Pricing In Business

Pricing is 25% of marketing strategy - yet most business owners view pricing as a simple, tactical decision.  The  most commonly used pricing model is "Cost Plus" (since my labor cost is $15 per hour - I'll charge the customer $30 per hour)

Fortunately, entrepreneurial-minded business owners can take advantage of their competitor's weakness by putting aside the "Cost Plus" pricing model and adapting the superior "Price Minus" model.  Keep in mind that the "Price Minus" model may also require adapting your existing business offering to be better aligned with customer demand.  The best way to illustrate the "Price Minus" model is through an example:

The founder of IKEA may be the wealthiest man in the world (nobody knows for sure since his largest asset is privately held).  IKEA embodies the "Price Minus" strategy.  Let's examine how IKEA decides to produce a desk for college-bound students.  First, they determine the demand for a desk containing ONLY certain important characteristics (e.g. comfortable, accommodates a laptop) and decide how much people will pay (detail on this to come).  Say they figure $135.  Second, they subtract the amount of profit they need...say $13.50.  Simple math means they have $121.50 ( $135 - 13.50) to build the desk. Ultimately, IKEA's target market (college kids in this case)  will do some searching around for a desk and they find just what they want at IKEA for $135.  But what about IKEA's competitors?  Target has an oak desk for $195 - too expensive.  Pier 1 has a desk for $130 - a stylish one - but without the comfortable, plastic chair that college kids "must have".  

Now that you see the power behind the "Price Minus" model, let's apply a three-step process to pricing any product or service:

1) Identify the Competitive Range of existing prices for all substitutes and alternatives to your business offering.  Example: Southwest Airlines identified that its competitor (at the high-end of the range) North West Airlines charged $450 for a ticket from Minneapolis to Phoenix, while Budget Rental Car (at the low-end) charged $110 to rent a car for the same trip.

2) Estimate your price within the Competitive Range according to the level of difficulty for competitors to "copy" your new pricing strategy.  If your product or service can quickly be duplicated by your competitors you will need to price at the low end of your selected range (about $110 in our Southwest Airlines example) to achieve a first mover advantage.  If your business has the benefit of high barriers to entry (e.g. patents, exclusive licenses) you can price closer to the high end of the Competitive Range (about $450).

3) Launch the new, efficiently-priced product or service.  After determining a price and subtracting the profit your business requires, the remainder is cost.  That cost figure drives the good or service your business produces.  If your good or service cannot be produced at that cost its time to strip out unneeded features.  In the case of Southwest Airlines, the company may have determined that serving peanuts instead of turkey sandwiches is an acceptable cost cut (and what customer would insist on the turkey sandwich if they realized the ticket cost builds in an extra $38).  I implore you...find those turkey sandwiches in your business and stop serving them to your customers!  The other possibility that exists for many businesses is forming an alliance with another entity that allows you to tap its competitive advantage (and superior cost structure).

This post is focused on Pricing strategy, which necessarily requires discussion of Product strategy.  The two go hand in hand.  Product (or service) research allows you to identify the features customer really care about.  Execute the "must haves" flawlessly and forget the rest.  This allows your company to create a unique value proposition that is priced right and most importantly....makes the competition irrelevant.



A Review of EntreLeadership by Dave Ramsey

During the holidays, I like to read genuine, paper-based books.  One chill morning, I was pleased to find in my stocking, a gift from one of my favorite, well-meaning family members: A book by Dave Ramsey called EntreLeadership.

I had heard of his success, but I had also heard reasons why Dave Ramsey is wrong.  However, I am a sucker for anything to do with business or entrepreneurship.  So, I read the book. 

Before I dissect Dave, some context is necessary.  To me, original research synthesized with mind-blowing implications for business, life and the future of mankind, written by a true thought leader, make for a great book.  In other words, the author’s work should be supported by facts.  Books such as Blink by Malcom Gladwell (how people make decisions) and Stumbling Upon Happiness (how people become “happy”) by Dan Gilbert fit this description.  EntreLeadership definitely does not.

Before I tell you what I liked about the book, let me give you its glaring weaknesses:
·         Oversimplification.  Sorry Dave – nothing about business is that simple.  Even the fine virtue of hard work (hardly a revolutionary concept) has been known to fail occasionally in business.
·         One dimensional.  If you are an engineer thinking about starting a flower arranging business on the side – Dave’s steps to success will be helpful.  Just say on the other hand you have a brilliant software concept you want developed.  Heed Dave’s advice at your own risk.  Your software developers may not stick around if you do as Dave does and tell your employees they “are stealing your money” by showing up at 8:10 (Dave’s office opens at 8:00 sharp).  No, people with skills don’t put up with that when millions of other startups are starving for talent.   
·         He’s too focused on debt as a big obstacle for business.  Dave doesn’t agree with debt.  Guess what Dave.  Hardly anybody can get a business loan these days.  Not even prime borrowers.  Bank of America started 2012 off by stating they are calling in existing business loans.  Even if they wanted to do so – there are no aspiring business people leveraging themselves to the hilt like it is 2005. 
·         Dave scoffs education (except for his Financial Peace Academy - $2,000 for 11 seminars).  He may be on to something.  If you want to start a window washing business –just get out there, have passion and do it.  However, if you are excited about a more complex field (e.g. medical devices or market research) – you just may need some academic background before you hang your shingle out.
·         Technology!  In a “practical” book about business the failure to mention technology is an inexcusable oversight.  It’s by far the most important, multi-decade trend reshaping every business from Mom and Pop’s shop to Google.  Any leader that ignores technology is clueless.    

In summary, Dave’s book is not all bad.  It’s not Jim Collins’ Good to Great (which actually includes research).  It’s more along the lines of Chicken Soup for the Soul.  And I truly mean that in a soft, nice sort of way.  For the high school student, the disgruntled cubicle grunt or bored retiree thinking about starting a business there is inspirational value.  So, yes in the end I am recommending the book –depending on who you are. For the serious business leader seeking an edge in the fast moving market place known as USA, I am going to ironically repeat some Dave Ramsey wisdom: Save your money!