Here are 3 basic principles that all SME business owners MUST understand and apply
1) Understand the value you bring to the client relationship and don’t be afraid charge what you are worth.
There are 2 ways of looking at pricing your products and services – “cost plus” is the most common. You add up all the costs you can identify that are associated with the sale (materials, labour, shipping, etc) and then add a profit margin that covers your overhead costs. So, what is wrong with this? This approach often eliminates any advantages you have been able to build into your business – better buying, productivity gains, lower overheads etc. As your costs go down, so does your sell price and therefore the profit you make – and that’s just dumb! Just think how much profit Apple would lose if they used this method.
For generations, marketers have talked about “market pricing” – this approach tries to establish the maximum price that the customer will bear to receive your product or service in the volumes that you are prepared to supply (a basic supply and demand relationship). So how do you simply apply this approach? If you are confident about the quality of your offering then quite simply, put your prices up! Most often we find that when we do this we get little to no pushback from loyal clients, because they know the value added is not just in the price of the product or service. I know this is hard to do but give it a try. Recently I challenged a client to increase prices by 10%. In the first month he would only increase by 5% and at our next meeting I asked, “how much push back did you get?” “none” was the answer “OK then put them up another 5%”. At our next meeting I asked the same question; he said two clients pushed back so I said “what did you do?” “I gave them a 2.5% discount if they paid their account on time”. Here is a business owner that learned something about the value his business adds to clients. The beauty of this approach is that every dollar of increase you get has no additional cost associated and it all flows through the business as profit.
2) Understand the impact of discounting, do the calculation BEFORE you offer a discount.
If you are making 30% gross profit and you discount your prices by 10% do you know how much more you need to sell at this new price to make the same gross profit dollars? No? Well can I suggest that until you work this out you do not discount!
The answer is 50%, let’s do the math:
Original 10% discount Extra sales New requirement
Sell $100 Sell $90 Sell $45 Sell $135
Cost $70 Cost $70 Cost $35 Cost $105
Profit $30 Profit $20 Profit $10 Profit $30
GP 30.0% GP 22.2% GP 22.2% GP% 22.2%
3) Know and chase the most profitable sales.
To be able to do this first you need to know which are your most profitable sales – do you know this? You would be surprised at how many small businesses have no idea where their most profitable business comes from. So how can we see this?
Step 1
An accurate costing/ estimating system, which needs to be able to allocate: materials (including wastage), labour (including downtime) and overhead costs to particular jobs, products, segments or markets – you will know what the most logical groups are for your business. This system needs to be constantly maintained to take into account any price increases in materials wages, rent etc.
Step 2
A feedback loop; firstly at a job/product level if possible (especially if you have high-value goods or services). This needs diligence and good internal systems that can trap all time and costs to a particular job in order to ascertain if profit was made in line with expectation. These are typically called “back costings” and should be a routine part of many businesses.
Step 3
Well-structured management accounts. Your accounting system can be a very good tool to provide high-level information on profitability by key segments. Here are some basic rules for setting up your chart of accounts:
a) Track sales by logical groups eg, sales by range or product type, sales of labour hours, sales of parts, sales of shipping, etc
b) Then consider what costs can be directly aligned with these groups eg product purchases by type, direct wages, parts or raw materials purchased, freight and import costs, etc.
c) Once this information is flowing, you can then see the profit you are making on the sales of product range/ type, labour, materials, shipping, etc. Ask your accountant or bookkeeper to help you with this so you can trap this information easily and make qualified decisions.
Once you have established where you are making or losing money, only then can you can go and chase the most profitable sales.
So that’s it, all you need to do now is put this into practice! If you need some help just get in touch.