IS IT YOUR PRICE?

One of the interesting P’s in the four (4) P’s of marketing is Price. It may interest you to know that of the 4P’s of marketing (Price, Product, Promotion and Place), Price is the only element that speaks directly to the top-line or the revenue earning potentials of the business. Will it be safe therefore to assume how you price your product or service has a direct consequence on the profitability and sustainability of your business?

I am of the opinion that the intensity of competitive rivalry in the Nigerian business environment is as fierce as other business capitals in the world. This reality sometimes pushes a lot of businesses especially Start-Up’s, Micro, Small and Medium Enterprises (MSME’s) to consider competing, on the basis of pricing. The practice whereby competitors lower their prices repeatedly to gain an improved share of the market is referred to as a “Price War”. While a price war has the short term benefit of attracting customers your way, the long term impact is that you will be most likely out of business sooner than you can imagine.

In his book Competitive Advantage: Creating and Sustaining Superior Performance, Michael Porter one of the leading voices in Business Strategy, came up with a framework that suggests how companies can sustain their competitive edge in business. This framework also referred to Porters Generic Strategies identified three strategies organizations can use if they are to build sustainable competitive advantage. These strategies are Cost Leadership, Differentiation and Focus.

Cost Leadership is often misrepresented as lower pricing when in essence it suggests that for an organization to have a sustainable competitive advantage, it has be so efficient and effective in the management of its resources such that it is able to produce a unit of its product or service at the least cost in their chosen industry. Please note that being able to produce a unit of a good or service at the least cost for a given level of quality in the industry is borne out of efficient and effective management of the resources available to the business and not an arbitrary reduction in prices because of the desire to increase market share. Differentiation Strategy, on the other hand, speaks to the uniqueness of the product or service as identified by the customer themselves; and for which they are willing and able to purchase the product or service regardless of the price. Organization’s that adopt focus strategy, identify a narrow segment of the market and within this narrow segment or narrow market focus, attempt to achieve either cost leadership or differentiation.

The above definitions actually give an insight into what organizations regardless of size should consider before fixing their prices. Some other important factors to remember in determining the price of a product or service are stated below:

Customers buy VALUE not price per se.

Not all customers are homogenous – different customers will value a product or service differently and as such will be willing to pay different prices for such a product or service.

Customers always buy the product or service they perceive to represent best value. The customer’s perception of value is therefore always relative to the competition.

The price of your product or service should at least cover all your variable costs with an added provision for profit.

Let me explain further with this illustration.

Abiodun and Gboyega are die-hard Premiership followers. Abiodun supports Arsenal while Gboyega supports Manchester United. Both men have an undeniable passion for football and decided within themselves to start selling football accessories. Abiodun and Gboyega situated their respective football accessory stores near a newly opened football park called Goal Centre. Every day hundreds of football enthusiasts went to Goal Centre to play five-a-side football. Abiodun and Gboyega stocked all kinds of football accessories including Jerseys, Socks, Shin-Pads, balls, and boots.

Gboyega gets all his football accessories from the UK. He travels there every three months to replenish his stock. Whenever he travels, he flies at least premium economy and spends a minimum of five days staying in a three-star hotel. He has a bank overdraft priced a 28% per annum with an annual clean up cycle from one of the leading Banks in the country. He has to pay cash every time he purchases stock from the manufacturers as he has found it difficult to obtain credit from the manufacturer. He has four sales staff and offers a free drink every time a customer comes to his store.

Abiodun also gets all his football accessories from the UK. His cousin Akin who lives in the UK helped him obtain a distributor’s credit from the same manufacturer Gboyega gets his football accessories from. The company ships a sufficient quantity of football accessories to him based on an agreed order level. He also has a credit period of 90 days. Abiodun is a very hands-on manager and has two sales assistants working with him. Abiodun sells a replica Manchester United jersey for Twenty-Five Thousand Naira and has a lot of patronage from the football enthusiasts who play football at Goal Centre. The total cost of getting a Manchester United jersey to Abiodun’s store from the UK was Twenty-Thousand Naira.

As he returned from his last trip, Gboyega was informed by his staff that sales remained low because his Manchester United Jerseys were sold for Thirty Thousand Naira and customers complained that they were too expensive (the total cost of getting a Manchester United jersey to Gboyega’s store was Twenty Five Thousand Naira). Unhappy that he was unable to compete with Abiodun, Gboyega reduced the prices of most of the items in his store when he announced a 30% reduction in prices such that a Manchester United Jersey in his store sold for twenty- one thousand naira. He saw a significant improvement in his monthly sales performance following this decision. A few months later, he went back to the UK to replenish his stock but could only afford to buy 70% of his usual inventory as he had less, cash following the heavy discounts given to customers.

