be a godsend but only if it fits within your value proposition.
Let me illustrate:
You own a small but successful coffee shop. For years you have enjoyed a virtual monopoly because you are the only coffee shop in the area. But the real reason you are successful is that your customers enjoy the experience of going to your shop. You have managed to pay off all your debts and saved a good amount of money over the years. One day, across the street, Starbucks opens up. You a terrified because you think that all your customers will flock to Starbucks. Without too much thought you decide to diversify your business thinking that the losses you incur from the lost customers can be made up from the new business. So you buy an internet business. Having been selling coffee for the past 15 years you know little to nothing about running an online business, but that doesn’t discourage you, you know that technology is the new way to go, so you invest many hours and dollars learning the trade. Meanwhile, your customers from the coffee shop start to feel neglected and wonder where you are. Slowly they actually begin to go to Starbucks because the value they once saw from your coffee shop (the great customer service you offered) is now gone.
This story outlines a common mistake in business. A threat appears or a new technology pops up and every company gets antsy. The first thing you should do when a threat appears or a new technology comes around is to first take a step back and analyze your value proposition.
The way you analyze your value proposition is to outline:
1. Your Goals: what you want your business to achieve;
2. Your Product Market Focus: what are the products/services you sell (or plan to) and to what markets; and
3. Your Core Activities: What are the value-adding activities your business does (or will do)
From these three components formulate your value proposition: what your business does to attract customers and add value to the market place. After you have outlined your value proposition, take a step back and try to see how technology can improve or help build momentum to your value proposition.
Never (and I mean never) add technology as a way to create a breakthrough. Think back to the story. If the owner had taken a step back and seen his/her value proposition he could have invested in technology that would have enhanced it as opposed to crippling it.
Remember, technology can be very beneficial to your business but it has to mesh well with your strategy.
Monday, February 14, 2011
Smile, the Real Secret of Customer Service
The idea that a business can survive without creating a positive experience for their customers is ridiculous. The Internet and the global economy create choice for the consumer, which means he or she can go anywhere for the product you offer – this is where customer service comes in. The reason you originally get a new customer is because you are offering a product or service that that customer needs. The reason you keep that customer, is because that customer viewed the original purchase as a positive experience and hence keeps coming back.
I go to the same coffee shop every morning. It’s not because of their coffee; I could probably find a better cup somewhere else. The reasons I go there are because they know me by name and provide me with an exceptional amount of service.
Don’t get me wrong, I’m not trying to lecture customer service as a new concept. There are literally thousands if not millions of businesses out there who have grasped the concept. No, the concept I am trying to outline in this post is that customer service really starts with a smile.
I want you to stop and think of a good experience you’ve had as a customer that didn’t include a smile. Can you think of one? Even when you’re on the phone, it’s almost as if you can feel a smile through the phone when it’s happening. Nothing says, "Hey, I'm approachable and my product is amazing" like a good ol' fashion smile. People are never intimidated by a person who is smiling! If you’re not convinced that one of the most important things in customer service is the smile, then let me outline a few points:
1. McDonald's (Fortune 500 Company…who doesn’t know McD’s) profits in 2010 were $4.95 Billion, up 5% from 2009. If you take a close look at their menu, you will see that they are giving away smiles for free. Think there’s a connection?
2. The Dalai Lama once said, "If you smile, life becomes sweeter. After all, if I smile at you, you will smile back!" Smiling emits a happy emotion that makes the receiver of the smile happy. As a customer, would you not go to a place that makes you feel happy?
3. Now think of Dirty Harry, he didn't smile. Did it make you want to buy products from him? My thoughts exactly!
You can have all the training in the world for your employees, but if they don’t smile I promise you it won’t matter. If you really want to create an experience for your customers then first thing to do is smile.
Try it out and I bet your customers will keep coming back. :)
If you would like some further reading on the customer experience take a look at the 1999 Harvard article by J. Pine and J. Gilmore: The Experience Economy.
I go to the same coffee shop every morning. It’s not because of their coffee; I could probably find a better cup somewhere else. The reasons I go there are because they know me by name and provide me with an exceptional amount of service.
Don’t get me wrong, I’m not trying to lecture customer service as a new concept. There are literally thousands if not millions of businesses out there who have grasped the concept. No, the concept I am trying to outline in this post is that customer service really starts with a smile.
