Bank Alfalah | SME Toolkit

Tactics to Avoid Lowering Your Prices

Adapted from content excerpted from the American Express® OPEN Small Business Network

Many small businesses find themselves feeling pressure to lower their prices. It may come when a low-priced competitor shows up in your market, or when a pinched economy hits your industry. Yet few small businesses can afford to get themselves involved in a price war.

There are a handful of times when dropping prices makes sense; for example, when your cost of doing business has dropped and you want to pass along these savings. But if your existing prices are set to cover expenses and necessary profits, lowering them could damage the bottom line. What’s the answer? Consider using these tactics to attract and retain customers without getting out the red pen.

Emphasize customer service

By demonstrating the added value you give customers, you may be able to justify higher prices while keeping the competition at bay. You can showcase superior customer service through generous return terms, longer than average warranties, free delivery, express ordering for regular customers, or other customer care techniques. This tactic is more strategic than getting into pricing wars with competitors because it encourages long-term client relationships. Competing on price often leaves companies catering to fickle customers who may or may not return in the future.

Package products and services together

You can create more value for customers by grouping related products and selling them for a price that is greater than any single item, but less than it would cost to buy each one separately. For example, a bookseller might package elegant pens with journals or a dictionary with an atlas and thesaurus. This tactic can help you avoid permanently reducing prices on any single item while increasing your overall sales.

Decrease amount along with price

If you find the market is demanding lower prices, consider whether or not there is a way to offer goods and services in smaller amounts. For example, if you’re a Web designer, are there efficiencies you can build into the project development process that would allow you to offer services at a lower cost? If you sell beauty supplies, can you package products in 6.5-ounce containers rather than 8-ounce? This tactic can give customers the perception that you’ve lowered prices while helping you to keep costs in line.

Add services

Instead of cutting prices, maintain them and include an additional service for the same amount. For example, a bookstore owner might offer free gift-wrapping with each order, or a personal trainer might offer an hour of nutrition counseling with the purchase of 10 sessions.

Copyright © 1995-2016, American Express Company. All Rights Reserved.

Pricing Q&A’s

Adapted from content excerpted from the American Express® OPEN Small Business Network

Whether you sell a product or service, the price you charge your customer will have a direct impact on the success of your business. Unfortunately, pricing is one of the least understood facets of running a small business. Many small business owners calculate their basic costs, and then pick a price arbitrarily. Arbitrary prices, however, mean arbitrary results. Taking the time to evaluate all the factors that will impact your price – from your expenses to your image to your customers’ prices – will help ensure you develop an effective pricing strategy.Select from the questions below to get answers to some of the most common questions about pricing strategies:

  • I’ve heard that a small business needs to follow certain pricing formulas. What are they? Are they effective?
  • What expenses should I factor in when determining my costs?
  • How can I determine what the market is willing to pay for my product or service?
  • I have a wide range of competitors whose prices fall into an equally broad spectrum. How do I know whether to come in high or low?
  • I’m looking to get in the door at a new, potentially lucrative customer. Should I lower my price to make my business look more appealing?
  • Should a service business price by the hour or by the job?
  • I’m afraid I may do a lot of work for my client and then get burned when I bill them. Is there anything I can do?
  • How do I set marketable wholesale prices?

Two commonly used pricing formulas are direct costs-plus-overhead-plus-profit, and doubling wholesale price.

Unfortunately, formulas can be problematic. Here’s why:

  • They don’t consider all the hidden costs and other factors you should look at when determining prices.
  • They don’t take into account that the price you charge for anything is tied to what customers are willing – or expect – to pay. A lot of people forget that no matter how much your product or service is worth in your eyes, if people won’t pay that much for it, it won’t sell.
  • They don’t calculate the “psychological” component. Customers do not always make their purchasing decisions on the basis of logic. For example, sometimes customers will equate quality with price – if your price is too low, they may be suspicious that they’re getting something not quite up to standard and avoid buying at your “bargain” price.

