The Profit Gene by Liz Lynch

Attracting New Customers With New Pricing Models

It’s been a while since I’ve loved enough songs on an album to buy the whole CD, so consequently, my music collection has been stuck in the 80s and 90s. But selecting songs a la carte at iTunes’ has me buying music again. I’ve probably spent more money on music this year than I have in the last five years combined.

A different pricing model can attract customers who have left or never consumed in the first place.  It could also steal unsatisfied customers away competitors.  Take this example from Inc. Magazine “Goodbye, Retainers: Pay as You Go with Results-Based PR.”

Traditional pricing models for public relations services involve a monthly retainer where PR firms get a monthly fee to pitch on your behalf to media outlets, regardless of whether those pitches result in successful placements.  You’re paying for the hours they work rather than the results they get. In other words, your interests aren’t aligned.

The article describes a new model of pay-for-placement arrangements where “companies pay only when their PR rep lands them mentions in the press.”  This can be an appealing model not just for public relations, but for any service firm, to win new business provided that you keep some key things in mind:

You have to price the pay-for-performance fee so that it compares favorably to a retainer in the eyes of the client. For example, if you hit a home run, you should be entitled to just as much or more than what the client would have paid you under a retainer arrangement. But for anything short of that, the client will expect to pay less than the retainer.

You have to understand your delivery costs and processes well enough to be sure that you can still make money. Pay-for-performance is best for work that you’ve done many times before so you know exactly what it will take to do the work you’re required to do.

You have to be pickier in selecting your clients.  You need to work with the strongest clients so you’ll have the high probability for success. If you aren’t confident you can deliver, you’ll be tying up resources for no payout.

While pay-for-performance isn’t right for every company to offer or to buy for that matter, it’s certainly worth evaluating.

Be Okay With Walking Away

A client of mine recently lost a sale to a prospect who told him that while his work was the most impressive of all the companies bidding for the business, her point system for judging eliminated him because of the weight placed on costs.

Instead of being upset, however, my client was happy to lose the business.  “We offer more value for the kind of work we do than the cheaper vendors who win on price alone,” he told me.  “And we wouldn’t have made any money at the price level they needed us to be.”

Unless your business model allows you to compete effectively as a low cost provider – meaning that your cost structure actually is very low – you should never feel pressured to compete on price.  When you offer a highly customized product like my client does, you need to compete on value and stand behind it.  In other words, be okay with walking away.

This particular prospect saw the value my client offered but wasn’t willing to pay for it.  And my client wasn’t willing to offer the same value he provides to other clients, but at a lower price.  Why should he?  All that would do is erode his margins.  When you have finite capacity, as most businesses do, whether it’s people, time or equipment, you want to be sure that capacity is being used to service your highest margin accounts. 

Don’t dwell on unprofitable business that you lost.  Move quickly to finding that next great client who values quality as much as you do.

Stop Fumbling in the Dark With Your Pricing

Pricing matters.  A lot.  In the '90s, McKinsey & Co. published a study in the Harvard Business Review on the drivers of profitability.  They studied 2,600 companies in different industries with different economics and found some interesting things:  On average, a 1% improvement in volume increased operating profits by 3.3%.  While a 1% improvement in price, increased operating profits by 11.1%. 

What this is saying is that improvements in price typically have 3-4 times the effect on profitability as proportionate increases in volume.  Why might this be? 

When you sell more of something you have more revenue, but you also have more cost.  You have to make that additional widget and there’s a cost in materials and labor.  Or if you’re in a service business, you have the cost of the person doing the job, either yourself or one of your employees.  Not every extra dollar you bring in will fall to the bottom line.

When you bring in additional revenues through higher prices, all of that usually does fall to the bottom line.  Some companies in the McKinsey study were able to increase profits by 35% with just a modest 3% increase in price.  But it’s knowing how to increase the price that’s important.

Now, the reverse also holds true.  A 1% decrease in price, would destroy 11.1% of a company’s operating profits.  So, with such extreme profit leverage, pricing is something a company can always improve, and should strive to improve.

Measuring Customer Profitability

Getting business at any cost will cost you.

Robert Kaplan, Harvard Business School professor and author of The Balanced Scorecard explains why “some companies lose sight of the ultimate objective: to make a profit from selling products and services. In their zeal to delight customers, these companies actually lose money with them. They become customer-obsessed rather than customer-focused. When the customer says 'jump,' they ask 'how high?' They offer additional product features and services to their customers, but fail to receive prices that cover the costs for these additional features and services."

Read more:

A BALANCED SCORECARD APPROACH TO MEASURE CUSTOMER PROFITABILITY

Creating a Lower Price, Fewer Frills Service Option

Two weeks ago, I received a postcard from my friend Monica, an aesthetician who’s been featured in W magazine and the Daily Candy, advertising her “Express Summer Facial.” One hour for $100, half the time and half the price of her standard facial.  I did something I hadn’t done in 10 months.  I picked up the phone and made an appointment.

Until last August, I had gotten facials from Monica on a fairly regular basis.  She’s well-known for her wholistic, organic and healing treatments and I looked forward to the 2+ hours I’d spend there, getting pampered, centered and beautiful.  But as I got busier with my business, I couldn’t find the time to go.  And I had begun to feel that the full-blown facial was more than I needed, and more than I wanted to keep paying.

So I thought Monica’s introduction of a lower-priced, fewer frills option was absolutely brilliant.  The “full service” option is still available, but many of her clients who can’t spare 3 hours in their day for a facial and travel time – busy entrepreneurs like me as well as full-time moms with tight schedules – are now returning to the fold.

The other smart move is that branding it as a “summer” facial gives Monica the ability to discontinue the service later on if she chooses.  She can test this idea on a finite time frame to see how her clients like it and frankly, how she likes it.  After a couple of months she may find that seeing twice as many clients in a day isn’t her cup of tea and she has a built in excuse for terminating the service, and going back to a single, higher-priced offering.

Adding a stripped-down version of your signature product or service to your portfolio can be an effective way to employ excess capacity, bring in additional revenue to cover fixed costs, and ultimately increase your cash flow and profitability.

To Bonus or Not to Bonus?

Selling bundles of your product or service in 10 packs is a great idea from a cash flow standpoint, but how do you encourage potential buyers to part with their money?  What’s a good incentive?

I recently met with the bookkeeper of an exercise studio that offered 10 private sessions with a trainer for $950 instead of the normal $1000 ($100 per session).  Yet few people were taking advantage of the package, thinking that the $50 savings was not enough enticement to take such a big hit to their credit cards at once.

I suggested the studio change the offer to “Buy 10, get 1 free.”  What’s the difference?  Plenty.  From the customers’ point of view, they would be saving $100 instead of $50 – twice as much value.  From the studio’s standpoint, they would get the full $1000 instead of just $950.  While part of the extra $50 would go towards paying a trainer for the bonus session, the rest would go to the bottom line. 

Even if the entire $50 went to a trainer, the studio would be indifferent financially, but customers would be more likely to opt in, thereby increasing the studio's cash flow, and ultimately, its profitability.

To bonus or not to bonus?  You have to do the math for your own situation to decide, but running the numbers on this scenario showed that the free session was definitely the way to go.