More people heard that the price of a Manchester United jersey at Gboyega’s store was cheaper so he continued enjoying increased patronage. Abiodun, seeing a decline in sales, offered everyone who bought a jersey free name customization and a ball (these added freebies cost him only two thousand naira). This decision once again endeared a lot of customers to Abiodun’s store. By Gboyega’s next trip he was only able to purchase 50% of the stock levels he started off the business with and he was due in a month to pay down his Bank overdraft and rent. He was unable to meet these obligations as and when due and held a clearance sale to shut down the business. Abiodun enjoyed increased patronage as Gboyega’s former customers became his. The Manufacturers gave him an extended credit period because he now significantly surpassed his previous order levels and met his financial obligations to them as and when due.

The illustration above attempts to capture what happens to a lot of MSME’s. Both businesses sold the same products but had different cost structures. Price wars at best only give short term gains. All entrepreneurs should remember that building a sustainable business requires incorporating sustainable practices borne out of a clear thought process. Fighting a price war can be likened to running another person’s race. Most of the time, we don’t know the basis or circumstances that influence the pricing decisions or cost structures of our competitors, yet many entrepreneurs reduce the prices of their products because a competitor just did so. Price determination should be strategic, borne out of a deep understanding of the market, cost structures, industry, environment, and circumstances unique to the business. Entrepreneurs’ should always run their race and not another’s, keeping their eyes on the price by seeking ways of improving their product offerings, service delivery,  getting favorable terms of trade, etc. not fighting price wars that may be counterproductive. Let price determination be borne out of the fundamentals unique to every business not by mimicking what your rivals do every time. Their price doesn’t have to be your price.

THE PARABLE OF ASSETS, LIABILITIES AND EQUITY.

A young man once asked his Father, what must I do to be a successful entrepreneur? His Father looked at him and with a big smile on his face then beckoned on him to take a seat. As both men sat, his Father told him a parable.

There were two women, one with a degree from a reputable University named Zeo and another named Zara who didn’t go to the University but learned the art of trading from her mother. Zeo and Zara set out to start-up businesses in their chosen fields. Zeo was a gifted Baker and set out to start a Bakery while Zara a very good cook set out to start a Restaurant. Before departing from home, Zeo was given some money by her parents and also obtained a loan from her best friend Zikora which was to be paid up in six months. Zara’s mother applied for a six-month loan from her co-operative, sold some of her possessions and gave the money she had put together to her.

Zeo chose to situate the Bakery in an upscale neighborhood where most of the residents appeared to live healthy lives as most of them were seen jogging very early in the morning every day. She got a space in a high street shopping mall and contracted a leading interior decoration company to help with the interior and exterior design of the Bakery she named “Zeo’s”. After finishing the interior and exterior design of the Bakery, Zeo set out to buy Bakery equipment’s only to realize that she had spent more than she should have on leasing and renovating/ upgrading the space where the Bakery was situated. Instead of buying new equipment’s, she resorted to buying fairly used equipment’s. With the money she had left, she had a launch party where she and her very excited friends sang, danced and posted pictures on social media all night

Zara elected to open her restaurant close to a major bus terminal in a densely populated part of town where hundreds of people took the bus on a daily basis. Her Restaurant named after her, served local delicacies with the option to sit in and eat or take-away. She ensured her environment was always clean and made sure her sales girl was courteous to everyone who came to buy a meal. Her investment in acquiring assets for use in the restaurant was minimal as she bought only the basics with the mind-set that she will buy more equipment’s as the restaurant grew.

Both businesses started about the same time but three months into starting the Bakery, Zeo complained that her patronage was not as she envisaged. Her friends always came around and she was more than happy to give them pastries and bread every time they were leaving and even when they decided to buy, they bought on credit most of the time. Her oven started developing problems and she was unable to produce on some days. She had issues with the service charge at the shopping mall; the management of the mall wanted to collect service fees upfront for a three months period going forward. Zeo was distraught, everything seemed to be falling apart. She had not repaid her loan, no money, no customers, faulty equipment’s and increasing administrative overheads were her new reality.

Zara was having a different experience. Her native jollof rice was the rave of the moment as customers from within and outside her locality patronized her. She employed a “pay before service” philosophy. Her sales girl did the serving while she collected the money from the customer. She had repaid the monthly instalments on the loan her mother took on her behalf as and when due. Business was really good.

