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Pricing is one of the most powerful strategies available to businesses, yet it is under utilized. A McKinsey & Company study of the Global 1,200 found that if companies increased prices by just 1%, and demand remained constant, operating profits would, on average, increase by 11%. Using a 1% increase in price, some companies would see even more growth in percentage of profit: Sears, 155%; McKesson, 100%, Tyson, 81%, Land O’Lakes, 58%, Whirlpool, 35%. Just as important, price is a key attribute that consumers consider before making a purchase.
The following 10 pricing tips can reap higher profits, generate growth and better serve customers by providing options.
Stop Marking up Costs
The most common mistake in pricing involves setting prices by marking up costs (“I need a 30% margin”). While easy to implement, these “cost-plus” prices bear absolutely no relation to the amount that consumers are willing to pay. As a result, profits are left on the table daily.
Set Prices that Capture Value
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Manhattan street vendors understand the principle of value-based pricing. The moment that it looks like it will rain, they raise their umbrella prices. This hike has nothing to do with costs; instead it’s all about capturing the increased value that customers place on a safe haven from rain. The right way to set prices involves capturing the value that customers place on a product by “thinking like a customer.” Customers evaluate a product and its next best alternative(s) and then ask themselves, “Are the extra bells and whistles worth the price premium (organic vs. regular) or does the discount stripped down model make sense (private label vs. brand name). They choose the product that provides the best deal (price vs. attributes).
Create a Value Statement
Every company should have a value statement that clearly articulates why customers should purchase their product over competitors’ offerings. Be specific in listing reasons…this is not a time to be modest. This statement will boost the confidence of your frontline so they can look customers squarely in the eye and say, “I know that you have options, but here are the reasons why you should buy our product.”
It is Okay to Earn High Profits
Many are uncomfortable setting prices above what they consider to be “fair” and are quick to offer unnecessary discounts. It is fair to charge “what the market will bear” prices to compensate for the hard work and financial risk necessary to bring products to market. It is also important to reinforce the truism that most customers are not loyal—if a new product offers a better value (more attributes and/or cheaper price), many will defect.
A Discount Today Doesn’t Guarantee a Premium Tomorrow
Many people believe that offering a discount as an incentive to trial a product will lead to future full price purchases. This rarely works out. Offering periodic discounts serves price sensitive customers (which is a great strategy) but often devalues a product in customers’ minds. This devaluation can impede future full price purchases.
Offer Product Versions
One of the easiest ways to enhance profits and better serve customers is to offer good, better and best versions. These options allow customers to choose how much to pay for a product.
Implement Differential Pricing
For any product, some customers are willing to pay more than others. Differential pricing involves offering tactics that identify and offer discounts to price sensitive customers by using hurdles, customer characteristics, selling characteristics and selling strategy tactics. For example, customers who look out for, cut out, organize, carry and then redeem coupons are demonstrating (jumping a hurdle) that low prices are important to them.
Since pricing is an underutilized strategy, it is fertile ground for new profits. The beauty of focusing on pricing is that many concepts are straightforward to implement and can start producing profits almost immediately.
Rafi Mohammed, Ph.D is the author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow (HarperBusiness) and the founder of Culture of Profit LLC, a Cambridge, Massachusetts-based company that consults with businesses to help develop and improve their pricing strategy. He is an economics graduate of Boston University, the London School of Economics & Political Science, and Cornell University (Ph.D.).