Pricing strategies and profit maximization

From: alexhormozi

The goal of achieving rapid and substantial wealth, as demonstrated by one individual who earned more in a year than the combined salaries of several major CEOs, often stems from understanding and implementing specific business principles that make earning money “feel illegal” due to its speed and magnitude [00:00:00], [00:00:16]. This article outlines three key ways to accomplish this: focusing on value-based pricing, optimizing the cash conversion cycle, and understanding wealth alchemy.

Value-Based Pricing

The first way to make money quickly is to deeply understand value creation [00:00:21]. Instead of basing prices on cost, success comes from selling based on the value created for the customer [00:01:50]. A business was able to charge gym owners $42,000 per year for a license, significantly more than competitors who charged only a tenth of that amount, because they focused on delivering immense value [00:00:39], [00:02:02].

The Value Equation

The “value equation” consists of four core components that determine a product’s or service’s perceived worth to a customer [00:02:14]:

1. Dream Outcome: The ultimate desired result or transformation the customer seeks (e.g., making more money, losing weight, fixing a relationship, gaining status) [00:02:21].
2. Perceived Likelihood of Achievement (Risk): How probable it is that the customer will achieve their desired outcome after purchasing. Lower risk increases perceived value [00:02:33].
3. Time: The duration it takes for the customer to achieve the dream outcome. Shorter time frames increase value [00:02:44].
4. Effort and Sacrifice: The amount of work or changes the customer must undertake. Lower effort and sacrifice increase value [00:02:56].

The most valuable offering would be immediate, require no effort, be guaranteed, and perfectly align with the customer’s desires [00:03:21]. In a Business-to-Business (B2B) setting, value is often monetary, such as an increase in profits [00:03:36]. In a Business-to-Consumer (B2C) setting, value can be more abstract, like improved appearance, social status, or daily well-being [00:03:41]. By addressing these four components—making the outcome more desirable, more likely, faster, and easier—businesses can justify premium pricing [00:09:58].

For instance, a hand-carved wood table costing $20,000providesthesamebasicfunctionasa$50 plastic table (holding items and eating) [00:04:17], [00:04:30]. However, its value is derived from the status it confers, the guarantee of its quality (lowering risk), immediate delivery (reducing time), and white-glove assembly service (eliminating effort) [00:04:48], [00:05:17].

Price as a Profit Lever

Price is the single largest lever for profit [00:06:29]. A simple example illustrates this:

• Before: Selling a table for $100withacostof$50 and other expenses of $30yieldsanetprofitof$20 [00:06:42].
• After: Repositioning the table as a highly valuable item for $1,000.Evenwithincreasedcostsfordelivery($200) and sales/marketing ($130),thenetprofitjumpsto$620 [00:07:05].

This demonstrates a 10x increase in price leading to a 31x increase in profit [00:09:04], [00:09:08]. The cost of acquiring a new customer (CAC) in an industry typically doesn’t vary significantly between competitors [00:08:29]. Therefore, businesses that charge more per customer, based on higher value, achieve disproportionately higher profits [00:08:48].

Avoiding Price Wars

Competing primarily on price is often described as the “worst possible strategy,” as only one entity can win by being the cheapest [00:09:31]. A McKinsey survey found that 85% of companies compete on price, but only 1% win [00:09:21]. There is no reward for being the second cheapest; it only leads to lost money [00:09:39]. Conversely, there is a distinct benefit to being the most expensive, which is directly correlated with the amount of value provided [00:09:47].

Cash Conversion Cycle and Client-Financed Acquisition

The second principle for rapid financial growth is to operate within a fast cash conversion cycle [00:12:26], which involves securing payments upfront. This allowed a business to go from $1,000inabankaccountto$10 million in sales and $6 million in profit within 10 months [00:11:34], [00:11:52], primarily by achieving a 100:1 return on advertising [00:12:13]. This strategy, known as “client-financed acquisition,” uses customers’ money as a loan to acquire more customers [00:13:34].

Consider an example where acquiring a customer costs $100inmarketing[00:12:47].Iftheproductcosts$100 and has a $50margin,thebusinessisinitially$50 in the red after the first transaction [00:13:05]. To become self-financing, the first customer needs to pay enough to cover their own acquisition cost, the cost of acquiring the next customer, and the cost of goods sold (COGS) [00:13:52]. So, if CAC is $100andCOGSis$50, the first customer should ideally generate $250($100 for them, $100forthenext,$50 COGS) [00:14:12]. This allows for continuous reinvestment into customer acquisition [00:14:22].

Businesses that generate quick returns (e.g., $100backforevery$1 invested in a day) are like investing machines, making them more attractive than traditional investments like the S&P 500 [00:15:06]. This principle enabled a gym business to open new locations every six months using only cash flow, by spending $100adayonadvertisingtoimmediatelygenerate$2,500-$3,000 back from customers [00:16:25], [00:16:37]. Within weeks, enough cash was generated to cover setup costs and initial payroll [00:16:46].

