instance, the owner of a company was trying to convince a potential buyer that the company was worth a great deal more than was shown on the books because the owner pocketed so much cash. But because the owner could not prove the cash flow either in his books or in his personal tax returns, the valuation of the company remained very low and no deal could be struck.
It is standard practice when preparing a company for sale to declare all revenues and take the tax hit during the last couple of years before the anticipated sale date. This bumps the revenue and the sale price. The new owner can employ whatever tax scheme he or she wishes after the cash has changed hands.
The business has no difficulty finding the cash to pay its bills
This would appear to be a “no-brainer” until you consider the colossal number of business owners who struggle to make payroll or find the money to pay for goods ordered to restock the shelves. Every time the price is too low, any minor expense that takes cash from the bank account — a sudden increase in Worker’s Compensation rates, for example, or a fire, or a vehicle that is damaged by an employee — means there is a mad scramble for cash. If you have ever read any financial self-help books, you will remember that paying yourself first, or “saving for a rainy day,” is the key to being able to sleep at night.
The business attracts the best quality customers who are willing to pay for the value added by the company
This is really the crux of the pricing issue. Good quality customers recognize the value in what your business offers and willingly write the checks. To get to that position, the business owner has to clearly articulate to the potential customer why his or her price has value for the customer’s money.
Following are two examples of how perception can create “value for money.”
Example 1
Many years ago at a presentation in Chicago, we were shown two pictures. One showed an unshaven man with a bulging abdomen, wearing a dirty, torn t-shirt with a cigarette pack twisted up under the shirt’s left arm. He wore dark glasses, had a cigarette hanging from his lower lip and was ignoring the camera.
The second picture showed a clean shaven man in a white lab coat looking right at the camera and clutching a clip board.
The presenter asked the room full of business owners what these two individuals did for a living. We replied that the first one had to be a plumber and the second a doctor.
In fact, both pictures were of the same person, just presented in a way that made one look more valuable than the other. Although there are jokes about doctors being paid less than plumbers these days, the point of the slide show was to demonstrate the importance of presentation to gain price and market share.
Example 2
Plumbers have a bad, perhaps unearned, reputation for being slovenly and unreliable. But in the middle 1990s in Richmond, British Columbia, I came across a fellow who helped me with a toilet problem that arose after a visit from small members of the family, and was ultimately caused by the unauthorized presence of a toothbrush stuck in the toilet.
I had a very narrow window of opportunity, so Bob the plumber had to arrive at my house at 7:00 a.m. I would be away and my wife would have to let this stranger into our house at that early hour.
At precisely 7:00 a.m., Bob arrived and rang the doorbell. Bob was dressed in clean, pressed white overalls and presented his business card to my wife as she opened the door. When he finished fixing the toilet, he used his wet-dry vacuum to clean up the inevitable water spill and left a bill for me to pay.
Bob’s Plumbing got a great review from my wife who proceeded to tell others about his services. How else could he stand out from the crowd? Wearing white overalls! Presenting a business card! Cleaning up all the water spills! Bob added value to his service, which in turn earned him valuable word-of-mouth promotion and the opportunity to further his business.
The business generates a reasonable return on investment
It is a good return if the $200,000 you have invested in your business gives you better returns than the bank would after taxes and your salary are paid. What this means is that if the cash you have invested in your business could be taken out and plunked into a bank account, would it earn more money than where it is currently in use?
Example 3
If $200,000 in a nice, safe bank account generates 15 percent in interest revenue per year, it will give you a a tidy $30,000 a year income before taxes.
If the business has $200,000 of your money invested in it — your cash — and the annual profit before tax is less than $30,000, then you have a poor investment. It would be smarter to have that cash in a nice, safe bank account.
In comparing these two situations, of course, the owner would be drawing a wage and some benefits out of the company cash flow. We can safely assume here that with $200,000 stuffed into a bank account, the owner would still be working. We are only talking about the return on cash invested.
Table 1: Where Is Your Money Better Employed?
In fact this comparison can be used to decide the value of a business being sold or bought. Essentially, if you would earn more money just by having the cash in the bank and earning interest on it than you would by investing the same sum in the business, why would you invest in the business?
Bids on jobs are planned to leave no money on the table
Lots of companies bid on many jobs but plan for a predetermined profit, leaving no money on the table.
What this means is that the company plans to lose some bids deliberately and uses the ratio of bid-to-job to test prices every day. If prices are too high, then the ratio of lost bids climbs. If the company gets too many jobs, then it is time to raise prices.
Of course, knowing what the costs are in this scenario is critically important. If prices are generally sliding, then being able to cut costs quickly is important. So too is having flexible communications with the sales team so that cost-added features can be trimmed to bring prices into alignment.
If the company gets 100 percent of its bids, the price is likely too low and money is being left on the table. The services of the company are being sold as a commodity because the sales process has not found a way to find value and to make the company different from the competition. If you and the competition are identical then the only thing left to differentiate you is price.
How Do You Know That Your Pricing Is Not Right?
The Hamster Cage Syndrome
A company in the United States fabricated large metal tanks for several major industrial manufacturers. With two of its three major customers, it made a profit on the tanks. On the third contract, the largest of the three customers, the company lost money. The result was the company struggled to pay its bills but looked “sexy” because it had large revenue volumes. When a company is really busy but the dollars just flow through the bank account leaving nothing at the end of the year, the prices may be too low. Here the owner of the business runs and runs all day on the “wheel” like a hamster and goes nowhere.
But shouldn’t you just cut costs and make a profit at lower prices?
Never pass up an opportunity to keep costs down. After all, the purpose of a business is to profit on the difference between selling price and costs.
However, every $1 earned from a price increase is $1 added to the bottom line. If your company typically generates