Business owners are challenged with setting a profitable price for their goods and services. In today’s story, Paula struggles with the common psychology of pricing. You’ll see how she overcame her struggle to achieve success and how you can do the same.
Paula was frantic! How did she get here? She'd worked so hard to build what she thought was a successful business only to watch it crash. What went wrong? She had more orders than she knew what to do with, and yet she was ready to close her doors. She thought, 'maybe one more call to the bank.' Maybe her banker, Jonathan, could bail her out by giving her another short-term loan.
She called Jonathan and he wasn't very friendly.
Jonathan said, "Paula, I'd like to help you out, but you still haven't paid back the last loan we gave you."
Paula reacted, "But, Jonathan, I have a large order. If I can fill it, I can get your cash back within a few weeks."
"That's what you said last time."
"I know, but this time is different."
"I'll tell you what. I've been working with a few other business owners who got help from a business coach they call 'Coach Russ'. I think he may be able to help you. Interested?"
Paula was heartbroken, "If I can't afford to produce 1,000 units for a large client, how can I afford to hire a business coach?"
"I'm not sure what Coach Russ charges. I don’t think he charges anything for his first meeting.”
"What do I have to lose? Do you have his number?"
Paula started a name-tag business out of her house. At first, she made crafty tags that were a hit for social events; and then she started making professional name tags for large conventions. Her name tags were quite popular, but Paula was always lacking cash.
Russ agreed to visit with Paula over the phone about her situation. Paula felt this was her last chance. Although, she had no idea how this Coach Russ could get her the $3,000 in cash to fill her new order. Or how he could help her come up with the additional $10,000 she owed the bank.
Russ asked, "What's your latest opportunity?"
At first, Paula thought Russ was being sarcastic, and said, "I'm not sure what you mean by OPPORTUNITY? My business is dying here, and all you can do is poke fun?"
Russ responded, "Sorry, I wasn't making fun. It's a habit of us coaches to look for OPPORTUNITIES. I suppose it’s a way of looking at the bright side. Let me rephrase my question. What seems to be the problem?"
Paula knew that she had overreacted, and explained to Russ how she was out of cash, had debt she couldn't pay back, and ten employees she’d have to let go, if she couldn't figure out how to fill her latest order.
Russ asked, "What's happened to put you in the situation you're in now?"
Paula reacted again, "Look, Coach Russ, I'm in financial trouble right NOW, and I thought that you could help me find a way out. I really don't have time to dwell on how I got here!"
"I realize that you're in trouble right now; and you need to find a way out. However, unless I know how you got here, it's doubtful, you will find a way out."
"I don't get it. What will looking at my past do for my present situation?"
"What would happen in your situation, if the bank agreed to loan you an additional $10,000?"
Paula shrugged, "I just spoke with my banker and he said no dice!"
"The reason he won't loan you money is that you have a tendency of not repaying your loans with no apparent change in how you're doing business. If we can show him that you’ve altered how you do business in a way that will ensure the bank get its money back, he may reconsider the loan."
Paula realized that she wouldn’t be able to dodge Russ's question. So, she thought about how she got to this ugly place of constantly borrowing money.
After a long pause, Paula responded, "If I knew how I got here, I wouldn't be here."
"Fair enough. Let's start with another question. You're obviously strapped for cash. And, you don't seem to be generating enough cash to pay the bank back for previous loans. There are only a few things that cause poor cash flow. You're either not charging enough for your name tags, your expenses are too high, or you’re paying your suppliers too much. Let's start with your suppliers. What do you pay per name tag for raw materials?"
"I pay about $0.50 for a blank name tag."
"Is this the best price you can pay? What do other suppliers charge for the same blank tag?"
"I think this is the best I can do."
"Okay. How much are you paying your employees to make the name tags?"
"I know where you're going with this, and the answer is NO, I'm not getting these name tags made in China!"
Russ didn't see this one coming, "I'm not thinking of exporting manufacturing to China. I'm simply interested in what you pay your workers to make a single tag."
