Establishing and maintaining a successful pricing strategy has emerged as a crucial consideration for companies hoping to enhance both their bottom line and competitive advantage. Many organizations spend years honing gains through outsourcing, cost-cutting, and the adoption of innovative new technologies. Unfortunately, a large number of companies continue to hold onto simplistic pricing practices, thereby failing to capitalize on their most profitable customer segments, and struggle to impact their profits. Strategic pricing practices have been proven to grow revenues by 9% or more with little incremental costs. Price is arguably the single most powerful lever you have for growing profitability. A 1% improvement in price can improve profits by up to 10% at the typical company. This is opportunity cost of ineffective pricing. Following is a list of just some of the most common pricing strategy mistakes companies make today.
1. Basing Prices on Costs, Rather Than Perceptions of Value
Although the “costs” involved in your business are relevant to the pricing process, it’s important to remember that they only have a particular role to play. Costs establish a lower boundary for your price – though in some cases, a company may decide to sell their product below its cost for a certain period of time. Organizations that base their prices on how much the service or product costs them face two unattractive scenarios.
First of all, if the price they provide is lower than the value that the customer gives to the product or service, they might feel that they’re achieving fast, and therefore successful sales. Unfortunately, making quick sales is not always the best result – especially if the company isn’t making as much of a profit as they could be. On the other hand, if a company prices their product too highly in comparison to how their customer values it, they’ll experience stagnating sales as the consumer won’t believe the benefit to them is worth the cost.
Contrastingly, setting a price according to a customer’s perceived value of the service or product leads to both solid growth and profitability.
2. Relying on “Marketplace” Pricing
Many companies fall into marketplace pricing because it seems like the safest and easiest choice available. Although the marketplace can provide an insight into “the wisdom of the crowds“, when companies rely entirely on the marketplace to set their price they run into trouble. First, consider this: What is the market price? Recently we asked a large sales organization to tell us whether one of their most popular products was priced higher or lower than the competition. In response, ⅓ said the competitor’s price was lower, ⅓ said the competitor was higher and ⅓ said they didn’t know. If you are thinking of using market pricing, the first thing I want to see is your evidence.
Second, market pricing is fine if you are talking about a commodity. For example this very second we could find the exact market price of pork bellies on the Chicago Mercantile Exchange. But let’s talk about a medical device used to treat cancer. That is a complex technology used in life and death situations. Each competitor provides a machine with unique strengths and weaknesses in treatment, so no two are the same. Now let’s talk about the environment. Literally, if the machine goes down patients could die. Service quality is vital. The cost for the system may be $3M, with additional service costs of $6M over the useful life. Used properly, the systems can generate revenues for a hospital of $3 million per year. In this case, what is the market price? Truth is that it does not exist. Yes, you need to understand how your value and price stack up versus the competition, but there is no market price. To leverage pricing power in this environment, management teams must be prepared to discover new ways of highlighting their product and differentiating themselves from other companies – creating additional value for their brand.
3. Using a Uniform Margin for All Products
Although the idea of uniformity in a company can seem beneficial at first – by suggesting that you can achieve the same high level of profit regardless of which product you’re selling, or how you’ve chosen to sell it, a completely uniform pricing strategy rarely works. The reality behind selling any service or product is that certain things will appeal differently to different people. Though one customer, or section of the market may value your product incredibly highly, another may find the same item boring or useless – meaning they’re less likely to pay the same price. Regardless of the service or product offered, companies only optimize profit when the price given is reflective of the customer’s interpretation of the product, and his or her willingness to pay. Slower moving items may need higher product margins, whereas high sales volumes may mean companies can afford a smaller margin.
4. Failing To Properly Examine The Risks of Changing Prices
From time to time, most businesses will have to change or increase their prices – which can be a sore point with certain customers. Though many companies know the effect higher prices will have on their customers, few recognize the risk those changes pose in regards to competitor reactions. Whether a company chooses to raise or lower prices, their behavior will stir a reaction in their competition – leading to problems like price wars, or even inflammatory advertising from other companies. In virtually every case, price wars are started unintentionally and have bad outcomes. The key is to change prices only with the long view in mind, and to anticipate competitor response. When the risk is high, many companies will choose to do pricing research and build mathematical models of their marketplace. Those models can be used to anticipate competitive effects and set long term pricing strategy.
Although it’s important to avoid hastily increasing, or reducing prices, it’s also crucial to ensure you don’t hold prices at the same level for too long – as marketplaces can change significantly within short periods of time. This is especially true in Tech. All companies must adjust and evolve to reflect the changes of their industry.
5. Spending Too Much Time Serving Unprofitable Customers
Many companies have no idea which of their customers is the most profitable – which is often where customer segmentation can be useful. Studies have suggested that around 80% of any company’s profits can be linked to only 20% of their overall consumer base. This means that a tiny portion of your market could be having a huge impact on your ability to create, and maintain success. Maximizing your profits means tracking down the customers that are most profitable to your business, and discovering ways of marketing your product or service to their specific needs. Without this tactic, you could deprive yourself of the loyalty that improved service and attention to certain customer segments may afford.
Your strategy for price realization should provide options for tailoring your products to specific customer segments. One way to do that is with services. Services can be very effective at helping customers get the highest utilization and value delivered, thereby increasing customer loyalty and willingness to pay.
Optimize Your Strategy
When it comes to running a successful business, optimizing your pricing strategy is just as important as managing sales volume and growth. Savvy companies will need to research and identify the various market segments they appeal to, and re-engineer their marketing and service operations to meet those customers’ needs. Companies must then align that research with the prices reflecting the value perceptions of consumers, helping companies to win customer loyalty, quicker sales, and enhanced profits. So what are you going to do to improve your pricing strategy?