By Jim Hunt
What to charge for your goods and services is a question many business people struggle with for all the years they’re in business. There’s a science to choosing appropriate pricing and it’s not difficult. Developing a price strategy is mostly research. In short, you must identify your cost of doing business and determine the price points occupied by your competitors. Once you have this information, the choices are pretty self-evident.
Any way you slice it
Many new businesses simply adopt a price five percent lower than an established competitor who appears to be doing well—and hope for the best. While some survive this tactic, none did so because of this choice. Any product or service can be bought at an astonishingly wide range of prices.
When you fly to another city, passengers in the seats around you each pay a different price for the same service. Currently, coast-to-coast flights vary from $300 to $1,900 round trip. That’s a 500 percent spread in price! You can buy a new passenger car for as little as $8,500 and for more than $35,000. They all perform the same function—transportation of passengers. What justifies the differences in price? Likewise, you can buy a water softener for $500, $2,500 or any price in between. Since each of these softeners makes hard water soft, what accounts for people’s willingness to buy at different price points?
Buying products or service
To understand price points we have to understand what people are buying. Most folks don’t set out to buy plane tickets, transportation vehicles or water softeners. They buy vacations, status and comfort; and these are judged by a different standard than simple commodities. In fact, most of us dislike being herded like cattle into cramped planes and left in near intimate proximity with total strangers. However, if you buy a vacation to a tropical island, the increased airfare due to late booking has little impact on the total vacation value. If you suddenly have to fly to another city for the business deal of the year, the near double cost for a last-minute booking is acceptable. In other words, you’ve just bought access on demand and that’s not priced by gallons of jet fuel.
Top-of-the-line automobiles don’t have $20,000 to $30,000 more steel and plastic in them. The price differences cannot be justified in additional raw materials. Autos feed fantasies: Jeeps make you an “outdoorsy” kind of person; Volvos show you value safety over looks, Taurus is a mid-priced car (so you didn’t pay too much or too little); Cadillacs show you made it and a Mercedes shows you made it and you have some class, too. Major automobile manufacturers offer products at all different price points to appeal to all different buyers, while small manufacturers usually pick a niche.
Water conditioning isn’t so different from these other products. It may come as a surprise to some readers of this magazine, but homeowners don’t pine away for water softeners and filters. We’re all familiar with homeowners that want their water problems to go away; they want safe or odorless water or cleaner clothes. We make a fundamental mistake if we try to sell these people equipment. They want solutions. And the equipment—like the airplane is to the ride—is just a necessary part of the process. Revlon said once: “In the factory, we make perfume; in the store, we sell dreams.” Another famous industrialist realized the same concept when he said, “We don’t sell drills, we sell holes.”
There are many different price points and different buyers at each price. We all know people who only compare the price of equipment. These are typically the least sophisticated buyers. They don’t look at the total cost of solving a water problem. Other folks seek out the best equipment and want to provide their own labor, thereby getting the best “value” for the money. Others will pay top dollar if they think it’s the final solution and they won’t have to deal with the problem again. There are buyers that only look at terms of the sale (monthly payments) rather than total price. Some buy service contracts, some don’t. Many rent. There are unlimited price points that can be addressed by different product/service permutations.
When you have identified your competition you can think about who you want to challenge directly, or what niche is unserved in your market, or what product/service combination fits your personality. It’s important to remember that price follows function and vice versa. If you claim to have the best product, best service, best warranty and best experience, then you better have one of the highest prices or many will doubt your claims.
Analyzing the competition
Use the competitive survey form (see Figure 1) to evaluate your competition. You’ll find some dealers typically sell one piece of equipment and others sell two or three pieces. When you record “price,” it should be the typical sale price without regard to equipment. People aren’t buying equipment, remember? Evaluate “service” to determine whether they service what they sell, and how long it takes them to respond. “Expertise” is a measure of how well they solve water problems. Evaluate “product” as equipment, installation, warranty and service package.
Now that you’ve collected good market research, the issue of price begins to get clearer. Those of you that found a Home Depot in your neighborhood have probably concluded selling softeners to the DYI (do-it-yourself) market is not the road to success. However, if you’ve got a dealership in rural America, a DYI approach might be good strategy. If you found five competitors with average installs between $1,000 and $1,900, you’ll probably want to investigate price points above or below that range. But wait: it’s too early to choose a price. You still have to determine your cost of doing business. You might find that you couldn’t take on Home Depot, even if you wanted.