Obviously, you need to factor in the basic direct costs like cost of goods and supplies and cost of labor. But many small businesses forget to factor in other indirect costs. Here are some categories to look at:

  • Furniture and equipment
  • Stationery, business cards, office supplies
  • Magazine subscriptions
  • Membership in professional organizations
  • Postage, express mail delivery, messenger services
  • Telephone and fax charges
  • Printing
  • Software
  • Travel and transportation fees
  • Consultant fees
  • Your time

Once you determine what it will cost you to sell your product, it’s time for research. You need to find out what the prices are for similar items or services. This will mostly likely be a matter of shopping or calling your competition. Be careful to examine what your competition offers along with the product. Do they provide personalized attention, a liberal return policy, or free delivery? All these factors are part of the package consumers look at when making a purchase decision and thus are important in pricing strategies too.If you become a low-priced vendor, you will likely be offering few frills and make your money on volume. Many experts contend this is dangerous ground for small businesses, because it puts them into the arena with larger price merchants who have greater buying power and can afford to undercut on price. For instance, a small stationery store or independent hardware store probably can’t make money by offering the same prices as a large “category killer” like Staples or Office Depot.

If you decide to go for the high end of the pricing spectrum, you will need to add value to what you are selling. This means providing extra services, products, or resources along with your product. You may think you cannot afford to offer anything extra, but oftentimes, adding value means bringing attention to something you already offer such as guaranteed online service, quick turn-around, high quality products, or extra features. Bringing attention to these in your marketing is often enough to justify a higher price to consumers.Many service businesses use pricing strategies where they work for less than they would like to because they want to develop a relationship. This may not be a good idea. Once you become a low-priced alternative, it is very hard to break out of this mold. In other words, if you condition your customers to respond to price, they usually won’t let you change. Instead, look at other ways to set yourself apart – whether through superior service, superior quality, or other value-added elements.Using an hourly rate or charging by the project usually depends on your business – different industries have different precedents, so you should research what is common in your business. Here are some examples of circumstances in which one method is better than the other:

  • If the job is one where your client may want to make changes to the project after the fact or mid-job, you’re better off charging by the hour. Say you’re a word processor and you spend a few days typing a lengthy thesis for a graduate student. After you’ve finished the work, he comes back to you with several revisions that he wants you to make in the finished paper. If you’d been charging by the job, you would be in for hours more work at no more money. If you charged by the hour, you would be compensated for the extra time added to the original job.
  • If your quoted hourly rate might make a customer balk, a project rate may be the way to go. For example, if you’re writing copy for an ad brochure and you know it will take you two hours, quoting $currency_symbol$125 an hour may sound too high. But negotiating a flat rate of $currency_symbol$250 may sound more reasonable.

Knowing how long it will take you to do a certain job is critical to figuring out how much to charge. If you don’t yet have the experience to know how long a job will take, find others in your line of work and ask them for an estimate.This is a common dilemma for service business, since there is usually no way to take back a service once you’ve given it. That’s why many service businesses require a portion of their payment up front. The usual method for doing this is to request one-third of a payment at the contract signing, one-third half-way through the job, and one-third on completion.Like any pricing question, determining what to charge retailers who will resell your product requires some homework. In general, retailers will not buy from you if they can get the product for less from someone else. Retailers also have to be able to double the price that you are charging them (the general retail price formula = wholesale x 2) and still get customers to buy.

In order to make sure you meet these requirements, use the following pricing strategies to set your wholesale prices:

  • Investigate your competition at the wholesale level by calling them for prices, attending trade shows, and talking to trade associations.
  • Talk to retailers. Ask shop owners where they purchase and what they pay. Or go to stores and divide the retail price by two to determine wholesale price.
  • Call the association for the retailers you want to sell to and find out what the typical mark-up rate is. That will help you determine what the retailers you’ll be selling to will be willing to pay.

Copyright © 1995-2016, American Express Company. All Rights Reserved.

Achieving Lowest Expenses

Provided by My Own Business Content Partner for the SME Toolkit

OBJECTIVE:

Your business growth will come about by not only making money but by carefully investing the cash produced by frugal spending. You will learn the importance of minimizing your expenses and how to achieve it.

