The fastest and most effective way for a company to realise its maximum profitability is to get its pricing right. The right price can boost profits far quicker than increasing sales volume; the wrong price can shrink profits just as quickly.
It can be a natural instinct to shy away from initiatives to improve pricing for fear of alienating, or even losing, customers but the result of not managing prices is far more damaging.
Why you may ask? Well did you know that a 10% improvement in price leads to a much better return than a 10% reduction in fixed costs, or even a 10% improvement in sales volume? This chart gives you the lowdown:
In this guide, we highlight 6 pricing strategies to increase your profitability.
Why Is Increasing Profitability Important?
Profitability is important for the survival and growth of a business. Without profit, a business can't survive in the long term as it would not be able to pay its expenses such as salaries, rent, utilities, and materials.
Here are some other key reasons why you need to focus on improving your profitability:
Investment: Increasing profitability generates more cash, which can be reinvested back into the business to fund research and development, new product lines, expansion into new markets, and other growth opportunities.
Creditworthiness: Profitable businesses have an easier time obtaining loans from banks and other financial institutions. Increased profitability shows lenders that the business has a strong track record and is likely to repay the loan.
Attracting Investors: Investors are attracted to businesses that demonstrate a capacity for generating profits. This is particularly true for public companies, where profitability often translates into higher share prices.
Competitive Advantage: High profitability can provide a competitive advantage. It allows businesses to invest in superior production methods, marketing strategies, and customer service.
Cushion Against Future Downturns: Having a high-profit margin gives businesses a cushion to weather future downturns. If profits are already thin when a downturn hits, the business may not be able to survive.
What Is The Best Price for Profitability?
Unfortunately, no one pricing strategy or formula will produce the greatest profit under all conditions. Achieving the "best" price is a dynamic process that involves continuous evaluation and adjustment of your pricing strategy.
Here are the factors that impact the best price for profitability:
Market Conditions: These can drastically change, affecting what would be considered the optimal price. The perfect price at one time may not be as effective in different market circumstances.
Cost Considerations: The price should be sufficient to cover all your expenses and still leave room for profit. This means taking into account all costs associated with producing, distributing, and marketing the product.
Market Dynamics: The price should be competitive enough to attract customers and boost sales volume. This requires understanding your target audience, their purchasing power, and what they're willing to pay for your product.
Psychological Factors: Pricing can also be influenced by customers' perception of value. These can sometimes be out of your control, but effective management of your company's or product's image and positioning can play a significant role.
Competitive Landscape: You need to consider what your competitors are charging for similar products or services. While you don't want to start a price war, you need to ensure your price reflects the value relative to competitors' offerings.
The 6 Ways to Boost Profitability
1. Set Prices to Capture Value
Your price sends a strong message to your market and it needs to be consistent with the value you’re delivering. For example, if your value proposition is operational efficiency, then your price needs to be extremely competitive. If your value proposition is product leadership a low price will send the wrong message.
This pricing strategy considers the value of your product or service, as opposed to the costs incurred to create and produce it. You will need to determine how much money or value your product or service will generate for your customers originating from factors such as increased efficiency, happiness or stability - and entails putting yourself into your customers' shoes to set a profitable price.
Customers will evaluate a product and its next best alternative(s) and then ask themselves, “Are the extras worth it?" or is the discounted product as good as the "high end" one. They will ultimately choose the product that provides the best deal (price vs. attributes).
A value-based strategy enables companies to:
- Deploy this strategy across a broader range of customers and markets
- Establish value-added supplier relationships
- Extend the lifecycle of existing products
- Capture maximum value of new product offerings
- Identify high-value customer segments
- Ultimately increase your profitability
2. Differentiate Your Customers
Pricing is the one area of business where companies often behave as if all their customers are identical - by setting one price for each product. The key to developing a comprehensive pricing strategy involves embracing (and thereby profiting from) the fact that customers’ pricing needs differ - and setting prices accordingly.
One of the easiest ways to enhance profitability and better serve customers is to offer good, better, and best versions of your product or service. These options allow customers to choose how much to pay for a product – and what will best suit their requirements. For any product, some customers are willing to pay more than others.
You can also differentiate your prices based on the type of customer, quantity ordered, delivery time, payment terms, location, etc.
3. Use Pricing Analytics
Use a predictive, analytic tool to identify what is likely to happen in the future and to set your pricing/performance strategy to better react to those predictions.
The pricing analytics should evaluate past performance in specific market conditions and suggest what you’ll be able to sell in a particular product line. These analytics will allow you to track prices, goals and performance.
With objective evidence from pricing analysis, it makes it much easier for your salespeople to make a decision on whether a discount is really necessary.
