The Bottom Line: The Importance of Strategic Pricing

by David Shepherd

Congratulations if you've made it this far in the "8 Steps Challenge." If not, rest assured that this 5th step alone will be well worth reading, but I would also strongly encourage you to find the previous four and read them in order.

Regardless of your involvement to date, this halfway point is an excellent time for a brief review of what you should have accomplished. In Step 1, you readied your organization—and yourself—for change. There are wrenching changes affecting the A&D industry and those firms incapable of recognizing the looming impact and adapting will fall further and further behind. In fact, I gave a speech to about 300 designers last week in Atlanta and warned them that within five years, they would find themselves in one of four categories:

1. Extinct. (No explanation necessary.)
2. Same ol', same ol'. These firms will make the extinct ones look lucky, for at least they will have clearly moved on to new endeavors. The "same ol's" will talk about good years and bad, and the market "coming back," not realizing that the profit margin they've given up to new industry forces is never going to return.
3. Chaotic. These will be the so-called "growing" firms because their top line is growing (sales), but they will be unaware that even as they add people, space and systems, their incremental costs are growing even faster as a percentage. Unfortunately, with the largely useless accounting systems that most firms employ, these firms will hail their increase in "profits" at the same time their cash flow heads toward disaster.
4. Adaptable. Large or small, those who understand the changes in the industry will not only be able to survive, but will thrive as they pick up more and more business from the first three categories above.

The difference in which state you find yourself in the future depends on your openness to change.

In Step 2, you were introduced to a management reporting system that enabled you to determine which aspects of your operation (service, product, specific product lines, project management, etc.) are truly making money, and by matching up relevant supporting costs, determining where you're losing money. This alone can offer a roadmap to how the industry is changing as you will see which "columns" of revenue are holding their margins over time and which ones are being whittled away.

In Step 3, you took a similar approach to determining which type of client will be your client of the future. The key characteristics, of course, will be that the products and services they want most are the least affected by margin creep (due to the Internet, Mega-stores, direct sales and the bidding process) and that they are most likely to give you more business in the future. Step 4, often referred to as developing switching costs, asked you to create ways to lock your clients into your organization. Far too many designers do one job for a client and then break rule 101 of basic sales—they forget to ask for the add-on order a few months, or even a few years later.

This brings us to perhaps the most powerful step of all, Step 5—Pricing. Most small business owners and managers don't understand the power of strategic pricing. They tend to get it completely wrong and give up the weapon that makes all the difference in merely surviving, much less thriving.

One of the reasons they get it wrong is that pricing is best determined by hundreds of different tests and detailed, statistical market research. Naturally, small businesses don't have the resources to conduct or purchase extensive market analysis, so they often price according to what they call "market price," which reminds me of every mother's query of her child: "If little Johnny jumped off the bridge, would you jump off too?" If you feel you have to price like everyone else, you're also jumping off the bridge. In fact, only about 1-in-10 design firms is making the kind of money that it could be. Decision makers are too busy trying to be like each other.

In my workshops with designers (see www.designingprofits.com) we create and discover a variety of ways to raise prices without even calling it a price increase. You should experiment with unbundling everything you do for a client (proposals, consulting, design, procurement, project management, receiving, implementation, etc.) and then, like pieces of a jigsaw puzzle, put those pieces back together in a clever way that not only squeezes more profit out of a given job, but also makes it harder for a client to make a direct comparison between you and your competitor. That way, at least the client will have to ask what the difference between the two of you is, a question that hopefully you crave to have asked, and for which you have an exceptional and definitive response.

The reason price increases are so powerful is that pricing is a magic number, of sorts. By that I mean that it doesn't go through your business model, but around it. From there it goes straight to the bottom line and potentially, into your pocket. For example, if you increased sales by adding a $25,000 job, just like all your other jobs, and your firm was able to maintain a 10 percent pre-tax profit, $2,500 would fall to your bottom line. But if you kept the same number of jobs and simply increased prices enough to raise your top line by that same $25,000, all of it would fall to the bottom line. Roll the clock forward 10 years, invest that extra $25,000 per year at 7 percent, and you've accumulated over $360,000!

That's $360,000 in retained earnings, all because a $500,000 firm strategically raised its prices just 5 percent, or a $1 million firm raised its prices 2.5 percent, or a $2.5 million firm raised its prices 1 percent. Do it right, and your clients may not even notice, or they'll thank you for it because you'll cleverly package the price shift with a clearer definition of the accompanying benefits.

One of the things I like best about what I do is receiving feedback from designers months, or even years after they've attended one of my conferences. As they share some of their success stories with me, one of the most common themes is that they couldn't believe after they raised their prices … their clients didn't even blink. The only way to really know how a client will react to a pricing change is to test it out. And, if you'll think back to Step 3, perhaps a good group to begin your test with is clients who are currently less than ideal, and who you'd probably be better off "firing" if you can't up their profit profile through strategic price increases.

In the next installment, in Step 6, we're going to deal with how to plan and budget for the firm you MUST have in order to succeed in the new era of design—not just the one that will pay the bills.