Price strategy is emerging as
the most important resource for companies to increase their competitive
advantage. The vast majority of companies have spent years achieving gains
through cost cutting, outsourcing, process re-engineering and the adoption of
innovative t technologies. However, the incremental benefits from these
important activities are diminishing, and companies need to look at other areas
to improve their business results.
Today, companies are looking
to serve well-defined market segments with specialized products, messages,
product variants and services, and to earn superior profit margins while doing
so. Savvy companies are implementing price optimization schemes and focusing on
building their organization to serve their most profitable customers. Many are
even "firing" customers who are unprofitable. All too many companies, however,
use simplistic pricing processes and cannot even identify their most profitable
customers or customer segments. This lack of information means that all too
many management teams have their sales staff focusing the bulk of their time
servicing the least profitable of their customers. Some companies even embrace policies
and pricing strategies that drive away their best customers, and then they
wonder why their profits are not growing.
In the course of our
engagements, we have seen examples of good and bad pricing policies. The
following is a list
of 10 of the most common mistakes companies make when
pricing their products and services.
Companies base their prices on their costs, not their customers’ perceptions of
Prices based on costs
invariably lead to one of two scenarios: (1) if the price is higher than
customers’ perceived value, the cost of sales goes up, sales cycles are
prolonged and profits suffer; (2) if the price is lower, sales are brisk, but
companies are leaving money on the table, and therefore not maximizing their
profit. Stop and think-what relevance does your cost have for your customers’
perception of value?
Companies base their prices on "the marketplace."
The marketplace is often
cited as the "wisdom of the crowds"-the collective judgment of a product’s
value. But by resorting to marketplace pricing, companies accept the
commoditization of their product or service. Instead, management teams must
find ways to differentiate their products or services so as to create
additional value for specific market segments. Consider Starbucks who still
(after recent changes) commands premium prices for what used to be a 99-cent
cup of coffee!
Companies attempt to achieve the same profit margin across different product
Some financial strategies
support a drive for uniformity, and companies try to achieve identical profit
margins for disparate product lines. The iron law of pricing is that different
customers assign different values to identical products. For any single
product, profit is optimized when the price reflects the customer’s willingness
Companies fail to segment their customers.
Customer segments are
differentiated by the customers’ different requirements for your product. The
value proposition for any product or service varies in different market
segments, and price strategy must reflect that difference. Your price strategy
should include options that tailor your product, packaging, delivery options,
marketing message and pricing structure to particular customer segments, in order
to capture the additional value created for these segments.
Companies hold prices at the same level for too long, ignoring changes in
costs, competitive environment and in customers’ preferences.
Most companies fear the
uproar of a price change and put it off as long as possible. Savvy companies
accustom their customers and their sales forces to frequent price changes. The
process of keeping customers informed of price changes can, in reality, be a
component of good customer service. Check with your local gas station-how often
do they change their price? And you still buy gas!
Companies often incentivize their salespeople on revenue generated, rather than
Volume-based sales incentives
create a drain on profits when salespeople are compensated to push volume at
the lowest possible price. This mistake is especially costly when salespeople
have the authority to negotiate discounts. Companies should define their
salesperson’s "job" as maximizing profitability and then incentivize
Companies change prices without forecasting competitors’ reactions.
Any change in your prices
will trigger a reaction by your competitors. Smart companies know enough about
their competitors to predict their reactions and get ready for them. This
avoids costly price wars that can destroy an entire industry’s profitability.
Companies spend insufficient resources managing their pricing practices.
Cost, sales volume and price
are the three basic variables that drive profit. Most management teams are
comfortable working on cost-reduction initiatives, and they have some level of
confidence in growing their sales volume. Many companies, however, only utilize
simplistic price procedures thinking maybe that pricing is less important than
other business processes or even "black art." It is neither. It is a managed
process. Good pricing strategies use hard data generated by modern methods such
as Value Attribute Positioning, Conjoint Analysis or Van Westendorp’s Price Sensitivity
Meter, to generate accurate hard data on the perceived value of a product or service,
thereby enabling mangers to maximize their profits by optimizing their prices.
Companies fail to establish internal procedures to optimize prices.
In some companies, the
hastily-called "price meeting" has become a regular occurrence-a last-minute
meeting to set the final price for a new product or service. The attendees are
often unprepared, and research is limited to a few salespeople’s anecdotes, perhaps
about a competitor’s price list, and a financial officer’s careful calculation
of the product’s cost structure across a variety of assumptions.
Companies spend most of their time serving their least profitable customers.
Know your customers: 80
percent of a company’s profits generally come from 20 percent of its customers.
Failure to identify and focus on this 20 percent leaves companies undefended
against wily competitors. Such failure also deprives the company of the loyalty
that more attention and better service would provide.
(Bonus entry): Companies rely on salespeople and other customer-facing staff
for intelligence about the value perceptions of their customers.
Such people are uncertain
sources because their information-gathering methodology is often haphazard, and
the information obtained thereby can be purely anecdotal and is neither precise
nor quantifiable. A customer will rarely tell the "complete truth" to a
salesperson, so any information the customer may volunteer will be biased in
many ways. Savvy companies employ trained professionals to collect and analyze
the data to identify and evaluate the value perceptions of their marketplace.
Large companies have entire departments doing this full-time; smaller companies
may outsource it to a specialist like Atenga.
The optimization of pricing
strategy is as important as the management of costs and the growth of sales
volume. Since most companies have never done it, rigorous price optimization
has emerged as an important source of competitive advantage and increased
profitability. The iron law of pricing states that different customers will
ascribe different values to your products and services. Savvy companies do the
research to identify the various market segments they serve, and they re-engineer
their marketing, packaging and service operations to excel at meeting their
needs. They use that research to align their prices with the value perceptions
of their customers. In this way they win customer loyalty, lower costs of
sales, and above all, enhanced profits. iBi