When people think about getting more customers to buy their product, one of the first things that comes to their minds is cutting prices.
But if you lower the price of your product too much, you’ll attract the wrong type of customer. This person will only buy when they’re getting a bargain.
How do you price a product in such a way that brings in new customers AND ensures a profit for you? By learning about strategic pricing and figuring out your allowable acquisition cost.
There are three steps to doing this.
Step 1) Calculate your Lifetime Gross Profit
Suppose you’re in the pool supply business and you’ve found that the average customer will stay with you for five years and spend $100 a year with you. That’s a total of $500 in revenue. If you pay wholesale for the supplies you sell, your cost of goods will be about half of that, or $250.
This leaves you with $250 in gross profit over the five-year lifetime of your average customer.
$500 lifetime gross sales – $250 cost of goods sold = $250 lifetime gross profit
Step 2) Calculate your Liftetime Net Value
Your lifetime gross profit doesn’t account for all your overhead expenses, including rent, utilities, and payroll.
So before you can determine your allowable acquisition cost, you’ll need to include these expenses.
You have to deduct them from your gross profit. If you’re in a retail business, we’ll assume that your overhead is equal to half of your gross profit.
$250 lifetime gross profit – $125 lifetime overhead = $125 lifetime net value
Step 3) Determine a Reasonable Profit
The last step is to calculate the profit you want to make, and deduct that from the lifetime net value. A general rule for retail businesses is to yield 10 percent net profits.
However, since this leaves too little room for error, using 20 percent of gross sales for profit will give you more breathing room. In our example, we’d have:
$125 lifetime net value – $100 lifetime net profit (20 percent of $500) = $25 allowable acquisition cost
What does this Mean?
So in this example, you could lose $25 on every first-time sale AND still have a business that generates a 20 percent profit over your average customer’s lifetime.
This information could give you a big advantage over your competitors.
So although this strategic pricing strategy isn’t the only way to bring in new customers, it’s one of the most common. Know your allowable acquisition cost, and you can try all kinds of different discounts without taking much risk.
Once you’ve earned the business of your first customers, you can add them to your customer list. Then develop your relationship with your customers as much as you can. This will allow you to sell them products that are similar to the one they first bought from you, but at higher prices.
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