Are you a business owner frustrated by increasing sales but disappointing profits? Or maybe a product rollout did not generate the expected bottom-line improvements. Do you have a documented pricing strategy? Why not?
In a previous blog, I outlined thoughtful price increases as one way to help protect and even grow the bottom line in an uncertain business environment.
Should the economy enter a period of “stagflation”, strategic pricing decisions will become paramount.
Where to start?
What information do you have available to analyze past and current performance? Do you know the true costs of all your products and services?
- To effectively implement a pricing plan, you need several sources of data beyond your sales/order entry systems… mainly to capture input costs and aid in reporting.
- This includes your general ledger (GL) or cost accounting system, purchase order, and accounts payable systems, inventory management software, payroll, and timekeeping systems.
- One major limitation many business owners uncover when they begin this process is that their GL is not set up to capture or report at the right level of detail or in a timely manner.
- To have timely and actionable data, you’ll need to create a controlled and disciplined spreadsheet process to synthesize and report meaningful operational performance data outside of the GL.
- You want to know where you are at today and where you are headed… not just how you did 30 days ago.
How to get there…
Group your data from your different sources at the level that makes sense for your business. If your data is limited, group it to the lowest level at which you can reasonably align pricing and product/service inputs.
Build a model from your historical information. This is also a great start for a budget or forecast if you don’t already have one. If not, you’ll need to create a database and model that can be used to run scenarios and versions. Keep it as simple as possible for ease of understanding and management, but not so simple that important insights cannot be gained from if / then scenarios.
Focus on contribution margin (CM) of each product or service line. CM is the unit price minus direct variable costs. The goal is to understand how much each product or service is contributing before fixed costs. If additional and specific fixed costs or capital investments are needed to add or increase product volumes, those can be included in an extended analysis.
Now What? Analysis and Tough Decisions…
If you have sales and finance teams, bring them together. Compare your model pricing to industry standards and/or competitors. Examine products and services with the highest CM and ask these questions:
- Can you expand your sales reach and volumes?
- Can you increase prices further?
- Do you have cost advantages over competitors in some way?
Also, examine lines with lower or underperforming CM.
- Can prices be increased?
- Will a price increase or decrease lead to a greater CM relative to the volume impact?
- Are these products and services needed to support other critical profitable lines?
- Are you better off by dropping the product or service altogether so you can expand others?
- This can be emotional, but follow the data…
Develop a written pricing strategy and guidelines
Maximizing profit while balancing customer satisfaction requires:
- A documented market pricing approach, including policies and procedures so your sales team knows how to price, adjust, and/or discount your products.
- A catalog or database of current product pricing for quotes and job/product costing.
- Periodic pricing and product performance review.
A fractional CFO can work with you or your sales leader to develop these tools.
Jason Dean is Area President with FocusCFO and is based in Nashville, TN.