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:
Unfortunately, no one pricing strategy or formula will produce the greatest profit under ALL conditions. Up-to-date knowledge of market conditions is also essential for maximum profitability because the "right" selling price for a product under one set of market conditions may be the wrong price at another time.
The "best" price for a product is not necessarily the price that will sell the most units. Nor is it always the price that will bring in the greatest amount of cash. Rather, the "best" price is one that will maximise the profitability of your company.
The "best" selling price should be both cost and market orientated - high enough to cover your costs and help you make a profit but low enough to attract customers and build sales volume.
In addition to the physical factors of cost and profit, price is subject to psychological factors, some of which are unfortunately out of your control. To have any control here you will need to do a good job on your corporate/product image and positioning.
If you want to increase your profitability here are 6 pricing strategies to consider.
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
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.
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.
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.
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!
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.
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.