SELF EMPLOYMENT SAVVY: Katherine Arno

Price/value ratio not an easy equation

Copyright © 2005 Blethen Maine Newspapers Inc.

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More Pricing Info For more online information regarding pricing and the price/value ratio: Search "pricing" at the Edward Lowe Foundation, whose work focuses on second-stage companies. Search "pricing" at the Kauffman Foundation, dedicated to supporting entrepreneurial activities. Search "pricing" to find templates provided by the U.S. Small Business Administration to compute break even, value-based pricing, cost based pricing. Search "pricing" at this site created for use by SBDC counselors in the United States, but much of it is accessible to any visitor. Visit the website of the Maine Small Business Development Centers to explore "Information Library." To top of story

A small firestorm erupted recently when a ranking state official warned that "the perception of Maine as a travel bargain has disappeared over the last five years."

The speaker quickly explained to the tourism businesses listening at an industry conference that it wasn't necessary to drop prices to restore value. Improving the "value equation by improving service," was the answer, he said.

While some in the tourism industry were miffed by the comments, countering that pricing still hovers around 1999-2000 levels when a nationwide tourism slump first began, the many reactions to it point out just how tricky the ratio of value to price can be.

"Everybody I know in this industry wants to produce the WOW!" says Nancy Gray, owner of the Harraseeket Inn in Freeport, about the issue of price vs. value. "They want their customers to feel like they discovered something special and they want their customers to return."

At the same time, says Gray, "We (meaning the Maine tourism industry) don't want to be known as the cheapest place around; People don't enjoy themselves when they feel what they are doing is cheap."

"We don't make decisions on price alone," says Tom Leach, Freeport resident and a certified business counselor at the Maine Small Business Development Centers' (Maine SBDC) Portland Service Center at USM. "P=V or price equals value," says Leach, drawing on one of the many economics equations that he likes to cite. "But economics is based on the idea that we are rational and much to the chagrin of economists, our emotions sometimes influence what we are willing to pay, making pricing decisions more than just a matter of math."

It is not surprising, then, that pricing is one of the most difficult decisions for small business.

Break Even Point

When pricing, says Leach, who is also an associate professor of business at New England University, it's essential to start with the break even point.

That's where Gray begins. For her, establishing a price first involves identifying all pertinent cost factors including materials, labor and overhead costs. "It's that simple," she says, "then you find the price where you break even ­ at least break even, but making a profit would be wonderful!"

Gray, who has been called a "master of New England inn keeping," has significant practice identifying those costs, but according to Leach, many small firms fail to analyze them sufficiently and consequently fail to price for break even, let alone profit.

Leach says there are several approaches to computing break-even, depending on the type of business. In the case of lodging, computing breakeven involves figuring what occupancy rate is needed to cover all fixed and variable costs. This kind of computing can be done on a cash flow sheet. In a retail situation, "numerous products have different profit margins so calculating breakeven per unit would be confounding," says Leach, "so you get down to dollar volume and there is another formula for that."

Elasticity

Leach says a valuable concept for business owners to understand is elasticity. "If price changes slightly and sales change dramatically, then a price is elastic or sensitive," he says, "If a price changes but sales remain unaffected, the pricing in that situation is inelastic."

Pricing for a four diamond lodging like the Harraseeket Inn is more inelastic (less sensitive) than a budget hotel where the consumer is seeking the lowest price versus unique amenities. In addition, the closer a product resembles the competition, says Leach, the less price difference customers will tolerate. As long as it differentiated from competition, a product will be less price-sensitive, he says.

Nonetheless, Gray remains concerned about the long-lasting impact of 9-11 and the tech sector downturn of 1999 ­ outside influences ­ that, she says, continues to have lingering impact on the hospitality industry ­ including four diamond enterprises.

Lowering Price Not Always the Answer

Lowering prices is not always the answer to making more sales and to making an essential profit. Maine SBDC State Director John Massaua offers the example of the restaurateur who incurred extensive debt to build a larger space so that he could sell more low-priced meals. Selling more at a lower price gave him high debt and no profit; he went out of business. Years later, his second restaurant involved a smaller space with quality, higher priced meals. He resisted the temptation to expand by incurring debt. He didn't try to attract more business with less expensive meals. Long lines and scarce weekend reservations became an acceptable condition at his now profitable establishment. "The restaurateur simply chose to control demand by pricing for the value he was delivering," says Massaua, "rather than let demand control him."

"Price is not the only decision criteria," says Leach. Like the restaurant in Massaua's story, lowering price is not likely to be how a four diamond hotel increase sales. These customers are looking for amenities like those found at Gray's Harraseeket Inn, including its doorman, lavish gardens, and personalized service. Cutting prices would mean cutting back on those amenities, which is what the customer values.

To add value to product or service, "Surpass their expectations," says Leach, "after that, you have wowed them!" The "wow" that he and Gray talk about is key to repeat customers. "Service counts more than anything else," says Gray, "That's how you build value."

"In the end," says Leach, "Maine tourism ­ or any other business for that matter - isn't as much about pricing as it is about value."

Katherine Arno is the Director of Training and Communications for the Maine Small Business Development Centers (www.mainesbdc.org) in its Portland center at the University of Southern Maine. Kate owned her own small business in Maine for eight years. Today, aside from working with small business issues at Maine SBDC, she helps her husband with the small business that he has owned in Freeport for 12 years. She can be reached at Karno@maine.edu.