  • Wealth accumulation is a matter of frugality
    • The man next door
    • The power of compounding
    • The value of the money you save
  • The Wal-Mart Model
    • Keeping costs low and discounting heavily
    • Ranked number one for lowest ratio expenses to sales
    • Share profits with your managers
    • Operating principles
  • Frugality does not mean compromising quality
    • Toyota
    • See’s Candy
  • Other Risks in cost-control plans
    • Deferred repairs and maintenance
    • Inadequate product development and research
  • Ways to accomplish ongoing corporate frugality
    • Create profit sharing incentives
    • Practical cost saving ideas
    • Build an image of austerity
  • Top Ten Do’s and Don’ts

The Man Next Door

The greatest motivation for your being in business is to build wealth. This goal is not accomplished just by making money…it is also a result of not spending money. There is a famous study of the characteristics of wealth by researchers Thomas Stanley and William Danko in their book The Millionaire Next Door. It revealed that most people with high incomes fail to accumulate lasting wealth because they also live high lifestyles.

On the other hand, wealthy people generally have a high income and a frugal mindset. You may be surprised to learn that the unpretentious person in your neighborhood who drives the ten-year-old Chevy (“the man next door”) may be the only millionaire on the block. According to Stanley and Danko, the common characteristics of wealthy people include:

  • They are frugal and live well below their means.
  • They allocate their lives efficiently in ways conducive to making money.
  • They value financial success more than showing off wealth.
  • They were self-made men and women (not inherited wealth).
  • They chose the right business to begin with.

Accomplishing wealth in business is also not just a matter of making money…it is also a matter of not spending money. Your business growth will come about by not only making money but by carefully investing the cash produced by frugal spending.

The power of compounding

Compounding has been called the eighth wonder of the world and the investor’s best friend. By definition, it happens when interest is added to principal so that the interest that has been added also earns interest. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount. The real power comes into play over time so it’s a good idea to start early. Its power is also based on the interest rate, or rate of return, which is earned.

Money you have put in or add to your business is called equity. How much you earn on each dollar you put in is called return on equity or ROE. Return on equity will vary from industry to industry. For example, the ROE of the top five companies in the railroads industry ranges from 15.5% to 12.2%.

Each year the money you save by being frugal will be invested in growing the business. The measurement of your success will then depend on how wisely you allocate your compounded earnings.

The value of the money you save

We can now place a dollar value on your frugality. Let’s assume you can cut out $10,000 of costs each year for the next ten years. Each year the $10,000 saved will be going into expanding the business. Your ROE is 15%. At the end of 10 years, the $10,000 you have saved each year will be worth:

$280,017 (Over a Quarter Million Dollars)

Keeping cost low and discounting heavily.

Sam Walton grew up poor on a rural Missouri farm during the great depression of the 1930’s. He learned the value of money by growing up in poverty. In his stores, he gave people what they wanted by focusing on low selling prices.

Ranking number one in ratio of expenses-to-sales.

For decades, Wal-Mart has accomplished the lowest expenses to sales in their industry which enabled them to discount deeply. However, the huge savings that Wal-Mart has accomplished did not affect the product quality: savings were entirely focused on costs unrelated to product cost or quality. According to Sam, the two most important words he ever wrote were on the first Wal-Mart sign: “Satisfaction Guaranteed”.

Following the worldwide financial collapse of 2008, firms began cutting out expensive habits that had been built up over time. Cost savings were mandated and even as businesses began recovering, the savings continued to be enjoyed. Generous spending habits were permanently replaced by lower cost disciplines. For example, many firms replaced expensive travel budgets with online conferencing and have continued the practice.

While Wal-Mart provides a good example of successful frugality in the discount department store industry, any business in any industry can enjoy the same benefit that happens when costs are reduced: every dollar saved can be reinvested in the business and continue to grow on a compounded basis.

Share profits with your managers

Implementing incentive plans that are based on profit sharing can become a powerful tool in maintaining ongoing frugality and efficiencies because the plan will be consistent with the objective of cutting out unnecessary costs. To a profit-sharing manager, a penny saved means money in his or her pocket. And as long as the plan is implemented, the incentive to cut costs will remain intact. By sharing your profits with all your managers, you can be perceived as a partner and together you all can perform beyond your expectations.

