The Marketing Plan – Price Your Services – What not to do

You have done your competitive market research and have identified the strengths and weaknesses of your competition. You have a good handle on their price points. You know your product is better. You can price your product just under the competition and you will take your market share. There are even studies and mathematical equations that indicate that pricing your product 20-30 % under the latest competitor will give you a 10-15% market penetration. You do the numbers and price your product. You are set to be a successful entrepreneur. All you need to do is get the word out and you are set.

Unfortunately, it does not work that way. This is a Marketing Plan of Failure. One of the immediate red flags I identify is when the use of funds indicates an amount for advertising. It means that the company has used this type of methodology in determining pricing, which will most likely be too low to cover production and sales costs, and revenues, which will be too high because it just does not work that way.

To help understand why this common thought process is completely off base we need to look at a couple of factors. First the price/quality ratio is perception. Very rarely is the best product at the cheapest price a market leader. The market leader is the product that the client quickly identifies as the best product. Second a plan based on the lowest cost provider model always fails because there is someone out there who can do it better, cheaper, faster or who does not care about making money and will sell the product at a loss just to keep others out of the market. Finally, while it is the entrepreneur’s nature to be optimistic about future sales, he often overlooks many of the costs of doing business or producing a product.

Let’s take a bank’s checking account as an example. Most banks have come out with a plan where you pay $10-12 a month and on every movement you acquire points that can be redeemed for awards or sometimes, even money. You think this is great, I can earn points toward vacations, hotel upgrades, a big screen TV, and or even get part of my money back. Sounds great, but it is not. A closer look at the product shows that while you will pay $144 annually you can only earn about $100 in benefits. If you close the account early you are responsible for fees to close the rewards program and if you do not have enough points they are just lost. So in the worst case the bank makes $44 for doing nothing and in the best case makes $144 and keeps its client tied into the account for other services. The best deal on the account is the free checking with direct deposit. No frills, no interest, no nothing but it is the least expensive way to use the bank’s services. So why do people choose the rewards accounts, because they perceive they are getting something for nothing.

The most well known example of the imminent failure of the lowest price business model is the recent bust in the Telecommunications industry. Every new player that entered the market dropped prices by 30%. They did not anticipate that there would be other market competitors and as they took market share from those already in the market these competitors would also lower prices. In the end the corporate earnings across the board were severely damaged. All of the new players went bankrupt and the only ones left standing are the ones who were already in the market and had significant cash reserves and existing networks. Today the companies created from the deregulation are now coming back together. In thirty years the cycle has come full circle.

Finally, I know you think you know what it costs to build your product. You may even have signed a contract with a foreign company to build it cheaper and better but every business decision has consequences and is sooner or later reflected in the costs of doing business. Let’s say you decide to build your product in China, what happens if the product quality drops just a bit and the number of returns increases as a percentage. A good friend of mine who brought the first cell phone to production for Motorola told me horror stories of ramping up production. Fortunately Motorola had deep pockets and was able to source materials and people to make things work but they did it at 500% of the original budget. I have seen this across many sectors in both products and services.

I know this all sounds negative instead it is reality. Your plan needs to take these thoughts into account and your judgment must be cautious both on the cost and on the revenue side. A wrong step and you will most likely lose your company and all the work you have put into it. Some venture firms will identify cost or revenue variations and not say anything. The deal will be structured in a way that gives them control should the financial parameters vary more than a predefined percentage. When it happens, because it will, they walk away with the company, replace you with someone else, pump in some new money and sell the company for 4 times what they invested. Be careful and be cautious, it is your money and your life’s work we are talking about here.

Tags: Small Business Private Equity Business Plans Financial Model Financing Marketing Sales Product Pricing