How to get your pricing right

By Marianne Curphey

While watching  re-runs of The Apprentice, it struck me forcibly how little time or attention the contestants gave to working out how they were going to make a profit from their business.

For example in one exercise the two teams were given the task of selling fast food to commuters with an initial budget of £250 for ingredients. Despite backgrounds in management, accountancy and sales, few team members seemed to grasp the concept that getting the pricing strategy right was absolutely fundamental to the success or failure of the project. They didn’t have profit targets and they weren’t keeping track of whether they were generating a decent return on Alan Sugar’s investment.

These would-be entrepreneurs demonstrated a trait which often leads to business failure – a lack of understanding of the fundamental importance of cash-flow.

If they had been in a real-life business environment, looking for investment from business angels (wealthy investors who support fledgling businesses), they would have been eaten alive. They may be called “angels”, but professional investors make Lord Sugar look like a pussy cat. They have very specific targets for the return on their initial investment, a timetable for exiting when they have made the money they want, and no hesitation in pulling the plug (ie the funding) if it is clear things are not working out.

In fact, it could be argued, as entrepreneur Luke Johnson does here in the Daily Mail, that The Apprentice does nothing to show would-be business owners the practical aspects of running a company, and instead sacrifices genuine business insight for pure reality-show entertainment.

So, forget about the circus show of television, and start to think like a real entrepreneur. Whether you plan to expand your business to the point where you will be seeking outside investment, or you want to keep it relatively small, but successful, you need to understand the principles of profit, cash-flow and putting together a balance sheet.

So here’s how to get your pricing right:

1. Work out your fixed costs: what are the recurring items or bills that you need to purchase or pay for each month in order to run your business?

2.  What are your variable costs? One-off or unusual items (capital expenditure: buying a long-term asset for the business), annual insurance costs (you can break this down into a per-month sum or build it into an annual balance sheet projection)

3. What is your  “break-even” point?  What do you need to make each month to pay basic bills like utilities, phone, rent or leasing costs for your premises, stock storage costs or staff wages? This is the amount you need just to stay afloat and keep your bank manager happy.

4. What is the cost involved per unit? ie providing each service or doing an individual job – ie travel costs, materials, phone calls?

5. What is the value your product or service provides to your customers? The Business Link website has an excellent explanation of the difference between the cost to you of providing the service, the financial reward you receive in return (ie the price) and the value the customer places on your service.

6. What benefits do you provide and on what criteria do customers buy – reliability, reputation, speed of delivery?

7. Establish your value. This is vital, because it helps you work out your unique selling point (USP), enables you to explain to customers why you are different from your competitors, and means you are not selling on price only, which is a dangerous game.

You may have the most brilliant business idea in history, but without a sound understanding of the way finance works, you will struggle to grow your fledging business. One of the most common mistakes when starting out is to concentrate too much on the names, logos, website or premises of your business, and spend too little time on working out the hardcore finances.

In my next blog I will be looking about how to assess your prices in comparison to your competitors, and whether to pursue volume or a smaller number of high-value sales.

regards, Marianne