Operating principles

Along with a deeply embedded spirit of frugality Wal-Mart also embedded these operating principles:

  • Commit to your business
  • Share your profits with all your associates
  • Motivate your partners
  • Communicate everything you possibly can to your partners
  • Listen to everyone and get them talking
  • Exceed your customer expectations

A warning: a misguided frugality program can lead to the diminishment of product quality and market share. Cost reduction of expenses should not be made at the expense of product or service quality. Over-zealous cost reduction programs can impact in product quality resulting in diminishing hard-earned reputations. Here are two examples:

  • Toyota – Toyota experienced loss of market share when the emphasis on cost reduction spilled over to quality compromises that were even obvious to the customers. Even in luxury sedans, driver’s floor mats developed a hole at 25,000 miles while earlier models were still fine after 100,000 miles. Expense reduction programs must be limited to expenses that do not impact product quality or safety.
  • See’s Candy – On the other hand, for decades, See’s has been an earnings powerhouse in the boxed candy industry by avoidance of any cost reduction efforts that could detract from the quality of their candy. Their secret of success lies in their trademarked logo: “Quality Without Compromise©.”

Deferred repairs and maintenance

Deferred maintenance is the practice of putting off maintenance activities such as repairs on property or machinery in order to cut costs. As a rule, an ongoing policy of deferred maintenance will result in higher costs, the breakdown of assets and even adversely affect health and safety. For example, following the 2010 oil spill in the Gulf of Mexico it became evident that safety and cost drives had clashed and that deferred repair was a “critical factor” in the incident.

When maintenance budgets are left in the hands of managers whose compensation is based on earnings, there could be a temptation to defer maintenance in order to increase earnings. A remedy could be mandating a maintenance budget each year based on past experience.

Inadequate product development and research (Research and Development: R & D)

In businesses with fast changing technology, research and new product development is a necessary cost of doing business. Your larger competitors will disclose their research budgets as a percentage of sales in their published annual reports. Once again, managers on income-based incentives could be tempted to underfund development and research. As with deferred maintenance, a solution could be mandating the R & D budget. In cases where a pilot plant is required to prove out a concept, care must be taken to patiently take the time and expense to fully make an evaluation.

Create profit sharing incentives

Profits are diminished by expenses. So if you pay incentive compensation to your managers based on earnings you will create a powerful group of partners who will have a direct incentive to reduce costs. Basically, you will be paying bonuses to your managers in return for the value they provide to the company by cutting costs….with the result of the greater overall success of the company.

Practical cost saving ideas

Most all businesses readily claim that they’re already operating at the lowest possible level of costs. But the truth according to cost containment expert Max Friar of Alliance Cost Containment is that every company is bleeding profits through a thousand little cuts. And most companies are spending 15-30% more on indirect operating costs than necessary. While it is easy to focus on high-dollar costs such as healthcare insurance, few managers are watching the pennies. Here are some opportunities Mr. Friar points out:

  • Corporate Purchasing Cards. Why permit staff to buy items at full retail from multiple vendors rather than getting volume discounts by shopping through designated suppliers?
    Utilities. Your electric utility can provide an energy audit and give you a long list of conservation tools.
  • Association Discounts. Your industry association may offer group purchasing discounts your company could take advantage of including fleet services, insurance, workers compensation premiums and many other opportunities.
  • Travel and entertainment. If you don’t have a per diem allowance when not entertaining, you are probably paying more to feed the staff than you need to. Are employees directed to specific hotel groups to capture bonus points?
  • Supplier Consolidation. Set a goal of reducing your suppliers by 5% next year and pay bonuses to employees who figure a way to do it. This results in better pricing through higher volume.
  • Parcel Shipping. Are packages sent via overnight delivery qualified to go 2nd-day delivery? Are you using multiple shipping vendors and missing out on volume discounts? A few policy controls and supervision can pay back big dividends.

Build an image of austerity

During the economic depression starting in 2008, chief executives found their firms could function perfectly well with lower levels of spending on travel, supplies, and office space. But over time abuses can creep back in. The ongoing challenge is to adhere to tight budget disciplines and not allow expense from creeping back.

