The best way to know that you are underpricing is because nobody is whining about your price. In fact, you are so popular that you are completely swamped with business you have no hope of appropriately servicing.
Businesses are so concerned with overpricing and scaring away their customers that they tend to do exactly the opposite. They underprice. Then they get afraid to test higher price points.
Sometimes underpricing happens by accident. Businesses just don’t increase their prices on a regular basis. So years go by and then they find themselves significantly below the rest of the competition.
If you are not increasing your prices with inflation, you are taking a price cut. You can bet your suppliers are not doing this practice.
If you are going to make a mistake with pricing, err towards overpricing. It is much easier to drop your price than to increase it.
Price dropping makes customers happy. Increasing prices often has the directly opposite effect.
Gross Profit Margin
If you think that improving your gross profit margin is something you need to do, it may be that you’re underpricing.
Here are some indicators that you can use to see if this is happening:
If your gross profit margin is getting smaller while your sales volume is the same or is increasing, you’re in trouble. This is a good indicator that you need to increase your prices.
For many businesses, granular records are not kept of product costs. It’s too much work so they amortise the costs at a total business level.
But it is critically important that you do have per product or per line of product view of your costs. One of the important considerations to make in business is to exit products that are not profitable. You can’t identify unprofitable products if you don’t keep good cost records at a product level.
Gross profit margin and net profit are different things. Even though your net profit may be decreasing, it may or may not be a sign of pricing since many factors contribute to net profit.
It could, however, be a warning of things to come so be alert to signs.
NO WHINING ABOUT YOUR PRICE
The second best indicator that you may be underpricing is the failure of anyone to complain about or haggle over your prices.
Everyone complains about prices. You should want some complaining.
In fact, your prices should be sufficiently high that the price whining level is just right. (You can tweak it to suit your own level of tolerance.)
LARGE STAMPEDE OF INCOMING CUSTOMERS
Market share is terrific.
If you can take business from your competitors (especially the bigger ones) it’s a great result for a small to medium sized businesses.
It must be profitable business however or you’ll go out of business.
Large influxes of incoming customers tend to indicate that your pricing is competitive – perhaps too competitive – and, worse still, you may end up having trouble servicing them all.
The more customers you get, the more likely you are to need to hire staff to help, the higher your costs will climb.
KNOWN PRICE-BUYERS START BUYING
If known price buyers start purchasing from you, you know you’re a bargain basement.
(A quick test you can use is to offer the price buyer your list price (not any discounted or special price) and see if they still buy from you. If they do, increase your prices. Simple as that.)
Responding to Underpricing
The simple answer is that you have to increase your prices. You may want to consider doing it such a way as to avoid a bill-shock factor for customers.
You should expect to lose some sales volume.
Losing sales volume is not problematic – if the sales volume you keep or gain compensates in profit for it. It is better to sell less for greater profit, than more for less profit.
Here are some suggestions about what you can do:
RAISE PRICES REGULARLY IN INCREMENTS
This is probably has the least shock factor and is the easiest to explain to customers. Everyone expects costs to rise so therefore there is an expectation that prices follow suit.
If you have account customers (customers that buy from you regularly) you should notify them in advance that your prices will be increasing.
You should adopt this practice (of regular price increases) as standard practice regardless of current circumstances.
CREATE TIERED LEVEL OF PRICES
This tactic requires that you create different levels of product and that each level is priced differently.
This model is commonly applied in the software industry where manufacturers release trial software versions (often for free), educational licenses, single license and enterprise-level or multi-license versions, but the pricing model can be applied to almost any industry. Your current version, the one that is underpriced, could be the cheapest you offer.
The intent should be to move all your customers to a more profitable level. One way of doing so is to give them a period of time within which they move over before you exit the old.
Raise them in one fell swoop but add value to the product to soften the blow.
Closely related to the tiered structure is the value-add model. The more they pay, the greater the inherent value. An example of this in action is mobile phone capped calling plans. Let’s say that on a $49 capped plan, the customer receives approximately $300 worth of calls. If they move up to a $79 capped plan, the value they receive is $500 worth of calls.
The incentive to move is that if they make more calls on their capped plan than their plan allows for, they are charged full rate. So, say the $49 capped customer makes $200 more than the $300 worth of calls they are entitled to, their bill will be $249 for that month. That’s a pretty good incentive to move to $79 per month.
Of course, these are contract rates. Mobile phone plans include mobile handsets, the costs of which are amortised over a contract term. To port your mobile phone service to another telecommunications provider, you need to wait out your contract or pay an early termination penalty.
RAISE THEM IN ONE FELL SWOOP
Sick of tiptoeing around? Don’t care what happens next? There is no return business or account holding customers to worry about?
Just raise your prices. No extras, no bonuses, no explanation. See what happens.
You may find that it makes no difference at all to sales volume, but improves your profit immensely.
At the heart of pricing is the subjective nature of it. There is no right or wrong answer.
What you must do is be prepared to experiment with pricing, and try different pricing models to find out what best works for your business and the nuances of your particular industry.
READ: More about pricing strategy.