Pricing is your most powerful lever to quickly increase profit, and in the long run as well. Assuming you have a 10% gross margin, if you could raise your prices by 1%, your profit would increase by 10%. Not only does pricing have great leverage, but price changes can be implemented quickly and dramatically influence buyer decisions.
So why do most companies under-emphasize pricing? There are three reasons: uncertainty, status quo, and conflicting influences.
Uncertainty: It’s hard to know the right price to charge. Companies put a lot of effort into cutting costs because it’s easy to tell when they’ve saved a dollar. But if you raise the price, the volume may go down, and then what happens to revenue and profit?
The profit-maximizing pricing strategy is almost always Value-based Pricing, which simply means charge what your customers are willing to pay. But it’s impossible to do perfectly. You can’t read your customers’ minds. You don’t know how much they would be willing to pay. Heck, they don’t even know. It’s a given that it won’t be perfect, but you can get close.
Companies with a deep understanding of how buyers perceive value get much closer to ideal pricing. By helping buyers create individual business cases, salespeople can learn the economic value of the solution for those buyers. Economic value is highly correlated with willingness to pay.
To make matters worse, every customer is different. Even if you could read each customer’s mind, could you charge them different prices? The most successful companies implement price segmentation techniques in an effort to get those customers who are willing to pay more, to pay more. This may not be perfect, but it captures more of your market’s willingness to pay.
The remainder of the uncertainty is in the pricing strategy. What decisions should you make? Should you charge for options? Should you move to subscription pricing? Should you add more price segmentation? Should you change the packaging? These are all hard questions to answer. It’s so much easier to stick with what you have.
Conflicting Influences: As you’ve just read, nobody knows exactly what to do. Hence, everybody’s opinion seems to carry similar weight.
Finance and accounting have a strong preference for cost-plus pricing. Even though it’s not optimal, it ensures you don’t lose money on any single transaction.
Sales teams push for lower prices, especially if their commission is based on the overall revenue. They want the sales to go as quickly and easily as possible. They don’t want price as an objection.
Product teams, or those who have P&L responsibility, push for higher prices. They wonder why salespeople discount so much, so often. These are often the groups pushing for new pricing strategies to capture more of what the market will bear.
Status Quo: Let’s say you could get the different departments to agree to implement a new pricing strategy. That’s when the hard work begins.
You have sales teams that need to be convinced and then taught to use the new pricing strategy. This is especially challenging with the salespeople who were successful in using the old pricing.
You likely have IT systems that are unable to execute the new strategy. You may have quoting systems that can’t handle the new strategy. Your billing systems are likely designed around your current processes. New pricing strategies often require large IT investments.
Your products and packaging may need to be tweaked to maximize the potential of any new strategy. Your marketing may need to explain the new pricing.
In many companies, changing a single price is challenging. Changing a pricing strategy feels impossible.
Hopefully, at this point, you’re having thoughts like, “That doesn’t apply to us,” or “We can overcome that.” After all, as an executive, you’re used to overcoming obstacles. Then my question would be, why are you under-utilizing this powerful tool to capture more profit quickly?
As you saw earlier, a 1% improvement in pricing can lead to 10% more profit. But most well-executed pricing initiatives can drive five or even ten times that. Think about how much energy and effort your company puts into controlling costs. Is the return anywhere near these numbers?
It may be time for you to emphasize pricing, overcome these obstacles, and drive increased profit; a lot of profit.
Written by Mark Stiving, Ph.D.
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