By Matt Cottrill, MBA, CEO Growth Track Advisors

Effective pricing strategy is one of the fundamental drivers in growing a small business and making it a profitable business. Yet many entrepreneurs struggle to find the right balance between over-pricing and the risk of losing business, and under-pricing, with its associated risk of leaving profits on the table. Pricing strategy is one of the most difficult elements of running a successful business, and one of the least understood by entrepreneurs.

There are 5 common pricing pitfalls that get in the way of business success:

• Cost-based pricing
• Failure to adequately understand the customer’s pain or opportunity, which leads to the inability to quantify ($$) the value you provide
• Lack of confidence to price based on value
• Providing free services in anticipation of an order
• Misunderstanding of cost

Increasing price is one of the most effective strategies for boosting profits. Every dollar of increase goes straight to the bottom line. A manufacturing client recently calculated that a 3% increase in their aggregate price equated to a 39% increase in gross profit. What is the impact of a modest price increase on your business?

The most prevalent pricing pitfall among entrepreneurs is the use of cost-based pricing. With this strategy, the selling price is based on the cost of the product or service plus a (sometimes arbitrary) margin. The pitfall with this strategy is that the selling price has no correlation to the value your product or service offers the customer, which leads to leaving profits on the table. This is particularly common with manufacturers of engineered and custom designed products.

Value-based pricing strategy is a methodology that uses the value that your product or service provides to the customer as the basis for setting the price. The concept is easy to understand, but difficult to execute. It approaches pricing strategy from a completely different perspective versus cost-based pricing. Think of cost-base pricing as a bottom up approach and value-based pricing as a top down approach. The difference between the two is the amount of profits left on the table.

In order to effectively execute a value-based pricing strategy you must be able to identify the value that you bring to the table, then quantify that value. The value typically shows up as the pain you eliminate for customers, based on jobs they are struggling with, or opportunities that you help them capture. Quantifying the value is difficult and can be an inexact science. However with the proper approach, a reasonable estimation of the value usually can be monetized.

A recent client had an opportunity to enter a new market. Their belief was that their service would provide compelling value to this new customer base but they weren’t sure how to specifically identify the value or quantify what impact it would have. We took them through the Growth Track Value Pricing Workshop℠ to identify and quantify the value they would be providing to the customer. The results were eye opening. By doing a structured deep dive to understand and quantify the value, they discovered that the value that they were delivering to their customers was far greater than they had realized. As a result of going through the process, they increased their price by 40%.

Once you understand the process necessary to price based on value, the challenge is to consistently execute this strategy. A structured sales process can be very effective in helping the company consistently execute this strategy. The structure will help guide your organization through a process that creates a deep rich understanding of your customer. In addition, an effective sales process will provide critical information to help quantify the value. Without an effective and structured sales process it is difficult to execute value-based pricing consistently.

Lastly, once you’ve identified the value you provide to your customer, and are able to quantify it, it must be communicated. Many times customers do not realize the extent ($$) of value that you provide, so it becomes an education process for you to help your customer understand your value. This education will set the foundation for a much more favorable outcome from your negotiations.

Being armed with deep, rich information about the value you provide customers will significantly boost your confidence to price based on that value. In addition, it will provide the basis for a much more impactful value proposition. Once implemented, value-based pricing will provide an immediate positive impact on bottom line profits.