- Know your strengths. How does your product or product range stack up against the competition? Are your products higher quality, lower quality, or indistinguishable from your competitors’ products? Do you have an edge that can justify higher prices? How about all the other elements that make up your total service package? Do you provide a bigger inventory, faster delivery, better payment terms, wider product line, better service on returned items? If not, can you change your operations to gain an edge in any of these areas? Consider holding a brainstorming session with your salespeople to go over these questions. The answers might point the way to pricing decisions, and they’ll certainly give you good replies to customer pricing objections.
- Put yourself in your customers’ shoes. Try to understand your customers’ needs. Are they under profit pressure? What changes are occurring in their industry? How can you adjust your products or service to add value for them - value that they might be willing to pay for? What are their alternatives if you raise prices? If your salespeople are staying in touch with their customers, they should already have the answers to many of these questions.
- Know your competition. Run through the same questions you asked about yourself applied to your competitors. What are their strengths and weaknesses? What can they offer your customers that you can’t? How will they respond if you change prices? Here again, your sales staff should have good information on the competition they face.
In business, making pricing decisions is always tough - and even more so when the economy is slow and sales are slipping. It’s tempting to cut prices hoping to generate higher sales volume. But sometimes that just produces lower margins on a low volume. What do you do if you’re being squeezed by cost increases? Can you increase prices in a slow economy? How do you respond if your customers complain? Can you justify holding prices steady if your competitors cut their prices? There are no easy answers, but running through a three-step process can help you make the right decision.
Suppose you’re selling your business, and it’s worth $400,000. You’re offered $210,000 down and lump sums of $100,000 at the end of year one and year two. Should you take the offer?
Most people know that $1,000 now is worth more than $1,000 a year from now. Here’s why:
1. Inflation: In a year, a dollar will buy less than it would today.
2. Risk: Over time, the risk increases that some of the money owed you will not be paid.
3. Opportunity loss: Funds on hand could be invested and earning more money.
Present value analysis attempts to quantify these variables. It discounts the value of future funds by estimating inflation rates, risks of loss, and rates of return from alternative investments.
Assume you could earn 2% by investing in a $100,000 CD. Disregarding compounding, in a year your investment would be worth $102,000. Conversely, if you postponed receipt of $100,000 for a year and inflation eroded the principal by 3%, you’d receive the equivalent of $97,000 in today’s dollars. (Note that with 3% erosion, even the $102,000 CD proceeds would be worth only $98,940 in today’s dollars.)
In the opening example, your proposed "investment" (a two-year $200,000 note receivable) would be far riskier than a CD. To compensate, you might decide not to accept anything less than an 8% return. A present value table indicates that at 8%, the discount factors for one and two years are .926 and .857, respectively. $100,000 times .926 is $92,600; $100,000 times .857 is $85,700.
Thus, in today’s dollars, the buyer is offering $388,300 ($210,000 down payment plus $92,600 plus $85,700). Since your business is worth $400,000, you would be selling for $11,700 less than full value.
A similar analysis can be applied to any business transaction involving future payments. For help with the calculations or assistance with any of your business needs, call us for an appointment.