Pricing For Profit

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Larry, the owner of a small company that manufactured etched-aluminum pictures, once asked me for help. "I don't have any cash," he said, "but my certified public accountant tells me I'm profitable. Would you look at my books and tell me what's happening?"

It turned out that by ignoring significant waste and spoilage, Larry had underestimated the cost of his products. He was paying close to $10 for materials to make his pictures, but he was selling them for only $8.99 because he thought they cost around $6. He appeared to be making a profit because the extra $4 of cost stayed on his books as inventory. He would have discovered the problem if had counted and valued his inventory. But he never took the time to do this because he was always scrambling for cash. (His accountant hadn't found the problem either, since he'd only been asked to do what's called a compilation, not a complete audit.)

* Inattention. With so much else going on, managers often ignore pricing. The most careful attention that I've ever seen given to pricing was by the president of a fast-growing chain of restaurants. During the late 1970s, when inflation was high, his staff checked prices and costs every week. If margins dropped to a certain level, the president immediately repriced and reprinted his menus. At times he reprinted menus every six weeks or so.

"What about your competitors?" I once asked this restaurant owner. "Don't they concern you?"

"No," he said, "for three reasons. First, no one controls costs better than we do. So when we see our margins slipping, we know that inflation is driving our costs up, not our own inefficiencies. Second, we have so much competition that someone is always raising prices. They've got to. Their costs are probably higher than ours. Third, we raise prices by small amounts frequently. This way, our customers don't seem to mind as much, and we maintain every little bit of margin we can."

My own experience in manufacturing and years of research by marketing theorists support the wisdom of the restaurateur's third point. Evidently, customers prefer price increases that are frequent but small to those that are infrequent but large. And certainly a policy of frequent price increases allows a company to maintain every last bit of margin it can.

* Full product lines. Many small manufacturing companies are convinced they must offer customers a full product line. Their marketing managers, often coming from large companies, condemn a partial line with all the fervor of an environmentalist in sludge. But the financial reality is that you may lack the resources and the sales volume to develop, price, and sell the additional products profitably.

I once worked with a company that made very good potting soil for house-plants. But to fill out the product line, the company also sold dehydrated cow manure, decorative stones, plant food, and so on -- all at a loss. The quality of the oddball products was below that of the potting soil, but the cost of sales was significantly higher. That was because the company knew nothing about the technology of the other products; it didn't have the special equipment needed to produce them efficiently; and it couldn't generate enough sales volume to justify acquiring the necessary knowledge and equipment. The company sold its secondary products for all the market would bear, but the losses on those goods nearly sank it.

If you need a full product line, there are other approaches. One, recently popularized by marketing consultant Regis McKenna, is to form a strategic alliance with other firms also looking to fill out their lines. Aldus Corp. has done this very successfully. The three-year-old company produces PageMaker, one of the best-known software packages for desktop publishing on microcomputers. Aldus has formed an alliance to sell a complete system for desktop publishing, which includes a computer and laser printer from Hewlett-Packard Co., a word processor and system software from Microsoft Corp., and the page-layout software from Aldus. The company has other strategic alliances in the works.

* Inappropriate objectives. Marketing theorists talk a lot about pricing objectives. Is your objective to maximize current profits? To penetrate new markets? To capture market share? To discourage entrants? To build traffic in a retail store? Or something else? Your pricing policies, they tell us, can be a very effective device to achieve these and other objectives.

Unfortunately, if your company is like most I've seen, you have a hard enough time generating current profits. Trying to achieve the other objectives through general price cuts usually requires more cash, more market knowledge, and more ability to forecast the future than you can muster. This is not to say, however, that if you have a Cadillac product you must ignore the Chevrolet marketplace. It does say that you should protect your Cadillac margins by selling Chevys in the Chevrolet marketplace.

When sales are slower than you would like, it takes knowledge and creativity to turn the situation around without sacrificing margins. Perhaps the positioning of the product needs to be changed or new segments found. Perhaps the product needs to be changed or redefined.

Sometimes, of course, when nothing else seems to work, a price cut may be the only way to increase sales. But sharp entrepreneurs will look to price cuts as a last resort, not as the first point of attack.

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