The young man appeared to be enjoying the story when his father asked him if he was able to extract any lessons from the parable. As he was about to respond, his father motioned towards him and continued speaking. “To become a successful entrepreneur, you need to understand the role of Assets, Liabilities and Equity in the business” he said. He went on to explain what he meant by Assets, Liabilities and Equity. The accounting equation (Assets= Liabilities+ Equity) truly sums it all. It suggests that assets can be acquired either through liabilities (debt) or equity or a combination of both. Assets can be referred to as resources controlled by a business from which future economic benefits are expected to flow to the business. “Future economic benefits” from that definition refer to the income generated by the business and it is safe to assume therefrom that cash will flow to the business. Liabilities on the other hand can be described as a “present obligation, arising from past transactions which when settled or paid will lead to an outflow of economic benefit from the business’’. Equity can be described as an “owners claim to a business’s net assets” and net assets refers to total assets less total liabilities. Equity is sometimes referred to as the cash or idea the owner of the business makes available to start up the business.

Assets can either be acquired by way of debt (loans, borrowings from family and friends) or Equity (personal savings, inheritance, funds from partners etc). One of the principal things done with loans or equity is the acquisition of assets (note that for a start-up, debt and/or equity can also be used for set-up costs). These assets are expected to generate income or enable income generation. It is this cash that is in turn used to settle expenses that maybe incurred during the course of business or liabilities as and when they fall due. Excess cash can also be used in acquiring new assets, used for growing the business or even paid out as dividend to the owners of the business.

Looking lost, the young man asked “Father, how does all this relate to your parable”? His Father answered with the following points:

The monies obtained by Zeo from her parents and the proceeds from Zara’s mother’s possession were equity in the business. Every start-up business needs equity as it shows a level of belief in the business idea or as some will say skin in the game.

The six month loan Zeo took from Zikora and the loan Zara’s mum took on her behalf from the co-operative are Liabilities. These loans have cash flow implications as principal and interest will have to be repaid based on the terms of the loan. Start-ups and small businesses are encouraged to use more of equity at the start and when the business starts generating a regular cash flow pattern, they can consider taking debt by way of loans if and only where necessary.

Zeo and Zara used their debt and equity differently. While Zeo used her’s  for non-income generating assets leading to poor cash flows, Zara used hers wisely, spending wisely and being more deliberate about getting the proceeds of her sales.

To be a successful entrepreneur, you need more than talent. Zeo and Zara were gifted at what they did but the decision making required to manage a successful enterprise was evidently better with Zara.

Cash is the life-blood of any organization. Any business that is starved of cash will find it difficult to operate whether in the short, medium or long term. Cash is used to fund day to day operations of the business, repay loans, settle overheads, invest, acquire assets and at the right time pay dividends.

An understanding of your market and the interplay of product, price, promotion and place (4p’s of marketing) are as important as the talent, capital and passion any entrepreneur possesses.

The Father asked his Son, is there any other lesson you have learned? The son replied heartily, “business thrives when friends and family pay for goods and services”.

WHAT SMALL BUSINESSES CAN DO TO SURVIVE THEIR EARLY YEARS?

In part one of this article, I identified five of the many reasons why start-up’s, and SME’s fail. In this concluding part, I will like to focus on what small businesses can do to survive their early years and build lasting and sustainable businesses.

It is no longer news that Nigeria is in a recession. Businesses are going through some of the most turbulent periods in their existence with the effect of the recession biting harder than the global economic crisis of 2008. Companies are falling like a deck of cards and even some big organizations which will hitherto had been deemed “too big to fail” appear to be grasping at straws in an attempt to survive the recession. If it was difficult for small businesses to survive their early years in periods of economic boom, it is almost certain that they will struggle more during the recession. What can small businesses do to survive these turbulent times?

Get a firm grip on your finances

Businesses are set up with a profit objective. Profit is earned when expenses are deducted from the revenue generated from a business. The term “finances” is generally used to describe how we manage money or resources that generate money. I will want us to view the term “finances” from the standpoint of Revenue, Expenses, and Cash-flows.

To survive, start-ups and SME’s have to think deeply about the best ways to optimize the concepts aforementioned. Permit me to break down these concepts without sounding technical.

Revenue: Grow your sales at the right price!

This refers to the income or benefits a business generates from carrying out its normal activities during a specific period. For example a restaurant generates revenue from the sale of food and drinks, a shoemaker generates revenue from production or repairs of shoes, a tailor from the sewing of dresses etc.

