Are you charging enough? Understanding business margins

By Steph Gemson on Small Business UK - Advice and Ideas for UK Small Businesses and SMEs

In today’s uncertain economic landscape, many UK businesses face significant challenges in maintaining healthy profit margins. Rising raw material costs, increased energy prices, and higher living expenses have forced many small business owners to rethink their pricing strategies.

According to research from the Federation of Small Businesses, a notable percentage of UK businesses fail due to improper pricing, often undercharging for their products or services. Understanding business margins and the factors affecting them has never been more important.

In this piece, I’ll explore the importance of business margins, common pricing pitfalls, and how to ensure your business not only survives but thrives, even in turbulent times.

The importance of margins

To understand how well your business is performing, you must first grasp two key margins: gross profit margin and net profit margin.

• Gross Profit Margin is the percentage of sales remaining after deducting direct costs like raw materials and direct labour. It reflects how well you’re managing production costs. Ideally, gross profit margins should remain stable year-on-year. If costs rise due to inflation or supply chain disruptions, your prices must adjust accordingly to maintain profitability.
• Net Profit Margin reflects overall profitability after all costs, including overheads like rent, utilities, and insurance, have been deducted. This is where businesses often encounter challenges. While gross profit margins may stay stable, net profit margins can fluctuate due to increasing overheads like marketing or utility costs.

Common pitfalls in pricing strategies

A common mistake businesses make is failing to account for all their costs when setting prices, particularly in service-based industries. Many business owners calculate a mark-up based only on direct costs like materials and labour, overlooking indirect costs such as rent, utilities, and insurance. This can significantly reduce profitability.

For example, a painter and decorator may estimate materials and labour costs and add a 35 per cent mark-up, assuming they’ll make a good profit. However, they may overlook overheads like vehicle maintenance, rent for a storage unit, and professional fees, resulting in a smaller-than-expected profit margin.

How economic challenges affect margins

In today’s economic climate, businesses face constant cost pressures from raw materials to energy bills. For industries like construction, where material prices fluctuate, pricing strategies need to be agile. An annual review of prices may no longer be sufficient.

If your business faces volatile costs, it’s essential to stay up to date on supplier prices and adjust your quotes accordingly. In construction, for example, many businesses now update quotes every 30 days to account for material price changes. Setting expiration dates on quotes can protect businesses from being locked into outdated prices.

Practical tips for setting prices

1. Market research: Before adjusting prices, understand what your competitors are charging. Many businesses fear losing customers if they raise prices, but thorough market research can confirm that your prices are competitive. If you offer superior service or faster delivery you can justify charging a premium.
2. Cost analysis: Break down every cost that goes into your product or service, from direct costs like materials to indirect costs like insurance. This gives you a complete picture of what it takes to keep your business running and ensures your prices reflect a healthy margin.
3. Value proposition: Clearly articulate the value you offer. If you charge more than competitors explain why. It could be faster turnaround times, higher-quality materials, or better customer service, customers need to understand the benefits of choosing your business.
4. Quarterly pricing reviews: Regular reviews are essential, particularly in industries where costs fluctuate. Collaborate with your accountant to calculate your gross and net profit margins regularly. This will help you adjust prices before costs spiral out of control.
5. Set expiry dates on quotes: In volatile sectors like construction or catering, limit the validity of quotes to 30 days. This allows you to revisit pricing based on up-to-date supplier costs and avoid losing profits due to rising prices.

Balancing price increases with customer loyalty

One of the biggest concerns when raising prices is maintaining customer trust and loyalty. Business owners often fear increasing prices will push customers away, but with the right approach it’s possible to retain loyalty while adjusting prices.

1. Communicate the ‘why’: Clear and open communication is key. Customers appreciate honesty, especially when they understand the reasons behind a price increase. Explain that rising costs for raw materials, energy, or wages are driving the change and frame it as necessary to maintain quality.
2. Provide notice: Giving customers advance notice before implementing price changes helps maintain positive relationships. A 30-to-60-day notice period allows customers time to adjust and shows that you value their business.
3. Offer added value: One way to justify a price increase is to enhance your offering. Whether it’s improved customer service, faster delivery, or a new feature, increasing the perceived value can make customers more accepting of the higher price.
4. Involve your customers: Customer feedback can be valuable when considering price adjustments. Engaging customers through surveys or feedback forms allows you to gauge sentiment and structure price changes in a way that maintains trust.
5. Tiered pricing options: Offering tiered pricing gives customers flexibility. Introducing a basic version of your product or service, alongside a premium package, allows customers to choose based on their budget, helping you retain clients who may be sensitive to price hikes.
6. Focus on customer relationships: Building strong customer relationships is key to maintaining loyalty during price increases. By continuing to provide excellent service and showing genuine care for customers, you can build loyalty that goes beyond price sensitivity.
7. Maintain quality: It’s essential to ensure that any price increase is matched by consistent or improved quality. Customers will tolerate price hikes if they feel they are still getting good value. Any perceived drop in quality can damage trust and lead to customer loss.

Still not sure if you should raise prices?

Maintaining healthy margins is essential for business survival, especially in turbulent economic times. By understanding your costs, conducting market research, and reviewing your pricing strategy regularly, you can keep your business competitive while ensuring profitability.

Don’t let the fear of losing customers prevent you from charging what your product or service is worth. With transparent communication and strong customer relationships, you can raise prices when necessary and maintain trust, ensuring long-term business success.

Steph Gemson is the founder of TaxGem.

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