First a couple of brief housekeeping notes: I got behind this last week, as in the office we were struggling to get everything that would normally happen in the last ten days of the month (including new quarterly price lists) done by the 20th, so my apologies for the long break between posts. However, I will be continuing to write regularly during the Christmas through New Year break.
I’ll also be taking the next ten days to try to work on finishing my pricing book scheduled to come out in the summer of 2025. Drive Thru MBA: Everything You Need to Know About Pricing I Learned in Fast Food is a book on pricing for the small business owner or other interested non-specialist reader, drawing on examples from my time managing pricing for Wendy’s. More on that in the months to come.
I hope to have some expanded types of content available here on Pricing Evolution in the new year.
And with those notes out of the way…
One of the key concepts that pricers talk about is “pocket price”. The idea here is: you are usually very conscious of what price your charge the customer, but is that really your final price?
Do you offer free shipping?
Do you accept credit cards and absorb the credit card fee?
Do you pay commission or referral fees to some other person or business?
If so, your final “pocket price” the amount of the price you actually keep to pay your expenses, is lower than the price your charge the customer.
Picture an example:
You sell a product for $50.
But it costs you $6 to pack the product and pay for the “free” shipping. That takes your price down from $50 to $44.
There’s also a 3% credit card processing fee which you pay. Now you’re at $42.50
And you actually sold this product through a larger site which lists your products. That site charges a 10% fee for the business you sell through them. Another $5 cost takes your actual pocket price down to $37.50
Perhaps you thought you had a 40% profit on this product: a product cost of $30 and a price of $50, plenty of profit to pay for your overhead expenses. But by the time you account for the pocket price, you’re down from a $20 profit to a $7.50 profit.
If your plan was that 30% of your revenue would go to overhead and you’d end up with a 10% profit, based on that $50 selling price — meaning that you expected the sale of one unit to contribute $15 to overhead expenses and leave you with $5 in profit — you’re actually losing money by the time you account for your selling expenses.
Let’s think about another example.
Say you have a company which does facility design services. You’re hired to design the renovation of an older building into an conference space. You’re paid $100,000 for your design work.
The business was referred to you by another company, and your agreement with them is that they get a 10% “finders fee” for business they win for you. So once you pay them, your pocket price is actually $90,000.
However, while the client pays their invoice for the first $30k in advance, the remaining $70k invoice which is due at the end of the project they drag out for three months before paying. You’ve had to draw on your company’s revolving line of credit to pay your staff and contractors while the project is going, and with interest rates where they are right now, a small business like yours is paying 15% APR on your revolver. This means that 90 days cost you $2,625.
For your $100,000 project, your actual pocket price was $87,375.
In a sense, this is just a matter of perspective. Another way you could remind yourself to be conscious of the same factors is to take these elements and make them a part of product cost. But one good reason to think about this in terms of the waterfall from invoice price to pocket price is because not all sales channels and customers will have the same pocket price for the same product.
Let’s think about our first example with online mail order again.
In that example, one of your major expenses was the 10% fee charged by the site through which you sold your product. You might examine: Is working through that site really worth it when they take a third of your profits? Are there other sales channels you could use that would cost less? Or should you perhaps price your product at $55 in that sales channel so that the higher price pays for the cost of selling?
Another major expense in that example was providing free shipping. You might ask yourself: Is it really necessary to provide free shipping in order to win your customers? Retailers like Amazon have made free shipping seem standard, but that isn’t because shipping doesn’t cost Amazon anything. On the one hand, they have used scale to drive down their shipping costs as much as possible. On the other, they require their vendors to provide products at a cost which will allow Amazon to make a profit even after shipping for free. So your options in order to reduce this hit might be either to charge a shipping fee, if not to cover the full cost of shipping at least to cover some of it, or to price your product higher in order to cover the average shipping cost of your products.
Some companies (though generally not consumer e-commerce where credit cards are the only option) are even beginning to pass credit card processing fees on to the customer. If you’re an online retailer, you probably can’t do that, but what you should do is make sure you price your product to cover that expense in the price. If you’re selling goods or services to other businesses, on the other hand, charging an extra free to cover the cost of credit card processing might be entirely reasonable, and a good way to encourage people to pay via ACH instead.
Going back to our facility design services example, you should be very aware of the cost of your different sales channels. If some of your business comes through a partner whom you have to pay a finders fee (in this example, 10% of your revenue) you should price that sales cost into the prices you bid for that work.
Similarly, slow payment can be a very real cost. You already know that from a cashflow perspective, it’s important to get your customers to pay as quickly as possible. However, when customers ask for longer payment terms, you should consider charging them more in return. A customer should not be able to get both the lowest price and also extended payment terms.
At the same time, calculating what money actually costs you is important. Every time I have seem a company offering a quick payment discount, it’s been a money-losing move. For instance, I recently saw a company with a cost of money about 15% per year offering a customer with 30 day terms a 5% discount to pay within ten days of invoicing. The actual value of getting paid 20 days earlier was just 0.8%. Only in the most competitive industry is a customer going to be motivated to do anything by a 0.8% discount.
In your own business, think about the additional costs which come with your sales:
Rebates
Sales incentives or fees
Partner or sales channel fees
Extended payment times
Prompt payment or cash payment discounts
Shipping costs
Payment processing costs
Remember that your price will not truly reach your bank account until you have dealt with all those costs. And then consider: are there things you should do differently in your business to either minimize those costs are charge for those services.