Determining your cost of doing business entails making a complete list of your expenses. Many dealerships started out in home offices or garages to save rent; he or she gets their health insurance coverage through their spouse’s job and they don’t have workmen’s comp or liability insurance. Even if you’re still in that position, complete the following exercise to begin thinking about where you want your business to be several years down the road. Establish goals to be an independent, stand-alone business that pays its own way.
Let’s draw a sample
Figure 2 lists many common expenses. You may have others, and we’ve included the numbers for a sample business. Sample Water Inc. does five new installs and $3,000 worth of service per week with a staff of five. The owner pays himself part as an owner, part as a salesperson, part as a service technician, part as an office/bookkeeper, and installer—you get the picture.
Sample Water Inc. does $10,000 in new installs and $3,000 in service per week, so it has a 70-30 percent split. That means new installs have to carry 70 percent of the overhead and service carries 30 percent. Before any variable costs like equipment purchases, labor, sales commission and supplies, there are overhead costs applied to each job. If Sample Water does 21 installs per month, they have to add $572.67 to each install before any other costs (see Figures 3 and 4).
Service work has a 30 percent burden, so assume 105 service calls per month and each call has to add $49.08 just to cover overhead (see Figure 5):
- Overhead—This is a number taken directly from the previous work sheet.
- Softeners—These are available at wholesale prices of $275 to $750 plus delivery, depending on features like meter vs. calendar clock, alternating twin tank vs. single tank, co-current vs. counter-current regeneration.
- Supplies—Keep in mind, we’re talking in addition to equipment costs including pipe, fittings, pipe hangers, solder, flux and so on.
- Labor—Attributed to one installer who does five installs per week, so labor is 20 percent of weekly pay.
- Commissions—This company has a full-time salesperson and the owner derives part of his pay from sales. If the salesperson makes four sales a week, s/he will have an annual income of $80,000. You might also have two $40,000-a-year salespeople that combined produce four installs per week. The owner sells one install per week and adds $20,800 to his annual salary.
- Plumbing permit—This price varies by community.
- Profit—In the above example, gross profit before taxes is only 10 percent, while many aspire to higher profit. Ten percent is a realistic goal.
Service work can also be priced in a similar fashion. To start, each service call has to cover $49.08 in overhead, commissions, labor and supplies. In our example, we assumed 105 service calls per month or two hours per call. So each call costs $18 per hour multiplied by two, or $36 in direct labor, plus $49.08 in overhead equals $85.08 before commissions and profit. The selling price in our example was $120, so a 20 percent commission is $24, bringing the total cost to $109.08, or a nine percent margin. This is pretty low profit, except that each job should have sales of parts and consumable supplies and the markup on these can now be considered pure profit. The bottom line is service labor has to be billed out at a minimum of $60 per hour. And that’s only if there are sales to accompany that service call.
National surveys indicate the average sale price of a water softener is $1,200 and the average service call labor rate is $37 per hour. Yet the numbers suggested here indicate a softener should sell for $2,000 and service calls should be billed at $60 per hour. What gives? These survey numbers are a little misleading because 20 percent of the dealers do most of the business, maybe as much as 80 percent. So the average prices are influenced by the 80 percent of the dealers doing a small amount of the total work. If a survey were taken of just the largest dealers, the prices would be much higher. In a few situations, the cost of doing business is low enough that a dealer can profitably offer the lower prices.
Most often new entrepreneurs are substituting labor for capital. They’re working long hours for short pay, often without insurance protection, and are selling cheap to get business. To move up to the next level, these dealers have to start charging higher prices first. Small dealerships are by their nature inefficient businesses, meaning there’s a small amount of business to support overhead. Actually, the smaller you are, the more you have to charge. Much of the overhead would remain the same if the business doubled or tripled. In reality, working cheap is a decision to subsidize the consumer.
To survive in business, don’t just copy someone else. Figure your cost of doing business. Research your competition. Pick a market niche and establish prices you can live with. Literally.
About the author
Jim Hunt is regional manager for DWC, a division of the Duff Co., a provider of products for quality water. He also is a member of the WC&P Technical Review Committee. He can be reached at 160 Front St., Marblehead, Mass., 01945, (781) 639-2213, (978) 834-3169 (fax) or email: email@example.com