Paula calmed down, "Sorry. My workers average about $10.50 per hour."
"Thanks, but I'm not interested in their hourly pay. How much does labor cost you per tag?"
Paula didn't know the answer to this question. She’d never calculated it before. There were a few more questions she couldn't find the answers to right away; and committed to Russ that she would find the answers and get back to him the next day.
After a long night, Paula was ready with the answers when Russ called back the next day. She shared with Russ, that it was costing her $0.50 per blank tag; and $1.00 per tag for labor, and an additional $1.00 per tag for general expenses.
Paula already knew the question that was coming next... and then Russ asked, "What do you charge per tag to your customers?"
With tears forming in her eyes, Paula responded, "I charge $2.25 per name tag to my clients."
Russ said, "What do you think the problem is?"
"I charge only $2.25 per name tag; and it's costing me $2.50. But there's no way my customers will pay more for my name tags. They buy from me because I offer a low price."
"There's one of three things you can do. You can reduce your costs; You can charge more; or you can do both."
"But, what do I do with my current 1,000 name tag order?"
"It doesn't sound like you can make this order without a loan from the bank; and you won't get a loan from the bank until you fix your pricing and cost problem for good. Even if the bank were foolish enough to give you a loan, you’d be losing $0.25 per name tag on your 1,000-name tag order. This means that, if you fulfill this order, you will be $250 further in debt."
Paula was convinced that her prices were as high as they could go. Russ was convinced that, like many of his business owner clients, she was charging way too little for her quality name tags. Paula saw no way out of her situation and so she decided to hire Russ by paying with her credit card, hoping that her company would turn the corner before the credit card payment was due.
In their first session, Russ asked Paula to research prices for name tags that were like hers. Paula realized that, although there were a lot of factory-made name tags, none were quite like hers. The factory name tags were selling for $1.50 per name tag, and there was no way she could drop her price that low if she was already losing money at $2.25.
Russ asked, "How would you feel, if you charged $7.50 per name tag?"
Paula laughed, "You're kidding. How on earth would my clients pay more than three times for the same name tag I was selling them for $2.25? And how can I compete with the $1.50 name tags people can buy from large factories?"
Russ persisted, "I didn't ask if you’d be successful. I asked, how you'd feel?"
"I'd feel foolish!"
"Okay. How would you feel, if you charged $7.50 per name tag, and you got the same number of clients you have now?"
Paul played along, "I would feel amazing! But I'd also feel like I was cheating my customers by charging too much."
Russ changed the conversation, "Do you think that you pay your employees too much?"
"No. In fact, I think I pay them too little. I can't afford health coverage or any other benefits. I won't be able to provide benefits at this rate."
Russ ignored Paula's doubt and asked, "What can you do to reduce your expenses?"
"I don't think I can reduce my expenses. We're running pretty lean as it is."
"Here's the thing, Paula. Most products sell for double what it costs you to make them. This means that your name tags should sell for at least $5.00 at your current costs. If you want to give your employees a raise, pay off debt and start making a profit, you need to charge $7.50 per name tag."
It was as if Paula could feel her heart breaking. How could this be? There was no way her dream name tag business could exist at such outrageous prices. The answer seemed obvious to her. She would have to close and file for bankruptcy.
Russ could see that Paula was going in the wrong direction and offered some advice, "Paula, pricing is a sensitive topic. But it doesn't have to be such a sticking point."
"How can I charge so much?"
"First of all, you have to understand that prices are established by two forces: 1) your cost; and 2) the market. You’ve told me that you can’t lower your expenses, and you acknowledge you’re not paying your people enough; so the only alternative is to raise your prices. If you've been honest with me, the market will respond positively."
"What do you mean, POSITIVELY?"
"If you’re selling your product at double your costs so that your business can survive, no one can sell your quality of name tags for less; and the market, your customers, will have no option but to purchase your name tags."