Good morning, Profit First Entrepreneurs. As I am writing this, I am visiting the lovely San Diego area, but today the topic on my heart is that of revenue and pricing.
One thing that I have observed with business owners is that there is always this apprehension about increasing prices or even charging a fair price. It’s almost like there’s this fear that, “If I charge a fair price, if I charge the market rate, I might not make the close, I might not get the client”. As a result of this fear of pricing their services in the correlation with the value that they provide, business owners will tell themselves, “Okay, I will decrease my markup just for you (because, of course, you are my favorite customer), I’ll discount it if you’re going to buy more services.” And these business owners wishfully believe, “I’ll make it up in volume.”
However, revenue is misleading. In fact, millions of dollars in revenue does not equate to millions of dollars in profit. In fact, it is quite possible to run a loss when you have a multi-million-dollar company. When entrepreneurs think about volume and sales, there is usually a false impression that although one may be selling a low margin product or service, there is this compounding effect. They believe that once a critical mass is achieved, then profits will naturally follow. Most entrepreneurs fail to consider is that the cost associated with running the business will also increase in proportion to the addition of sales volume.
For example, an increase in revenue will require an increase in sales volume. To generate this increase in volume a business owner will need to hire additional employees. Not only will inventory purchases need to increase, but the company will also experience an increase in utilities (electric, water, etc.). Additional lease space may be required to house this increase in inventory and headcount. The additional employees will require additional training, benefits, safety gear, computer technology, and phone lines. This cost to incur the additional volume will reduce the profits associated with the additional revenue earned.
When an entrepreneur discounts his or her prices, what happens is now the entrepreneur must absorb the costs out of his or her profit. When there are discounted prices, overall profit is less in comparison to what the company could have made had it just charged the market rate. Not only does discounting prices impact profits, but it also results in shortchanging the growth of the business and the team. The company is shortchanging its business because now it has less cashflow to work with. Now the entrepreneur is forced to make decisions of, “Okay, granted, the contract that I made is the contracted that I made, but who, internally, is going to fill the order that I just made?” Now because the company has less cashflow, the company must make very different decisions. Now instead of hiring an internal team member that is an “A” player, the business might have to settle for a “B” player, or even worse, a “C” player. This “C” player isn’t going to be as efficient and as experienced as the “A” player one might have preferred.
When entrepreneurs think about cutting prices, they must consider the domino effect. This decision is not just a bottom-line impact. Due to the decision to discount, the company will not have the cash flow to invest in the technology to automate processes that will allow it to operate faster and more efficiently. The company will not be able to recruit the person internally that’s going to be able to really serve its clients in an “All Star” fashion. Unfortunately, what ensues, is that the company ends up financing the endeavors of its client. In some ways, the entrepreneur ends up actually serving as a bank for its clients. Now the client has 30 days to turn around its invoice, in the meantime, the company is working on cashflows of just what it has right now. The company’s cash flows are tight because today the company has to purchase that next batch of raw materials, pay its internal team, reinvest in advertising, and pay operating expenses that are required to keep the office running.
And so really, profit first entrepreneurs, it is important to think about the domino effect that happens when you discount your prices. You’re not just charging a price for your own bottom line. You are representing your staff. You are representing your team, and at the end of the day, you’re also representing your client. If a company doesn’t charge a fair price, the company is not going to be able to put the right people on that job that will give the client the service and the quality that he or she is expecting. Instead, the client will be placed in a situation that’s high stress, and the client will be working with someone that they really didn’t want to work with because now, they’re working with somebody that doesn’t have the right experience.
So, Profit First Entrepreneurs, the best thing you can do for your clients, your team, and for yourselves, is charge a fair price. Do not discount your price, do not underplay yourself, rather, embrace the concept that not all contracts are good contracts. Sometimes, it’s better just to let a contract go, then to be bogged down and unable to serve the right contract when it comes along. When a company discounts its price, the company has to land another contract that will subsidize the shortfalls in cashflows and margins. Then at that point, the company is playing a float game, and “surprise”. Float games come to an end; and someone will end up losing. My Profit First Entrepreneur, friend, you’re better off just saying “no” to the customer that’s not willing to value you at the worth that you bring to the table.
Until the next time we meet again, I look forward to seeing you!