In our last installment, we discussed the crucial nature of selecting the right entity type for a new or growing business. This week, we’re going to cover another dangerous pitfall for business owners: underpricing their goods or services. For a new or struggling business, luring new customers with discounted prices can be very appealing. Many businesses will offer their product or service at deep discounts to “get customers in the door” only to learn that they’ve attracted a hoard of patrons unwilling to pay full price. It’s difficult to increase prices once you’ve done this, plus you may end up losing capacity because you are trying to keep up with volume that is priced too low to make a profit. This represents an opportunity cost in the higher-profit sales that you could be missing. Study industry benchmarks or other research to determine the right price for your product or service. If the price is too low to make a profit, you will never make it up on volume.
Underpricing is rampant in the professional services sector. In most cases, professionals adhere to the time-tested practice of billing by the hour, as if your service has an inherent value dependent on the amount of time it took to complete. In purely economic terms, it makes much more sense to price services based on the value enjoyed by the customer, not by the amount of input that went into its development. Imagine this example: a team of attorneys spends two weeks on a project to develop an innovative business structure for a client and bills the client accordingly. The next time the firm sees a similar set of circumstances, they will likely spend a fraction of that time to recommend the same strategy. Should they bill the second client less than the first? Consider this same premise applied to your favorite smartphone. The price of the very first unit of a new phone would be astronomical, but each subsequent phone could be had for “pennies on the dollar”! It’s important to consider the value of your service and price your services accordingly. To do this, it can be helpful to check out the pricing models of businesses like your own as well as consulting your financial expert. Tune in next week when we discuss one of the more insidious mistakes businesses both new and established sometimes make.
John R. McCallum, CPA
John R. McCallum is a member with GranthamPoole PLLC and a recognized leader in the field of cost segregation and various real estate taxation matters. He has also written, taught, and spoken on many topics in the area over the years. Please contact John at firstname.lastname@example.org, www.linkedin.com/in/john-mccallum, or 601-499-2400. CPA License # 5323
The above does not represent tax advice. Each situation is fact-dependent, and you should seek the advice of a competent advisor. GranthamPoole PLLC is a provider of tax, accounting, advisory and strategic services, partnering with clients across a broad spectrum of industries and sizes.