The optimal cash conversion cycle involves making at least twice the sum of customer acquisition cost (CAC) and cost of goods sold (COGS) within 30 days [00:20:09], because 30 days is the typical interest-free period for credit cards [00:21:03]. The faster the cash is collected (e.g., daily or weekly), the more frequently the cycle can be repeated, accelerating growth [00:21:23]. Many businesses fail to do this due to a limiting belief that they must follow industry standards, which often involve delayed payment terms [00:21:40]. Offering incentives for upfront or quarterly payments can significantly improve cash flow [00:22:04].

Optimizing Offers for Upfront Cash

To get customers to spend more money faster:

1. Raise the price of the core offering [00:23:59].
2. Get people to buy more immediately [00:24:01].

Businesses should not be afraid to make multiple offers, as people love buying even if they dislike being “sold” [00:24:07]. Offers should be convenient and desirable [00:24:17]. For example, in a weight loss business, customers who initially declined gym services might purchase nutrition seminars and supplements instead, often spending more on average [00:24:34], [00:25:03].

Customers often enter “hyper-buying cycles” when making a new decision (e.g., buying a new car, training for a marathon) [00:25:26]. This creates a natural problem-solution cycle where initial purchases open up needs for related items [00:26:04]. A running store customer buying shoes will also need socks, shorts, a tank top, an iPod wristband, a hydration pack, or even a coach [00:25:47], [00:26:18]. By making these related offers available, businesses provide more value and collect more cash upfront [00:26:38], [00:27:00]. Each upsell opportunity should still be structured according to the value equation components: dream outcome, risk-free, faster, and easier [00:27:04].

Wealth Alchemy and Permanent Customers

The third key is to understand “wealth alchemy,” which involves ignoring taxes in the short term and focusing on increasing enterprise value [00:30:36], [00:31:09], [00:37:35]. This strategy involves converting marketing spend into tax-free asset growth [00:29:36].

Consider a software company where:

• A free trial costs $100 to acquire [00:27:53].
• 1 out of 3 trials convert to a paying customer ($100/month) [00:28:06].
• This means it costs $300 to acquire a paying customer [00:28:18].
• 1 out of 3 paying customers becomes a “permanent customer” (never leaves the subscription) [00:28:23].
• The “permanent CAC” is $900($300 x 3) [00:28:32].
• Annual Recurring Revenue (ARR) for a permanent customer is $1,200($100 x 12 months) [00:28:42].
• If the software company’s revenue is valued at 10 times TopLine (typical for B2B SaaS with good retention) [00:29:07], then each permanent customer creates $12,000inEnterpriseValue($1,200 ARR x 10) [00:29:23].

This means investing $900inpermanentCACgenerates$1,200 in annual recurring revenue and a $12,000increaseintax-freeenterprisevalue[00:29:23],[00:29:36].Toachievea$120 million wealth goal, one would need 10,000 permanent customers [00:30:03], costing $9millioninpermanentCACtogenerate$12 million in annual revenue and a $120 million increase in asset value [00:30:33]. This represents a massive arbitrage between the cost of acquisition and the resulting asset value [00:31:33].

The Importance of Customer Retention

A crucial element of wealth alchemy is focusing on not losing customers [00:33:05]. Comparing two businesses:

• Business A: Acquires 100 customers in Year 1 and loses them. Acquires 200 in Year 2 and loses them. Acquires 300 in Year 3. Total customers at Year 3: 300, but constantly replacing churned customers [00:33:25].
• Business B: Acquires 100 customers in Year 1 and retains them. Acquires 100 more in Year 2, retaining previous customers. Acquires 100 more in Year 3. Total customers at Year 3: 300, with a growing base [00:33:46].

Business B is more desirable to own because time works for it, not against it [00:34:06]. It’s less risky, as it can grow even without increasing marketing spend [00:34:24]. Investors value businesses based on the likelihood of continued performance, effort required, and time to achieve ultimate value [00:34:33]. Businesses that cultivate “permanent customers” (those who stay long-term, e.g., 2+ years for agencies) are significantly more valuable than “churn factories” [00:34:49].

For example, Starbucks has an estimated Lifetime Value (LTV) per customer of $14,000, which is why they are so profitable, despite a low cost of acquisition for a single coffee purchase [00:35:43]. Their model is engineered for recurring or reoccurring customers [00:36:17]. Businesses should identify the characteristics of their “permanent customers” and tailor their marketing to attract more of them, even if the direct CAC for that specific avatar is higher [00:37:09].

Conclusion

To maximize profits and achieve rapid wealth growth, businesses should:

1. Sell off value, not cost, leveraging the value equation to make offerings less risky, faster, and easier [00:37:58]. This decouples the business from price wars.
2. Speed up the cash conversion cycle through strategic pricing and offers that generate upfront cash, enabling client-financed acquisition and unlimited customer growth [00:38:12].
3. Understand wealth alchemy by focusing on acquiring permanent, reoccurring customers [00:38:34]. This builds a stable revenue base that increases the business’s enterprise value, which grows tax-free until the business is sold [00:38:46]. This is the fundamental difference between simply making profit and building significant, compounding wealth [00:39:16]. This approach explains how individuals and companies can achieve massive net worth increases even while paying taxes on operational profits, as the bulk of their wealth grows tax-free as asset value [00:39:40].