To truly accomplish the credential “Number 1 in your industry for lowest ratio of expenses-to-sales” you must also lead by example and operate in a truly modest mode. For example,

  • Operate in modest, unpretentious premises
  • Drive mid-size not luxury cars
  • Everyone flies cabin class
  • Replace travel expenses with video and Web conferencing
  • Do not delegate authority for capital expenditures
  • Limit authority on operating expenses
  • Require travel expenses to be reported monthly rather than quarterly

THE TOP TEN DO’S

  • Live well below your means.
  • Value success more than showing off.
  • Invest compounded savings to build wealth.
  • Create profit center incentives.
  • Replace travel by use of online conferencing.
  • Share profits with your managers.
  • Strive for the lowest cost in your industry.
  • Maintain ongoing focus on frugality.
  • Treat your managers as partners.
  • Build an image of austerity.

THE TOP TEN DON’TS

  • Live beyond your means.
  • Compromise your product to cut cost.
  • Defer repairs and maintenance.
  • Delegate authority for capital expenditures.
  • Locate your business in expensive premises.
  • Ignore the power of compounded savings.
  • Drive a luxury car and fly first class.
  • Be secretive with your employees.
  • Allow abuses of expenses to creep back into your austerity plan.
  • Compromise on research and development.

Copyright © 1993, 1997-2016, My Own Business, Inc. All Rights Reserved.

Initial Cash Requirements

Provided by the International Finance Corporation

The costs of starting a business are often underestimated. New entrepreneurs should consider, at a minimum, six months personal and business cash flow to have an idea of the initial costs they will have to bear. Complete the tables in the Excel file that you can download below. The summary table will provide an overview of your total expenses over a period of six months.

This is intended to be a simple and practical tool to be adjusted and used by SMEs working in all sectors. You may adapt it to reflect your business needs, type of clientele, products and services you offer.

File Description: The file is a Microsoft Excel spreadsheet template. Once you’ve downloaded the file, you must copy it to your EXCELXLSTART directory in order to use it.

Special Features

  • Download this spreadsheet template just once, and be able to use it over and over again
  • The spreadsheet can be completely customized – you can quickly add or delete items or revise the format to meet your needs
  • The spreadsheet is easy to use. Just plug in your numbers and it will automatically compute the amount of cash needed to start you new business

Attachments:

Initial Cash Requirements

For more resources


Copyright © 2000 – 2017, International Finance Corporation. All Rights Reserved.

2121 Pennsylvania Avenue, N.W., Washington, D.C. 20433, www.ifc.org

The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. IFC does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon.

 

Cash Flow Sensitivity Analysis Worksheet

Provided by the International Finance Corporation

The cash flow budget worksheet allows the sensititvity analysis of your cash flow. Insert your cash flow informations in the middle column “expected cash flow” and the tool will calculate pessimistic and optimistic scenarios assuming a variation of 25% in receipts and disbursements. This is intended to be a simple and practical tool to be adjusted and used by SMEs working in all sectors. You may adapt it to reflect your business needs, type of clientele, products and services you offer.

This worksheet lists all the descriptions of the cash inflows and outflows of the new business. If you need additional categories of expenses you can quickly modify it. Just plug in your amounts and the spreadsheet will automatically compute the totals.

File Description: The file is a Microsoft Excel spreadsheet template. Once you’ve downloaded the file, you must copy it to your EXCELXLSTART directory in order to use it.


Special Features:

  • Download this spreadsheet template just once, and be able to use it over and over again
  • The spreadsheet contains the formatting for a cash flow sensitivity analysis
  • The spreadsheet can be completely customized — you can quickly add or delete items or revise the format to meet your needs
  • The spreadsheet is easy to use. Just plug in your inflows (income) and outflows (disbursements) and it will automatically show you what will happen to your cash flow when actual results are not what you expected

Attachments:

Cash Flow Sensitivity Analysis Worksheet


For more resources


Copyright © 2000 – 2017, International Finance Corporation. All Rights Reserved.

2121 Pennsylvania Avenue, N.W., Washington, D.C. 20433, www.ifc.org

The material in this work is copyrighted. Copying and/or transmitting portions or all of this work without permission may be a violation of applicable law. IFC does not guarantee the accuracy, reliability or completeness of the content included in this work, or for the conclusions or judgments described herein, and accepts no responsibility or liability for any omissions or errors (including, without limitation, typographical errors and technical errors) in the content whatsoever or for reliance thereon.