A friend of mine who was just opening a boutique told me that they were going to implement a pricing policy so that everything was priced twice the amount they paid for it. While this concept sounds simple enough, especially from a logistics perspective, I remember having serious doubts about their approach. The boutique was in an extremely niche market and I wondered how they were going to generate enough sales with this pricing strategy to stay in business.
Cash Flow Consideration
One concept my friend could have implemented was what I like to call the "Cash Flow Consideration" approach to pricing. A Cash Flow Consideration (CFC) appoach can be defined as an effort to offer your value proposition at an unsustainable price, in order to increase your overall cash flow volume which allows you to operate at an effective economy of scale.
The concept is that you may occasionally offer a product or take a job at a "theoretical loss," meaning that the job or product, in isolation, would not create sustainable revenue. The goal of the CFC approach is to take on additional work or offer products for the sole purpose of generating additional cash flow, regardless of the revenue or profit.
A Ben Affleck Example
The best example I can think of to explain this concept is from the movie The Company Men. In this movie, Ben Affleck's character learns that his brother-in-law (who is his employer) has taken a remodel job on at a price so low that he won't make any money, even though he is working long days and weekends to keep the contract deadline. He did this so his employees would have work in the off-season, even though he knew he wouldn't make any money on the job.
Let us consider a restaurant that is open for lunch and dinner 7 days a week and is usually only profitable on Friday, Saturday, and Sunday. The business has determined that they need to be open during the slower days to avoid the risk of loosing business on the weekends. This is where may restaurants apply the CFC approach by running promotions such as "half-off Wednesday" or "Senior Tuesday" during the slow days to help drive business. If they price these promotions correctly, they will be making more total money than if they had not run the promotion at all, meaning that servers get tips, bills get paid for the day, and the weekends generate profit rather than covering the costs of the week.
Fitness Center Application
Another example would be a fitness center which charges $20 per month for memberships. All of the local competition charges the same amount and the business doesn't want to decrease their price which would just lower the market price in the area. A CFC approach applied here would be to offer memberships at half-price to anyone who lives outside of gym's defined target market (say a 10 mile radius). This special price would be the best deal around for people living in the targeted area and would be offered through a special coupon promotion. Even if the extended distance is too much for the majority of people in the area, a few added members at this otherwise unsustainable price will increase the overall cash flow and be a win-win scenario.
Audit Firm Example
A final example of how the CFC approach can benefit the organizations economies of scale is to look at an audit firm. Let's say that the audit firm knows that a specific market branch essentially needs 15 CPA's to handle the demand of the busy season. Within this industry, it is not practical or effective to hire and train these employees on a temporary basis, so they must choose one of two options. First, they could staff less than 15 employees, which would have negative effects during the busy season. Alternatively, they could staff 15 employees and take on a few clients during non-peak time at a "theoretical loss." This results in an additional cash flow which can cover the cost of the additional employees, but won't generate any revenue - the revenue will be made in the busy season.
When have you seen opportunities to use the CFC approach to pricing?