I want you to stop and think of a good experience you’ve had as a customer that didn’t include a smile. Can you think of one? Even when you’re on the phone, it’s almost as if you can feel a smile through the phone when it’s happening. Nothing says, "Hey, I'm approachable and my product is amazing" like a good ol' fashion smile. People are never intimidated by a person who is smiling! If you’re not convinced that one of the most important things in customer service is the smile, then let me outline a few points:
1. McDonald's (Fortune 500 Company…who doesn’t know McD’s) profits in 2010 were $4.95 Billion, up 5% from 2009. If you take a close look at their menu, you will see that they are giving away smiles for free. Think there’s a connection?
2. The Dalai Lama once said, "If you smile, life becomes sweeter. After all, if I smile at you, you will smile back!" Smiling emits a happy emotion that makes the receiver of the smile happy. As a customer, would you not go to a place that makes you feel happy?
3. Now think of Dirty Harry, he didn't smile. Did it make you want to buy products from him? My thoughts exactly!
You can have all the training in the world for your employees, but if they don’t smile I promise you it won’t matter. If you really want to create an experience for your customers then first thing to do is smile.
Try it out and I bet your customers will keep coming back. :)
If you would like some further reading on the customer experience take a look at the 1999 Harvard article by J. Pine and J. Gilmore: The Experience Economy.
Monday, February 7, 2011
SME Strategy: Develop Internal Processes for Growth
Running a small business is not easy, it takes time and resources. So much in fact, that small business owners, perhaps like you, use it all up focusing almost entirely on the external processes and environment. By this I mean, the way your product gets to the customer, the service during the transaction or post purchase service, for example. Don't get my wrong, such processes are an integral part to a small business and, in reality, without such activities your small business wouldn't exist. But it is this focus of time and resource that hinders your ability to grow as a company.
To be fair, many times external processes are dictated by industry standards, competitors or customer mandates; but if so, why put effort into changing them. Leave the external processes as is because the real secret to growth is the internal processes of your company.
If you want to grow and succeed, the question you have to ask yourself is: how well managed are your internal processes?
The goal of an internal process, is to ensure that procedures are followed to reduce inefficiencies within the organization. Policies create a standardization which companies use to ensure consistency in processes as well as (probably most importantly) problem resolution. Consistency is necessary for growth and it allows your employees to know exactly what to do and when.
So if you are looking to grow your business make sure you have strong internal processes/policies in place so you can deal with the growth strategy and your policies/processes will deal with the issues of your business.
Internal processes add transparency to your business and ensure future success.
Let me know your thoughts.
To be fair, many times external processes are dictated by industry standards, competitors or customer mandates; but if so, why put effort into changing them. Leave the external processes as is because the real secret to growth is the internal processes of your company.
If you want to grow and succeed, the question you have to ask yourself is: how well managed are your internal processes?
The goal of an internal process, is to ensure that procedures are followed to reduce inefficiencies within the organization. Policies create a standardization which companies use to ensure consistency in processes as well as (probably most importantly) problem resolution. Consistency is necessary for growth and it allows your employees to know exactly what to do and when.
So if you are looking to grow your business make sure you have strong internal processes/policies in place so you can deal with the growth strategy and your policies/processes will deal with the issues of your business.
Internal processes add transparency to your business and ensure future success.
Let me know your thoughts.
Hello Out There!
Hello and welcome!
This is officially my first blog under Strategy Sense. This blog will (attempt) to encompass most things to do with with business strategy. I will be focusing mainly on business strategy as it deals with the business as a whole, but from time to time I may dive into a subcategory. I will try to hit many different industries so that it stays relevant for a wide range of readers. I will be blogging at least once a week, posts will be published Mondays so you have the entire week to soak them in.
I look forward to sharing with you.
This is officially my first blog under Strategy Sense. This blog will (attempt) to encompass most things to do with with business strategy. I will be focusing mainly on business strategy as it deals with the business as a whole, but from time to time I may dive into a subcategory. I will try to hit many different industries so that it stays relevant for a wide range of readers. I will be blogging at least once a week, posts will be published Mondays so you have the entire week to soak them in.
I look forward to sharing with you.
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