For many companies, the biggest driver of their overall profitability and company value is pricing. For a company with 5% operating margins, a 1% increase in price can, all other things being equal, increase profits by 20%! What other tool do you have that can grow profits so quickly?
Yet if you are like most company executives you will spend more time obsessing about your costs than your prices. Costs are relatively easy to manage and there are a host of management tools to help, including Business Process Redesign, Total Quality Management, Six Sigma and Lean Management.
So how can you get more focus onto your pricing strategy? What are the pricing methods and approaches that will help you maximise the long term performance of your business? In this article, I set out 5 strategies to drive profitable growth. Not all these are in widespread use, but by following their principles you will have developed solutions for better long term results.
Strategy 1: Price for customer value, not to cost
Customers do not care what your product or service costs to deliver. They are only concerned by its value to them. If they believe that your competitors provide the same or very similar solution at lower cost they will vote with their feet.
Your job is to ensure that your product/service has distinctive advantages compared to your competitors, and that your target customers appreciate them. In business-to-business sales this will probably mean showing the impact to their bottom line. In consumer markets psychological benefits will be more important.
Strategy 2: Segment and customise your offer
Virtually all markets can be segmented and it is possible to charge different prices to different customer groups. Airlines have traditionally offered first, business and economy class to their passengers, reflecting different customers’ willingness to pay for additional services. However, all the passengers leave and arrive at the same time! Similarly there is a £10,000(??) price difference between an entry level Volkswagen Golf and a top of the range model.
How can you segment your market to reflect different customer groups’ willingness to pay?Are you better off focusing on a less price-sensitive segment where you can deliver customer value profitably? The ideal position is to have prices specific to each of your customers – is that feasible for your business?
Strategy 3: Price to maximise long term shareholder value
Pricing to maximise shareholder value is not the same as maximising short term profit. Price increases often give companies short term profit increases, but if you do not offer customers extra perceived value your customers will drift to your competitors over time. Conversely, price reductions may simply attract high-cost customers who will switch as soon as a better offer comes along.
Pricing to maximise shareholder value, means that you set prices that maximise your long term cash-flows. This, in turn, requires an understanding of the real value of your offer to customers, the dynamics of your market and your underlying economics.
In the past couple of years M&S has understood that its prices were seen as too high and offering poor value for money. They have sought to lower overall prices with a strong focus on providing great “opening price points” for value lines, rather than reducing all prices by the same amount. This insight has helped them improve customer perceptions and increase volumes without destroying margins, and has contributed to a near doubling of their share price since 2004.
Strategy 4: Understand likely competitor strategies
You know all too well that you don’t make prices in a vacuum. The internet has made any price move even more visible to your customers and competitors. However, a reduction in price to drive share and volume can simply lead to a price war that lowers the overall profitability of your market.
For example, the competition amongst newspapers has led to periodic bursts of lower prices. Over time, however, newspaper editors have learnt that if one lowers price, they all will. The result is that price-led offers have reduced in frequency and they are now offering free CD’s and DVD’s rather than lower prices to attract readers.
Strategy 5: Create an effective organisation for price management
For many companies this is the single most important strategy to grow profits through pricing. The key issue is that actual realised prices rarely resemble invoiced prices.
Volume discounts, special offers, early payment discounts and simply discounting to get the deal all impact the bottom line. In many cases these discounts get lumped into general costs, rather than being allocated to specific products and customers, and underlying performance is difficult for managers to understand.
Jeff Immelt, chairman and CEO of corporate behemoth General Electric, recently estimated that his sales teams had combined pricing discretion of up to $50 billion! This is a huge number by anyone’s standards – even GE’s – and is nearly three times the size of their operating profits.
As Immelt said “We would never allow something like that on the cost side. When it comes to the prices we pay, we study them, we map them, we work them. But with the prices we offer, we’re too sloppy.”
If a process-focused and disciplined organisation such as GE has such a slack approach to price management, what opportunities for improvement exist at your company? What would the benefits be if your business reviewed its prices and its pricing strategy as closely as it does its costs? Which of the five strategies can you follow to improve your company’s performance?
What will it take for you to be satisfied that the price is right?
To find out more contact Stuart by clicking here or call +44-(0)1636-526111.