Pricing Products to Stay in Business

All companies need to think and run "lean," removing all costs that don't add value for the customer.

A surprising number of machine shops have a huge portion of their business (80 percent or more) tied up with a single customer or a small number of similar customers. While putting all your eggs in one basket and then closely watching that basket may not be a bad strategy, many shops don’t understand how they should price in this situation. Then they make the mistake of not truly understanding the consequences of pricing their services too aggressively—a mistake that ultimately can doom their business.

In today’s highly competitive marketplace, all companies need to think and run “lean,”removing all costs that don’t add value for the customer. This is true, regardless of the number of customers or the current differentiation that your services may offer.

At the same time, since all services eventually lose their competitive advantage, you must do two things to stay profitable: Ensure that the “value-added” you offer is really a value-add and not just a cost-add, and earn enough margin to invest in your future.

Too many shops fall short when it comes to investing in their future. When you have only a few customers or are dominated by a couple customers, those customers exert undue influence on you. When placed under increasing price pressure by those dominant customers, the shop owner either removes costs that are critical to their future, or they ignore those costs in their pricing model and then ultimately have to get rid of them to make a profit. If you don’t include the actual costs of being in business in your cost model, you eventually have to remove those costs to survive, if the majority of your business is priced against incomplete costs. Those costs that are often ignored include marketing and sales expenses, new service development (R&D) expense and new equipment investment.

While it can be argued that these current customers don’t value your marketing, sales or R&D expense and therefore, can’t be expected to pay for them, if you eliminate funding for either or both—by pricing your services as if they don’t exist—they won’t exist. It’s one thing to price marginal business on an incremental basis that ignores these two expenses; it’s quite another to ignore these costs for 80 percent or more of your business.

The truth is, these “expenses” are actually your investment in the future. Without marketing and sales to create new customers, and without new services and equipment, your existing business eventually becomes a commodity. If you don’t price to fund these investments in the future, you won’t have one. And without a future, you’re of no long-term value to your customers.

Unfortunately, in today’s buyer driven marketplace, most customers don’t care if you have a future or not. And while this may be short-sighted on the customer’s part, it nevertheless can result in your demise.

What should you do to protect yourself from this death spiral? The easy answer is to hold firm on your pricing. The answer is to recognize that to stay in business, you must invest something in R&D and/or marketing/sales. You must include some investment for these functions in your cost model if you use cost-based pricing. Then you have to invest that money in creating new services and/or new customers to move yourself from dependency on one (or very few) customer(s).

The better answer is to understand your value differentiation, which I have discussed in prior columns. If you don’t have a value differentiation, then you are only a commodity supplier. And if you don’t have a value differentiation and you only have one or two customers, you are really only a contract employee who owns their own tools.

If you don’t price to allow investment in the future, you are on the path to going out of business. And while you may respond that not pricing as low as possible will cause an even faster demise, I encourage you to remember that if your services are a commodity or becoming comoditized, you are probably more valuable to your current customers today than you will be tomorrow. Therefore, demand higher prices today (while you can) and invest in your tomorrow, so that you can escape this death trap.

Mitch Goozé is a partner with Customer Manufacturing Group, a marketing consulting company. He can be reached at 408-987-0140 or at mgooze@customermfg.com.