As an example, if a product is listed at £1,000, yet it is regularly sold for a 10% discount by your salesforce for £900, this means you have to sell 12 units to make the same amount in revenue compared to if no discount was applied. Can you be sure your customers would stop buying from you if you didn't discount? Price elasticity tests would allow you to support this decision.
|Price||Units to be sold||To make revenue of|
|£1,000 (list price)||10.00||£10,000|
|£900 (with discount)||11.11||£10,000|
And what about where the % of discounts are given? Are they typically at the 5%, 10%, 15%... boundary? Successful negotiation, and incremental profit gains is sometimes just the difference between giving a 14% discount over a 15% discount.
4. Invest in Pricing Software
Having effective pricing software enables businesses to automate the pricing process and really make inroads towards increased profitability. With an automated pricing system you can reset prices multiple times per day based on information from the marketplace.
This allows sales teams in the field to quote prices to customers from information and updates sent in real-time to their smartphones. The more accurate information your sales team has available, the better it will help when negotiating long-term contracts.
A pricing software system with a product analysis tool will also boost customer satisfaction and improve efficiency, speed up order processing and help identify substitute product lines that might better fit a customer's needs or budget.
This analysis allows a salesforce to look at the whole picture, rather than just on a transaction-by-transaction basis. This can help identify customers who purchase multiple products across different product segments.
Your sales team will have the advantage of being able to create a 'package deal', a one-stop shop for customers, allowing for up-selling and cross-selling opportunities.
5. Increase your prices
This can be a difficult decision but sometimes business owners are more concerned about this issue than their customers. Remember that your overheads are going up all the time. Of course you might lose the odd customer in the process but they won't be your best customers because most customers buy on value. They make a decision to buy based on the perceived worth of your product compared to what your competitors are offering – not just the price.
The longer you put off raising prices, the more you will eventually have to raise them to recover your margins - and then the size of the price increase might cause you to lose more customers than otherwise. Incremental increases have far less impact.
If you sell a range of product lines targeting different customer groups or market segments with different levels of competition, some may be able to stand price rises better than others.
Note to self: if your margin is 50%, a 10% increase in prices means you can lose 17% of your customers yet be no worse off!
6. Focus on Customer Loyalty
Customer loyalty is vital for both growth and profitability. Growth is achieved by providing a larger and more stable customer base and it generates more profit because loyal customers cost less and spend more. A profitable growth can only result from a strategy that creates loyal customers.
Focus on customers’ needs by delivering highly perceived quality products at a competitive price, within the shortest possible timescale, and with an excellent customer service. By deciding to be a hit with customers and by focusing on the creation of value, you will be able to succeed against your competitors.
Creating and delivering value for customers is the source of high customer satisfaction and loyalty that in return leads to profitability – just keeping 10% more customers per year can double the number of your customers in seven years (and triple it in ten years), and lead to excellent profit growth.
In a highly competitive environment, companies need to capture the full value of their product lines throughout their entire life cycle and through multiple distribution channels in order to be a leader. Since pricing is an underutilised strategy, it creates fertile ground for profitability.
The beauty of focusing on the pricing strategies mentioned here is that many of the concepts are straightforward to implement and can start producing profits almost immediately.
Pricing is one function that a company can always improve – and the rewards should be high. Few decisions have as large an impact on the profitability of your business as setting the right product prices. Your prices influence how many customers actually purchase your products, the types of customers you attract - and sales revenue. This all has a direct effect on your profit margins.
Every pricing decision you make should offer a win-win outcome where your customers get good value for their money and your business makes a healthy profit. So, start a review of your pricing strategy without delay and look forward to increased profitability.
How can marketing improve profitability?
Profitability can be enhanced through effective marketing techniques that drive increased sales and revenue. By understanding the target audience and implementing targeted promotional strategies, marketing can generate higher customer interest, resulting in improved profitability for the business.
What are the four profitability factors?
The four essential factors that contribute to profitability are revenue, cost of goods sold (COGS), operating expenses, and taxes. Revenue represents the total income generated from sales, while COGS encompasses the direct expenses associated with producing or acquiring the goods or services sold. Operating expenses cover the indirect costs involved in running the business, and taxes represent the obligations based on the profits earned.
What are 3 ways to improve profit?
- Increasing sales volume by attracting new customers, expanding into new markets, or upselling and cross-selling to existing customers.
- Reducing costs through measures like optimizing operations, streamlining processes, negotiating better deals with suppliers, or adopting cost-effective technologies.
- Enhancing pricing strategies by conducting market research, adjusting prices based on customer demand and competitive landscape, or introducing premium offerings with higher profit margins.
The Strategy and Tactics of Pricing, Tom Nagle and John Hogan, 2016.
Pricing Strategy: Tactics and Strategies for Pricing with Confidence, Warren D. Hamilton, 2014.
Pricing for Profit: How to Develop a Powerful Pricing Strategy for Your Business, Peter Hill, 2013.
Pricing Strategy: How to Price a Product, Bill McFarlane 2012.
Value-based Pricing: Drive Sales and Boost Your Bottom Line by Creating, Communicating and Capturing Customer Value, Harry Macdivitt and Mike Wilkinson, 2011.