The revenue a business generates has a direct relationship with the price of its goods or services. How small businesses price their goods and/or services will go a long way in helping them survive their early years or during a recession. There are many pricing strategies SME’s can adopt but as a guide, I will suggest that the price of goods and or services should always at least cover all costs plus a margin that ensures you can continue your carrying on your business activities. Please note that it is not advisable for businesses to engage in price-wars i.e. selling at a price lower than the market price to increase patronage.

Expenses: Keep your costs down!

An expense can be referred to as money spent or a cost incurred in the normal cause of a business activity which enables the business directly or indirectly generate revenue. Expenses are also referred to as costs. Expenses/Costs have different categorizations but always ultimately lead to an outflow from the business. I had earlier on defined profit as the deduction of expenses/costs from revenue. It is, therefore, safe to assume that the lower your expenses the more profitable a business can be.

A recession is normally characterized with higher than normal costs and sometimes limited disposable income. As such, small businesses should do everything within their powers to optimize costs. I have deliberately not used the word “reduce” costs because cost reduction may sometimes be inimical to the survival of a business as it may lead to a reduction in quality. Cost optimization on the other hand ensures that quality is retained but at the best possible cost. The following tips can help SME’s optimize their expenses/costs.

Keep a proper record of all expenses and pay particular attention to the cost type which takes out the most money.

Always separate business expenses from personal expenses.

Be financially responsible. Prepare an expense budget and measure how well you are performing against budget every week.

Ensure your expenses are not growing faster than your revenue.

Always seek to get the best deals from your suppliers or vendors

Ensure that you have up to date market information on all your business expenses.

Don’t spend on things that do not positively impact your sales.

Cash-flow: Cash is King!

There is the classic saying that “Cash is King”. Cash is the life of a business. It works like the heart in the human body. Once the heart stops beating, a person dies because blood supply to the body ceases. The same applies to business. The absence of cash in a business especially start-up’s and SME’s is akin to the absence of a beating heart in the human body.

Cash flow is the money that comes in and goes out of a company. It is the generation of income and the payment of expenses.

Cash inflows result from either the generation of revenue through the selling of goods and services, money borrowed, or money earned through investments. Cash outflow on the other hand refers to money that leaves the organization for the payment of expenses, acquisition of assets or settlement of business obligations.

When the cash that comes into the company is more than the cash that leaves, then a positive cash flow is experienced. The reverse experience is called a negative cash flow.

For start-ups to survive, there must be a sustained period of positive cash flows. The following tips can help Start-up’s and SME’s improve their cash flow management.

Always ensure you invoice as and when due

Delay expense payouts to a reasonable extent

Ask your customers to pay faster

Always monitor incoming cash and outgoing cash

Seek favorable payment terms from vendors or suppliers

Plan, plan and plan again

Finance purchase orders

Always ask for a deposit or milestone payment

When demand for your product is high and your quality is unmatchable, consider a raise in prices

Never have an idle cash balance. Where there is excess cash, place the cash in an interest yielding investment.

Validate your Business Model: Keep Creating and Delivering Value

The business environment is generally competitive and dynamic. It is always changing with new business models being tried and tested ever so often.

To survive the early years of a business and indeed a recession, SME and Start-up Managers must continuously engage in deep “soul searching” in which they will validate and re-validate their business models and approach to market.

A business model describes how organizations create, deliver, capture and retain value. Many organizations have failed because their understanding of the market they were playing in became obsolete and they could not create or deliver the value their market needed at a given time as their competitors did. While their business environment was changing, they remained fixated on their ways of doing things only to find themselves struggling not long after.

SME’s and start-ups should always seek to improve on the value they create. Please remember that what people pay for as a good or service has a direct relationship with the value they derive from it. An SME can validate its business model by:

Engaging in discussions with like-minded people

Spending quality time gathering and analyzing information related to their industry

Seeking new ways of improving their customer’s value perception for the right price.

Be Strong:

The harsh economic clime has all it takes to make one give up on their businesses. The saying that “tough times don’t last but tough people do” is more relevant to Nigerian entrepreneurs than it has ever been. Those who can put in place structures and processes that will enable their business survive this whirlwind of economic uncertainties will smile in the long run.

Though I am very certain that as a nation we will hobble out of this recession, the reality is that many organizations especially Start-Up’s and SME’s may find it hard to survive the harsh economic clime. It will be a tough ask but it is not an impossible task. The long term survival of the Nigerian economy depends on how SMEs grow and generate sustainable wealth for their stakeholders. If we as SME managers or Entrepreneurs do all we can to weather the storms, we may just be laying the foundation for that economic super power our dear nation Nigeria ought to be.