BEST PRICING STRATEGY
Jun 1, 2001 12:00 PM,
If you don’t ask, you don’t get. No one will offer to pay more for your products and services unless you ask for more.
If clients complain, let them complain about your prices. Because if your quality stinks, it doesn’t matter what you charge.
PEOPLE OFTEN ASK ME, “WHAT ARE YOU?” My most common retort is, “I’m a carbon-based life unit.” After a brief pause, I add, “I’m also a staunch supply-demand economist.” I believe that the market — not the government — should set the prices for products and services. I also believe that the value of something free is zero. That’s why when you give your sales reps vehicles, they often return them in such a state of disrepair that the car is worth more dead than alive. Finally, I truly believe that you should charge as much as you possibly can for your products and services, letting the market, and not your competition, set the true value.
Sounds like I’m a Republican, doesn’t it? I wasn’t always this self-assured and knowledgeable when it came to pricing strategies. Like most system integrators and service providers, I was a prisoner of my own beliefs. And then one day, my world changed.
THE DAY THE EARTH STOOD STILL
During the mid-1980s, our company was growing like gangbusters. Unfortunately, we grew ourselves into a cash-flow mess, putting our company out of compliance with the covenants of our bank note. Under pressure from the bank, we were forced to hire an outside consultant, Gerry Stanley, a retired executive. For a fee of $25,000, he spent two days examining our company. Most people thought we were crazy for spending that kind of money for two days’ worth of consulting. But we had no choice because the bank was breathing down our necks, demanding action.
After completing his review, Gerry revealed two findings from his study. They changed our company — and my life — forever. First he said, “Gentlemen, you don’t know what it costs to do business. You incorrectly allocate direct costs into overhead, and you don’t include all of your direct costs when pricing your products and services.” He was right. It’s a constant problem with many businesses, large and small. And it was a major problem in our company. So, we resolved to fix it.
Then he laid his second finding on us like a hammer. “You are pricing your products and services too low. You need to raise your prices by 35%! If you don’t, you won’t be able to grow your company. Plus, you run the risk of becoming insolvent.”
The silence was deafening. I looked across the table at my brother, Glen, and our jaws dropped to the floor. Since I was responsible for the sales side of our company, you can imagine how I felt to think of raising prices by 35%. We were already the highest price in town. I thought raising our prices so much would drive our clients into the arms of the competitors. But we had no choice, especially because the bank was concerned about our ability to repay the note. Woe were we!
SUNSHINE THROUGH THE CLOUDS
But then we came to the best part of the story — the silver lining. We reluctantly raised our prices by 35% for existing and new clients across the board; I prepared for the worst. You know what happened? Practically nothing. Ten percent of our clients complained, while the remaining ninety percent didn’t say a word.
There were some clients to take care of, but not nearly as many as I imagined there would be. So we got to it: We negotiated, we compromised, we haggled, you name it. There was one client who absolutely refused to pay the higher prices. So we responded accordingly: We rolled over onto our backs and said, “Mr. Client, our accounting department will never ever send you nasty letters like that again.” In other words, we maintained his old pricing.
I relate this story because it identifies the false belief that limits the profitability of most businesses, including my previous company. Like many companies, we had made the fatal mistake of deciding what prices the market would bear rather than letting the market make that decision. Gerry Stanley taught us the real value of supply-demand economics. He said, “If you’re doing a good job for your clients, then your clients will stay with you as long as they perceive the incremental value that your products and services deliver.”
Several years later, Glen added a corollary to our Gerry Stanley experience. He said, “If your clients are going to complain, let them complain about your prices. Because if your quality stinks, it doesn’t matter what you charge.”
And he was absolutely right! That’s why we became an even higher-priced spread, by challenging tradition and thinking outside of the box.
LEARN FROM OUR LEARNING
Although the $25,000 fee was a hefty price, it was the best $25,000 I ever spent. It taught us four key business lessons:
- Price your products and services based on what the market will bear. Leave it to the market to determine the price.
- Don’t second-guess the market with your own opinions about what the market will accept. You’re much more likely to undersell yourself this way.
- If you don’t ask, you don’t get. No one will offer to pay more for your products and services unless you ask for more.
- Don’t follow. Lead. It’s okay to be priced higher than your competitors, as long as you meet your clients’ expectations of quality.
Once we paid our $25,000 tuition, we began to apply the real power of the law of supply and demand to our two key markets: new and existing clients. Implemented through our sales compensation plan, we adopted a two-pronged pricing strategy, one for new clients and one for existing clients. For new clients, we aggressively went after accounts with potential for substantial back-end revenue after the initial sale. Becoming aggressive meant we would lower our price to whatever level necessary to win the initial project. Once we were in the account, it was almost impossible for us to be replaced by a competitor unless we failed to meet client expectations for service and quality. In most cases, our prices for new clients reflected what the market would bear in a highly competitive environment.
For existing accounts, we took a completely different approach to pricing; we seldom discounted prices to existing accounts unless we had a national accounts program or a special buying agreement. That’s because the competition was almost nonexistent for moves, adds and changes. We also raised the bar on our standard prices, setting them high for non-commodity products such as services and integrated systems. We charged what the market would actually bear rather than what we thought it would. For well-defined, off-the-shelf commodity products, we pegged our prices at the MSRP.
We didn’t discover the cure for the common cold, nor did we design a new way to safely process spent uranium fuel. But in the world of business, we discovered something of equal importance. We uncovered a great and valuable strategic treasure: pricing products at what the market will bear. We integrated this approach with our pricing strategy for our new and existing accounts. By aggressively capturing new accounts and maintaining high price levels on existing clients, we were able to achieve gross margins in excess of 50% and an operating profit of 20% — all because we discovered the true meaning of the law of supply and demand.
Alan Kruglak is the former owner of GIC, one of the most profitable systems integration firms in the country, sold to Sensormatic Electronics Corporation in 1995. For more information, you can reach Kruglak at 301/365-7522 or[email protected].