The latest economic downturn has done many things to contractors aside from chasing many out of business. Chief among them is a rising belief that customers - all customers - are now making their purchasing decisions based solely on price.
I hear it weekly from contractors.
“Customers are looking for the cheapest price.”
“Longtime customers who always bought from me are now getting three or four estimates and are going with the lowest-priced company - loyalty means nothing anymore!”
Sound familiar? Have you thought it yourself? Have you even said it out loud on more than one occasion?
The Economic Reality Of Selling On PriceLet’s talk about the key temptation when faced with this kind of pricing pressure. The primary temptation is to drop your prices. If customers are saying “no thanks,” what else are you going to do?
The decision to lower prices is typically not made by a company creating healthy profits. Usually the decision is made under duress where there is little room for error. The bank account is dwindling, a few customers push back on price and a couple of jobs are lost and the panic button is pushed. The owner feels he/she has no other option but to start to reduce prices and margins on all work. Usually the big work like installations and remodeling gets hit first, but in many cases service pricing also takes a haircut.
Leading the chorus in the owner’s ears to cut prices are usually the company service technicians and sales personnel and who can blame them? They are right on the front lines with people every week telling them your prices are too high. Of course, the call center personnel also know you are overpriced. They field the phone calls from customers chiming in about this price or that.
So the decision is made and prices are dropped.
Let’s look at the financial reality of this decision. Let’s say a company is doing $1 million in sales a year and is making zero profit. A decision is made to cut prices and expenses 10 percent to become “more competitive.”
A 10 percent expense reduction is dramatic and difficult to do. And in order to accomplish it, you likely have to cut in three key areas: direct labor (field employees), office salaries and advertising.
You can’t really cut material expenses. Just because you want to sell something for less does not mean your suppliers will sell it to you for less. You can’t decide to use less fuel or call your truck leasing company and tell them you have decided to reduce your monthly payments by 10 percent.
So, be very clear with yourself. In order to cut enough to pay for a 10 percent price reduction, you will have to find savings in field labor, office salaries or advertising.
Remember, cutting expenses in those areas could also result in further reduced sales, which when coupled with a price decrease could create a double whammy. Whatever you save you could lose in reduced sales.
Cut Prices To Grow Sales...Right?Let’s take a different view. The primary reason for a price decrease would be to stimulate sales. And just to be clear, let’s make sure it is understood how much sales would have to increase to cover a 10 percent price decrease. Remember, we started with a 10 percent reduction in selling prices. In order to get the benefit and create a minimum 10 percent net profit, the company would actually have to achieve a 20 percent increase in volume.
That means your company would need a 20 percent increase in the number of service calls or average sale from the price decrease for it to make sense.
I will admit it may be possible to reduce selling prices in new construction and gain enough work for it to make sense. If a builder or general contractor comes to you with a large job that you can have for a 10 percent price reduction and you have crunched the numbers and can cover your overhead with the increased volume, it could make sense. But this example involves one customer and a decision in the moment with all the facts in front of you. It is still risky business, but it can work.
Price Only Matters When Service Is NeededIn order for a 10 percent price reduction in service to generate an additional 20 percent increase in transactions or average sale, there would have to be widespread knowledge that your company is now the low-price leader. For that to happen, not one but the vast majority of customers would have to have some general knowledge of pricing.
If you went out on the street and asked 10 random homeowners what it costs to perform any repair or replacement job in our industry, you would likely be greeted with blank stares and widely disparate prices. Generally speaking, John Q. Public has no clue.
Compare that to a gallon of gas. Go ask customers what a gallon of gas costs and most will know the current price to the penny. They will also know what stations in town have the best gas prices. They know this because they buy gas every week.
Now let’s talk about your business. Average residential homeowners may use a plumbing service firm every 18 to 24 months. And they do not think about you until they need your service. They may buy one water heater in their life; get one sewer line repaired; have a couple of toilets repaired. You get the point.
In other words, you could hang a banner outside your office with a big sign that says “Prices Cut by 10 Percent!” and most customers would not even see it because they are not in the market for your services. They are virtually blind to it. They don’t care because they don’t intend to buy your services today, this week and, if they are lucky, ever.
So forget about people rushing to your door the day, week, month or year you drop your selling prices. I don’t care how much you advertise (which you can’t afford to because you dropped your prices), it is not going to increase transaction volume by 20 percent in service.
Let’s get back to your technicians and sales people. Are they really losing jobs because they are 10 percent higher? If the hourly rate in your flat-rate system was $270 per hour instead of $300, would it create a 100 percent close rate? What selling price would it really take to generate a 20 percent increase in close rate, which is what you would need to generate enough revenue to pay for a 10 percent price decrease?
The reality is you can’t afford to run your business with low enough selling prices that all consumers would buy. The same customer who declines your work at your current pricing will likely decline it at 10 percent less. A few more may filter in with the lower price - but not 20 percent more.
A 'Hail Mary' PassI am a longtime Minnesota Vikings fan, and a miserable memory is the 1975 NFC Championship game. It appeared the Vikings had the game won. With less than 30 seconds remaining, Dallas Cowboys’ quarterback Roger Staubach threw the now famous “Hail Mary” pass to wide receiver Drew Pearson, who illegally pushed off a Viking defender, caught the pass and scored the game-winning touchdown.
If you run that same play 100 times, it fails 99 times and the Vikings win the game. That pass was the first time in sports the term “Hail Mary” was used, which in sporting lexicon has now become synonymous with a desperate, last-second, high-risk action to win a game.
In my opinion, that is exactly what a decision to sell on price is - a “Hail Mary.”
What the latest economic downturn has created is a wider customer appreciation for value. When times were good with home values quickly rising and 401k statements appreciating month after month, consumers clearly felt more comfortable spending money with the belief that the good times would keep on rolling. How do I know this? I was one of them.
Today, customers are watching expenses more and looking for the best value for their money.
The reality when it comes to our business right now is this: Your job of creating value in your selling price is harder today than it was two years ago. The days of calls aplenty and take it or leave it pricing are over. Customers must be thoroughly educated and impressed before they will give you their hard-earned cash in exchange for your services.
With that being the case, before dropping prices and dramatically cutting expenses so you can afford to operate at a bare-bones level, ask yourself a few questions:
If you answered no to any of the above, start there before you print new price sheets, flat-rate books and succumb to the siren call of “a price cut.”