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.
Mistake #1: Companies base their prices on their costs, not their customers' perceptions of value.
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?
Mistake #2: 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!
Mistake #3: Companies attempt to achieve the same profit margin across different product lines.
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 to pay.
Mistake #4: 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.
Mistake #5: 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!
Mistake #6: Companies often incentivize their salespeople on revenue generated, rather than on profits.
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 profitability.
Mistake #7: 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.
Mistake #8: 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.
Mistake #9: 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.
Mistake #10: 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.
Mistake #11 (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