Pragmatic Pricing

A colleague recently asked what I thought of Groupon for the independent restaurant business.

My gut says it’s probably not a good idea, but it depends almost completely on how much additional business at regular prices you think each Groupon will generate for you.  Let’s do the math to see when it is the right decision.

Assume you sell a $20 Groupon.  That means the customer paid $10 and you received $5.  Let’s also assume that your variable costs are 75% of your normal price (50% food cost, 25% labor).  This means for each $20 Groupon, you put $5 in your pocket but paid out $15 in costs for a net loss of $10 per Groupon.

You need to sell an additional $40 in product at normal prices to make $10 in profit to offset this $10 loss.  So, if you believe each Groupon will generate additional regular price business at 2 times the Groupon value, then you will break even, not make money, break even.

In this example, if you only have 25% gross margin (75% variable costs) you need to have incremental sales at least 2 times the Groupon value to justify it.  However, if you have 50% gross margin, the math works out that you only have to sell half the Groupon value incrementally.  The lower your variable costs, the more likely Groupon will be valuable to you.

Page 5 of “The Uniform System of Accounts for Restaurants, 8th edition” says that “A prime cost (cost of sales plus labor) of 65% or less in a full-service operation generally offers a restaurant the potential to earn an adequate bottom-line profit …” If you have variable costs of 65%, your breakeven point for Groupon is selling an additional $1.15 at regular price for every $1 of Groupon.

No matter your costs, you have to generate a lot more full price business just to break even.  This may seem unreasonable, but there are three ways Groupon can help generate additional business.

1. That customer buys a lot more than the value of the Groupon during the visit.  You can help this along by offering a Groupon value that is much lower than your normal ticket value.

2. That customer returns and buys more.  Ideally, you create a loyal customer by offering great value and service.  However remember, when you attract customers with low prices, the type of customers you attract are the one who are the most price sensitive.  They are more likely to follow the coupon than be loyal.

3. The crowds at your restaurant attract more people that wouldn’t have tried.  Find ways to show off your crowd and definitely gather testimonials.

My advice to you before using Groupon is do the math.  Know how much additional full price business you need to generate just to break even.  Do you think you can achieve that and more?  If so, it may be worth it.  If not, well … try something else.

Mark Stiving, Ph.D. – Small Business Pricing Expert

Last week we saw two ways that give small businesses advantages over large companies: setting and executing new pricing strategies.  This is because large companies can’t move quickly. 

However, this week we look at some ways big companies have the advantage, and what you as a small business can do to mitigate your disadvantage.

First and most obvious, large companies usually have lower costs simply due to economies of scale.  You should NOT be competing on price anyway.  You should be competing with differentiation, charging a price that captures your additional value. You have read that message here many times so let’s move on to something you may not realize.

Second, large companies have data.  Their large IT organizations capture information about each quote, each order and each customer.  By organizing this data, big companies create key performance indicators (KPIs) to know when markets are changing.  They analyze the data, looking for market segments and areas where price changes might have a positive increase on profit.  Their pricing organizations are filled with data analysts who can make data sing.  (Yes, I love this.)

As a small business you don’t have all of this data.  You don’t have the analysts.  But you still need to find ways to gather similar insights and information without all of the infrastructure.  Here are two things you should be doing:

1.  Talk to your customers.  Ask them a lot of questions.  Be curious and listen to what they say.  Over time you will detect trends.  You will gain knowledge you wouldn’t normally have gotten.  Try to determine how much they really would have paid (without asking of course).  See if you can segment customer types into willingness to pay.  This is all qualitative, but it’s all you have.

2.  Gather data.  As you quote customers do you log the quote information so it’s easy to analyze later?  Do you have the purchases tied back to the quotes?  Do you know which quotes you won or lost?  At these early stages, make a point of collecting and organizing your data, most likely in Excel.  Before you know it you’ll be referring back to this data to help you make informed pricing decisions.

You do have disadvantages as a small business.  You don’t have the scale or the infrastructure larger companies have.  But you don’t have to simply accept these disadvantages.  Recognize them and do what you can to overcome them.  Talk to your customers and begin to structure your own data.

Mark Stiving, Ph.D. – Small Business Pricing Expert

Photo by Dunechaser

Like most marketing mix variables, pricing is different in small and large companies.  Some of these differences give small companies a clear advantage.

I work as a Director of Pricing at a multi-billion dollar corporation, yet I’ve run a start-up and spend a lot of time coaching small businesses. I’ve experienced the differences and they are stark. The two key advantages for small businesses are setting and executing pricing strategy.

Setting Pricing Strategy

Large corporations are like a boulder rolling downhill.  It’s almost impossible to change direction.  When a company has a pricing strategy in place it is very difficult to change it.  Nobody in a large corporation really owns pricing strategy, except maybe the CEO and he’s too busy with much more important issues (ahem). Besides, everyone in a corporation already implemented their role around the existing pricing strategy.

Small companies don’t have this problem.  Pricing strategy is almost always determined by the executives, and the executives are more closely involved in the business.  They are more likely to see the new strategies that will work.

Take Blockbuster and Netflix.  Someone inside Blockbuster must have come up with the idea to rent DVD’s on a monthly subscription before Netflix, but who would they tell?  How do you get an audience with the CEO to tell him your great idea?  How do you sell your boss so well that he sells his boss as convincingly who then sells his boss as convincingly who then …  You get the picture.  The idea must have been inside Blockbuster’s walls, but couldn’t percolate to the top in a persuasive enough manner.

Executing Pricing Strategy

Once a new pricing strategy is set, small businesses can just go execute.  A few people do most of the work, and they can be redirected.  In a large corporation, policies and procedures dictate how one department interacts with another.  IT systems must be built or modified.  Big change, like a change in pricing strategy, is a herculean task that requires huge change management efforts.

Even if the CEO of Blockbuster liked the idea of renting DVD’s using a monthly fee, it would take at least year to organize the company and get the processes in place to execute this.  Pricing strategies are so intimately tied to so many pieces of the business it’s impossible for a large corporation to change quickly.

As a small business owner, you have the ability to quickly make and execute pricing strategies.  Of course you don’t want to do this often, but you do want to think hard about how you could gain an advantage over your much larger competition.  After all, your competitor will not move quickly.  Use your advantage.

Mark Stiving, Ph.D. – Small business pricing expert

Picture by More Good Foundation

Think about your customers.  What is different about the ones who are willing to pay more vs the ones who need a low price to buy?  How can you charge one group more than another?  Keep thinking.  There are more ideas you haven’t thought of yet.

Here is a brilliant example.  Customers who are price sensitive probably comparison shop.  Customers who are not price sensitive probably just decide what they want and buy it.  In the world of Internet retail, you can tell these customers apart (at least statistically).

This became clear after reading this blog from Upstream Commerce. In it, Gilon Miller points out that you can tell how your website visitors arrived at your store.  If they came from a price comparison site, then they are probably very price sensitive so we want to price more aggressively.  If they came from a product review site, then they probably already know they want our product and are much less price sensitive.  Let’s charge them full price.

This is a wonderful example of price segmentation based on transaction characteristics.

You probably didn’t think up this one on your own (I know I didn’t).  There must be thousands more opportunities for price segmentation out there.  Keep thinking.

Mark Stiving, Ph.D. – Small Business Pricing Expert

Photo by Brian Watkins