Establishing your true costs

During good times many businesses can still thrive even if some of their products or services aren't profitable. However, when things begin to slow down it's essential to examine your true costs so you can identify, and rein in, any money losers.

When calculating true costs, you will need to take into account your:

• Variable costs
• Overheads
• The costs of any incentives

Variable costs are the costs of manufacturing and providing your actual product, including the costs of:

• Raw materials
• Packaging
• Warehousing
• Delivery
• Installation

Overheads: the true cost of any product should include a contribution to your overheads, or fixed costs, which include:

• Salaries
• Rent (if applicable)
• Insurance
• Loan repayments
• Overall marketing costs

Incentives: if you offer your customers incentives such as free add-ons, warranties, loyalty bonuses or credit terms, you will need to factor those costs into your true cost calculations as well.

Pricing fixes for money losers

After calculating your true costs, you may find that a certain product isn't profitable. While simply cutting the product from your offerings may be an option, you can also re-examine your pricing to look for ways to recoup more of your costs.

In many cases, charging for incentives that you formerly gave away can help considerably. You may also want to look at setting or raising order minimums to reduce processing costs and give you greater economies of scale in production.

Simplifying your pricing

An overly complicated pricing strategy can confuse and drive away potential customers. Using a tiered good-better-best approach can help you consolidate your price points while still allowing you to make more profit on customers who value a premium product or service.

At the "good" level, the customer can buy your product at a lower price but with fewer extras and incentives. At the opposite end, the "best" level combines higher prices with additional benefits for your customer. This can include more relaxed payment terms, additional support or a product with improved features.

Identifying critical price points

Another strategy for maximising profits in a downturn is to look for critical price points, a price at which demand is relatively high. If your product is currently priced just above a critical price point, demand will be markedly lower. By reducing prices to the critical point, you can often achieve much better sales.

Some price points are psychological, such as an item priced at £4.99 rather than £5, or a price at or just below the price for a very similar competing product.

Researching the market and examining your competitors' prices can help you better identify the critical price point you want to aim for. Keep in mind, however, that if your product or service offers more value to customers through better quality, service or convenience, then potential customers will often be willing to pay more.

Adding value rather than discounting

While lowering your prices could bring in more money in the short term, your customers may see it as an opening to ask for further price cuts. Additionally, raising your prices back up when times improve is also difficult.

Improving the value of your product is often a better long-term strategy than cutting prices. This can involve improving the quality of your product or service, but it can also include:

• Better customer service
• Extras, like free delivery
• Bundling in a complementary product
• More favourable payment terms
• Free training in how to best use your product

These kinds of incentives can also be used to reward customers who place bulk orders or who sign long-term contracts.

Incremental pricing

Incremental pricing is another pricing strategy that can help in a downturn.

For example, offering a discount of 5 per cent on the next £5000 after the first £5000 spent not only encourages customer loyalty - each tier of an incremental scheme can also be viewed as a spending goal to work towards. Many customers will spend more than they might otherwise in order to gain the discount, increasing your sales without adding to your marketing costs.

Whilst every effort has been made to ensure that the information given is not misleading, this material is provided only as part as an overview of the subject (at the time of publication ) and is not a substitute for specific professional advice. No responsibility can be accepted by Bank of Scotland for any loss or liability occasioned by any person acting or refraining from action as a result of the contents of this guide.

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