The Silent Profit Killer
Author: Scott Hallman
Do you remember the great recession of 2008 through 2010? Some people, by the way, thought it lasted a lot longer than 2010. Perhaps you’re one of them. It was devastating for businesses. Businesses saw their sales plummet, their profitability plummet, customers not engaging in spending as much money. It was a really, really trying time. Well, it was also a trying time for my client, Paul, who has a leading cleaning oriented service for consumers. One of the top in America, Paul, like millions of businesses around the globe was suffering from the impacts of the recession. But Paul did something bold. He pivoted in the midst of a recession, went completely against conventional wisdom and actually raised his prices.
Now, you may say, Scott, that’s absolutely crazy. But look, I’m going to share with you why it was a business changing act that he did. Before I tell you more about what Paul did, I want to talk about this silent profit killer so many businesses have been victim to, for a decade since the recession, and that is failure to raise prices and an overzealous discounting policy among others. It absolutely devastates profitability. Look, the bottom line is prices are going up. The large companies, they’re charging you more. Are groceries the same cost as they were five years ago? Not a chance. So you’ve got to have a pricing strategy in place and need to make sure it’s systematic. Are you going to watch your profits erode away and not even really know it or know why?
There are three margin erosion trends that we’re all experiencing.
- Transparent pricing. On the internet you can find and compare any price to almost anything. Now you’re especially prone to this if you sell a commodity, which by the way is becoming a bad business for most people unless you have overly efficient operations and marketing and distribution costs to drive the cost down. If you’re Walmart, commodities work pretty well. Others who have a unique or different business, or you can differentiate your service, it’s more difficult to actually transparently price as is the case with Paul. So the price is not such a big deal and you can actually avoid this price erosion that I’m talking about here.
- Marketing costs. It’s getting more and more expensive to acquire customers, clients or patients, isn’t it? This is happening to all businesses and it’s a real cost that is going up.
- Free shipping. Free shipping has now become the norm. And there’s a cost to that. We need to have strategies to be able to overcome these things and maintain our profitability and not allow our margins to erode right before our very eyes. For example, if you’re an internet business by up to 12%. There are ways to offset these things.
I created this concept called “net price” a few years ago because I got thinking to myself, what’s the money a business really gets to work with in order to pay for their costs of goods sold and their overhead, et cetera, and end up with a profit? And I came up with a simple concept of net price. Now it’s more complicated or more involved than I’m going to share here, but effectively think of it as you have a price, less your discounts and coupons, and other incentives. And I like also to take out of that credit cards because there’s ways to be able to sell things for cash and make more money. So when you pay the credit cards off and you minus your discounts, that’s the price you’re actually getting. We’re going to call that net price.
The next one is around “margin erosion”. What is margin erosion? Well, let’s first of all define margin. What I’m really talking about here is your gross profit margin. That is the price of selling your product or your service, the net price, less all the direct costs to deliver and fulfill on that. So we’re going to leave overhead out of this. We’re going to leave direct selling costs out of this. For now, we’re just going to take your general gross profit. So let’s say you have a business that generates a net profit of 10%, we’ll make this math easy here. So after your cost of your product, your overhead, your PR, your marketing, paying yourself a salary, by the way the market salary is really important, all your costs, at the end of the day, you have 10% before you pay taxes.
Now, let’s say your gross profit margin on your products and services, your average above among them all is about 50%. So again, we’re going to make the math easy here. If that’s the case, then let’s take a look at what happens when your costs go up. Now, inflation actually has been pretty good lately. It used to be it historically ran between 3 and 4%. It’s running around 2% to 2.1% now. So let’s say your costs go up 2% a year, no big deal, right? Well, if you’re at 10% profitability and your cost this year goes up 2%, you’ve now taken a 20% impact on your profitability, right? You’ve gone from 10% to 8%. Well, gosh, after two years, that’s a 40% impact if you don’t raise prices or do something else.
So what are the solutions?
For one, you can slash your operating and your marketing costs, do a bunch of layoffs and basically destroy your business. Most of you are probably not going to want to do that.
You can increase your operating and marketing efficiency, which I’m all about. I love that. To be able to change your cost structure.
Or third, you can raise your net price. What that really means is stop discounting so much and take a shot at raising your prices and see what happens. I’m talking about doing this intelligently. So number one, what do you do? I want you to survey your customers, your competitors. So many businesses we talk to don’t have a clue what their competitors charge, especially if it’s not a product where it’s advertised on the internet, but they have a service or they have a customized product where the prices are not known.
You need to assign a secret shopper to try to do business with those companies. You need to really learn what they’re charging at the end of the day. Often this exercise alone yields this aha moment of “whoa, we’re too inexpensive, the competitors are even more than we are.” So take time to try to learn what your competitors are charging.
Number two, raise your prices. Hey look, if you just cover the 2%, I’m happy, right? Let’s get going with this. Raise your prices and test it in a controllable environment where it’s not going to affect your entire business. You know if you sell something every single week to a different set of customers and you run this discounted price for a week or so, you’ll get a pretty good gauge, not scientific, but just starting to get a good gauge of what it’s going to do to your profitability.
Now let’s get back to Paul. Paul systematically and methodically raised his prices during the recession. The total? 17%. And all along the way we were measuring his conversion rates from leads to customers to make sure that that didn’t falter, which it did not. And he was then able to take and have a systematic approach to this for years to come thereafter. And that’s what I want for you as well.
In future articles, I want to share with you some simple strategies for helping you to maximize your price. The first and foremost I call compelling competitive advantages. And this is really all about how you differentiate your business from your competitors so they cannot compare on price and they’re willing to spend more money on you. The second is to utilize low cost value adds that again, differentiate you from your competitors and just make it feel like it’s less expensive overall to do business with you. And the third, I’m going to share with you a pricing strategy that results in your customers not even noticing or perceiving that you’ve raised the prices. It’s a great way to get your 2 or 3% and not have any impact on your business whatsoever.
To your success,
Scott
