Small Business Series - A Practical Pricing Checkup, Are You Charging Enough (Ep 3)

Bonus 100 And Series Context

Hi, this is Stephen McLain of the Finance Leader Podcast. This is bonus episode number 100. Now, good day, everybody. We are already on the third episode of this special small business series. The last two episodes consisted of looking at our revenues and profits, followed by last week, when we looked at the importance of our cash flow. If you missed those two episodes, please go back and listen when you get a chance. If you are a small business owner, these short episodes in this series are meant to get you thinking about your situation so you take action and make improvements where you need to for your business and your future.

Why Pricing Changes Everything

Now, this week I am talking about the prices you are charging. What if the reason you're working harder but not making significantly more money isn't a lack of customers? What if you're simply not charging enough? Again, we've already talked about the difference between revenue and profit and why cash flow matters. Pricing directly affects both. Now, before trying to sell more, let's make sure you are making enough on what you're already selling.

Four Common Ways Prices Get Set

Now, small businesses usually establish prices in one of four ways. Now, the first one, they look at what their competitors are charging, and then next, they may add a percentage to the costs and then they come up with a price, or use the same prices they've charged for years. And then finally, maybe they choose a price that they think their customers will accept and not push back on. The problem is that none of those methods necessarily tells the owner whether the price is right for their business. Now, competitors may have different costs, capacity, quality, positioning, more debt or less debt than you have, more employees, and even a different business model. Now, your competitor's price doesn't tell you what your business needs to charge to be profitable.

Mistake One Missing True Costs

Now let's review a few common pricing mistakes for small business. Now, pricing mistake number one, not knowing your true cost. Business owners frequently understand their obvious direct costs, but overlook everything required to operate the business. Now, for a product business, costs usually include your materials, inventory, shipping, packaging, credit card processing, and then also returns or damage inventory. Now, for a service business, it's usually labor hours, contracting costs, your software, required travel, and then any revisions and administrative work. And then, of course, there's overhead. And as the overhead do we often overlook or forget how to apply it, which that means your the uh the cost related to insurance and rent, accounting, technology, your marketing costs, any licenses you need, your cell phone, office supplies you may need, professional services, and then many other expenses. Now let's illustrate this with a very simple example. Let's say you charge $1,000 for a project and spend $200 on direct costs. Well, we can usually see those. Those are not hard to identify. It might look like you've made $800. But what about the 15 hours you spent doing the work, the three hours communicating with the client, and then also include in your software charges, your insurance, and then marketing and any other critical overhead. That $1,000 sale may be considerably less profitable than it appears.

Mistakes Two And Three Margin Fear

Now let's look at pricing mistake number two, and that's confusing revenue with profit. Now we have talked about that before. Now let's go back to episode one of this series for a moment. Selling more at an inadequate margin can actually make the owner's problems worse. Now, more customers can mean more work, which means more expenses, and that also means more complexity, more cash requirements without enough additional profit. Now, more sales don't solve the pricing problem. Sometimes they usually just multiply it. This is particularly important for owners who are already operating near their capacity. Now, pricing mistake number three is pricing based on fear. Now let's address that emotional side. Many owners know they probably should raise prices, but then worry, what if my customers leave? What if my competitors are cheaper? What if someone says no? No, what if I lose the sale? What does that mean to me? What does that mean to my business? Am I going to be losing money going forward? The objective isn't to charge the highest possible price, it is to establish a price that is appropriately balances customer value, market conditions, your costs, and then of course the required profitability. A business that consistently underprices itself may win customers while simultaneously weakening itself. A price that attracts customers but doesn't adequately support your business isn't a sustainable price.

Mistake Four Same Price For All

Now pricing mistake number four, charging everyone the same way. What we want to do is determine the difference between servicing your customer and also taking care of your own business. Now some customers require more support. They request frequent revisions, they pay late, and they order in small quantities. Some may require rush delivery or consume disproportionate amount of your time. Others are easier and less costly to serve. Likewise, different products and services can have substantially different margins. Now, as a business owner, examine profitability through the following lenses or filters. You want to look at it based on your customer, the product and service that you're providing, and also the project you're working on, rather than just looking only at total revenue. This creates an opportunity to discover which parts of the business deserve greater investment. Now let's tackle this final question.

Warning Signs Your Pricing Is Off

How to know whether you should review your prices? Here are several warning signs. Now your pricing probably deserves attention if revenue is increasing but profit isn't. You're consistently busy, but cash remains tight. Also, if your costs have increased substantially. This is another big one. You haven't raised prices in several years. And then, of course, you routinely discount to close a sale. This is something to consider. Certain customers consume significantly more time than expected, and your margins are declining. You're unable to build sufficient cash reserves. And you're working more without meaningfully increasing owner compensation. Now that's a big one. A business doesn't necessarily need to raise every price. These are signals that it should analyze their pricing.

A Simple Pricing Exercise

Now for action today, let's go through a simple pricing exercise. I want you to select your three highest products or services by revenue. Now for each one, write down what the selling price is. Now, what does the customer actually pay? I want you to write out the direct costs usually associated with that product or service. What does it cost to deliver that product or service? Now let's consider time. How much does the owner, the employees, or the contractor associated with that product or service, how much time does it really require to produce that product or service and deliver it to the customer? Now I want you to consider those other costs: your payment processing, your shipping, any software you may need, travel, the revisions that you need to make, commissions you need to pay. And then I want you to look at finally profit. After considering these costs, what are you actually keeping? Then ask yourself one more time if you sold twice as much of this tomorrow, would you be excited about the additional profit? Or would you simply become twice as busy? Revenue tells you what you sold, profit tells you what you earned, cash flow tells you whether you you can keep operating, and pricing has a direct impact on all three. You don't necessarily need more customers to build a more profitable business. Sometimes you need to make sure the customers and sales you already have are generating the financial return your business needs.

Key Takeaways And Next Episode

Now, for next episode, we will address the five numbers every business owner should know. Now, pricing gives the owner one important metric and that's margin. But episode four of this series, we're going to expand that into a simple management dashboard. Now, have a great week. I hope that as a small business owner, you are able to take away a few key ideas to help your business. Take care and thank you.