Pricing

Most small businesses set their first prices in one of two ways. They match what a competitor charges, or they pick a number low enough to win the first customers and plan to raise it later. Both are understandable, and neither connects the price to what the sale costs to deliver. When costs rise, as they tend to, the price stays put, and the margin shrinks a little every month without anyone deciding it should.

The Pricing driver makes that connection. Every price is set from the full direct cost of delivering it plus a target margin, so a sale is known to contribute before it is made. Discounts get a reason and a limit. Prices are reviewed whenever costs move, so a margin the business has earned is not slowly given back.

Of all the work on the first bridge, this usually moves value the most for the least effort. What it recovers is margin on revenue the business already has. It needs no new customers and no new capital, only a cost sheet and some conversations with existing customers.

A price built from cost

What the work produces is a written price for every significant product or service line, built from that line's fully allocated direct cost and a stated target gross margin, with the margin actually realized over the latest year above zero.

The price sheet starts from the cost of one unit of sale: the direct materials, the direct labour at its loaded cost (wages plus the payroll taxes and benefits that come with them), and any delivery cost per unit. The target margin is applied to that, and the result is set beside what the market charges. A cost-plus price well above the market says the cost is too high or the product is going to the wrong customer. A price well below it is money left on the table. The final number is still a judgment, but it is a judgment made with the cost in view.

The arithmetic has one trap. A 40 percent margin is earned on the price, not added to the cost. A job that costs $270 to deliver and is marked up by 40 percent sells for $378 and earns a margin of 28.6 percent. To earn 40 percent on the price, the job has to sell for $450. On one job the gap looks small. Over a year of jobs it is not.

This is the part of the work a buyer feels most directly in the size of the price they can pay. A buyer at the end of the bridge capitalizes the business's earnings, and every sale priced below its full cost comes straight out of those earnings. When each line's price and cost are known and every line earns a positive margin, the buyer can count the earnings in full.

When the sheet shows the old prices were wrong

The first time a business builds its price sheet properly, it usually learns something uncomfortable: some of what it sells is priced below full cost, and the customers buying it have paid that price for a long time. The sheet says what the price should be. It says nothing about how to get there.

It helps to split the move by customer. New customers can be quoted the new price from the day the sheet is finished, since they have no expectations to manage. Existing customers get notice and, where the gap is large, a series of steps, each small enough to absorb, with the whole gap closed within a stated period. Agreements signed from then on carry notice periods and cost pass-through terms, so later reviews can be acted on without a renegotiation.

Some existing customers will leave, which is why the owner decides in advance which ones are worth keeping at their current price. A customer who buys below cost makes the business busier and poorer with every order. Letting that customer go loses revenue, but a buyer capitalizes gross profit, and revenue sold below cost carries none.

Discounts with a reason and a limit

A price sheet means little if anyone can discount from it at will, so the same work sets a discount policy with a ceiling: who may discount, by how much, and for what reason. Any discount above the ceiling is approved and recorded.

Discounts are how a good price erodes without anyone deciding it should. Each one has a sensible reason at the time, usually closing a deal or keeping a customer. None of them looks like a price change, and added up they are one. Recording every discount above the ceiling turns that drift into a number the owner sees each month.

Prices that move with costs

The second half of the work is a price review on a fixed schedule through the year, and again whenever a major input cost moves materially, with each decision recorded. A buyer pays for margin they expect to last, and a margin nobody defends does not last long, so this is where the driver earns its place in how durable the earnings look.

Two things make the review work. It sits on the calendar at fixed dates, with the monthly margin report by line as its input, so it happens whether or not anyone feels like raising prices. And customer agreements carry the terms that let a decision take effect: notice periods and a way to pass on increases in input costs. A business that reviews its prices but has signed agreements freezing them for years has a review it cannot use.

The illustration shows what happens without it. A business charging the same price all year while its costs climb steadily earns less on every job each month. If its busiest season comes late in the year, the busiest month is the one in which it loses the most, and the harder the team works, the more money goes out of the door.

What has to be in place first

Two conditions come before the work. Direct costs must already be captured by line, which is the job of the neighbouring driver, Direct Cost Capture. A price cannot be built from a cost nobody knows, and the costs an uncaptured ledger hides, especially labour hours not recorded against any job, are exactly the ones that make a price look profitable when it is not.

The second condition is the owner. A business whose owner will never risk losing a customer over price cannot run this driver. Every review that ends in an increase loses someone, and the increase pays only if the margin gained on the customers who stay exceeds the margin lost on those who leave. An owner who cannot accept any loss will keep the first customers' prices forever and watch costs overtake them. What the driver asks is a decision, made ahead of time, that some customers are not worth keeping at the price they pay now.

Knowing that it works

Realized gross margin by line, each month, against the target, says more directly than any other number in the business whether prices are doing their job. A line that runs below its target month after month is either priced too low or costs more than the sheet assumes. Discounts above the ceiling are tracked each month, by count and in dollars, and a rising count is the earliest sign that people are working around the price sheet.

The owner can be tested on a single line, by walking its price from direct cost to the figure on the last invoice through materials, labour, delivery, margin, the market comparison and any discount given. An owner who can do that understands how the business makes money. One who cannot is relying on a price someone chose once, for reasons nobody remembers.

Why it slips, and what holds it

The decay this driver guards against is the slow kind. Prices lag costs, and gross margin erodes, usually without anyone having decided it should.

What holds it is the scheduled price review with a recorded decision, set up so it cannot be skipped without a written reason. Holding prices is a legitimate decision. The point is that someone makes one, because a business that never decides ends up selling at last year's prices with this year's costs.