Are you paying the price for low prices?

2008-09-08 00:00

Over the many years of writing business articles, I can’t count how many readers have commented and asked that I take a look at their businesses. When market conditions are tough, I find the most common disease among the small and medium enterprises (SMEs) is that of selling too cheaply. On looking at the income and expenditure accounts, I’ll ask the entrepreneur: “Do you realise that every day you are working for your landlord’s and bank manager’s benefit?”

Too often, the entrepreneur is taking chicken feed from the business and working to merely service debt. This cannot be right.

The owner of the SME evidently has the wrong attitude towards business and is frightened of price. These two considerations are linked via the fact that the owner does not want to upset his customers by selling his products at what he perceives is too high a price. This attitude results in a situation where the costs of products and services coming into the business are constantly going up, but not recovered fully in selling prices, resulting in diminishing profit.

If the variable costs (cost of sales) go up, then gross margin comes down. This means the business’s break-even point is increasing.

Similarly, if the fixed (overhead) costs are increasing, the break-even point is going up because there is more cost for the gross margin to recover against. More cash is going out and less profit is being produced.

I find it amazing that when I suggest the owners put up their prices, they cry: “If I put up my prices I will go out of business!”

The fact is, in most cases, they are already going out of business from the eroding gross margin and profit levels. The only question is how long can they take the pain before admitting they have to do something.

That something can only be one, or a combination, of the following actions: up the prices, reduce the variable or fixed costs, or change the mix of products sold to one that will produce a higher gross margin.

The last option would be to close up shop or sell the business. Finding a buyer for a loss-making venture is difficult in good times; in tough ones, nigh on impossible.

The answers lie in what I discussed over the past two weeks, particularly in “putting in the hours”.

If you really believe you need to, find the justification for higher prices. Look for all opportunities for adding value to your products or service.

Ask your staff, family and friends for suggestions. Pose simple questions, such as: “What would I have to do to justify increasing the price of these from R12 to R15?” Then stay quiet and listen to what they say.

When times are bad, you can often support a higher price by giving your customer time, attention and incredible service that will bring them back and get you recommended.

This opportunity is particularly relevant in South Africa, where poor service and poor quality is commonplace across markets and industries.

We tend to find that in a tight economy, we justify reduced staffing and even poorer service and product quality. If this is what you do, you won’t find an opportunity to increase selling prices, only a need to cut prices and you are back to the square one of ever reducing profits.

Finally, if your SME is not making profit, then something is dangerously wrong. In my experience, the root cause will be found in poor gross margins — both rand value and as a percentage of sales.

Correcting this situation will have much to do with fully recovering cost increases in your selling prices — not just putting prices up once a year in January.

Put up your prices when operating conditions dictate you need to.

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