Pricing is one of the most powerful — yet underutilized — strategies available to businesses. A McKinsey & Company study of the Global 1200 found that if companies increased prices by just 1%, and demand remained constant, on average, operating profits would increase by 11%. Using a one percent increase in price, some companies would see even more growth in percentage of profit: Sears, 155%; McKesson, 100%; Tyson, 81%; Land O'Lakes, 58%; Whirlpool, 35%. Just as important, price is a key attribute that consumers consider before making a purchase. The following 10 pricing tips can reap higher profits, generate growth and better serve customers by providing options.
- Stop marking up costs. The most common mistake in pricing involves setting prices by marking up costs ("I need a 30% margin"). While easy to implement, these "cost-plus" prices bear absolutely no relation to the amount that consumers are willing to pay. As a result, profits are left on the table daily.
- Set prices that capture value. Manhattan street vendors understand the principle of value-based pricing. The moment that it looks like it will rain, they raise their umbrella prices. This hike has nothing to do with costs; instead, it's all about capturing the increased value that customers place on a safe haven from rain. The right way to set prices involves capturing the value that customers place on a product by "thinking like a customer." Customers evaluate a product and its next best alternative(s) and then ask themselves, "Are the extra bells and whistles worth the price premium (organic versus regular) or does the discount stripped-down model make sense (private label versus brand name). They choose the product that provides the best deal (price versus attributes).
- Create a value statement. Every company should have a value statement that clearly articulates why customers should purchase their product over competitors' offerings. Be specific in listing reasons — this is not a time to be modest. This statement will boost the confidence of your frontline so they can look customers squarely in the eye and say, "I know that you have options, but here are the reasons why you should buy our product."
- Reinforce to employees that it is okay to earn high profits. I've found that many employees are uncomfortable setting prices above what they consider to be "fair" and are quick to offer unnecessary discounts. It is fair to charge "what the market will bear" prices to compensate for the hard work and financial risk necessary to bring products to market. It is also important to reinforce the truism that most customers are not loyal — if a new product offers a better value (more attributes and/or cheaper price), many will defect.
- Realize that a discount today doesn't guarantee a premium tomorrow. Many people believe that offering a discount as an incentive to trial a product will lead to future full price purchases. In my experience, this rarely works out. Offering periodic discounts serves price sensitive customers (which is a great strategy) but often devalues a product in customers' minds. This devaluation can impede future full price purchases.
- Understand that customers have different pricing needs. In virtually every facet of business (product development, marketing, distribution), companies develop strategies based on the truism that customers differ from each other. However, when it comes to pricing, many companies behave as though their customers are identical by setting just one price for each product. The key to developing a comprehensive pricing strategy involves embracing (and profiting from) the fact that customers' pricing needs differ in three primary ways: pricing plans, product preferences and product valuations. Pick-a-plan, versioning and differential pricing tactics serve these diverse needs.
- Provide pick-a-plan options. Customers are often interested in a product but refrain from purchasing simply because the pricing plan does not work for them. While some want to purchase outright, others may prefer a selling strategy, such as rent, lease, prepay or all-you-can-eat. A pick-a-plan strategy activates these dormant customers. New pricing plans attract customers by providing ownership options, mitigating uncertain value, offering price assurance and overcoming financial constraints.
- Offer product versions. One of the easiest ways to enhance profits and better serve customers is to offer good, better and best versions. These options allow customers to choose how much to pay for a product. Many gourmet restaurants offer early-bird, regular and chef's-table options. Price sensitive gourmands come for the early-bird specials while well-heeled diners willingly pay an extra $50 to sit at the chef's table.
- Implement differential pricing. For any product, some customers are willing to pay more than others. Differential pricing involves offering tactics that identify and offer discounts to price sensitive customers by using hurdles, customer characteristics, selling characteristics and selling strategy tactics. For example, customers who look out for, cut out, organize, carry and then redeem coupons are demonstrating (jumping a hurdle) that low prices are important to them.
- Use pricing tactics to complete your customer puzzle. Companies should think of their potential customer base as a giant jigsaw puzzle. Each new pricing tactic adds another customer segment piece to the puzzle. Normal Norman's buy at full price (value-based price), Noncommittal Nancys come for leases (pricing plans), High-end Harrys buy the top-of-the-line (versions) and Discount Davids are added by offering 10% off on Tuesday promotions (differential pricing). Starting with a value-based price, employing pick-a-plan, versioning and differential pricing tactics adds the pricing related segments necessary to complete a company's potential customer puzzle. Offering consumers pricing choices generates growth and increases profits.
Since pricing is an underutilized strategy, it is fertile ground for new profits. The beauty of focusing on pricing is that many concepts are straightforward to implement and can start producing profits almost immediately. What better pricing windfall can your company start reaping tomorrow morning?
RAFI MOHAMMED, Ph.D is the author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow (HarperBusiness). He has been working on pricing issues for the last 20 years. Mr. Mohammed is the founder of Culture of Profit LLC, a Cambridge, Massachusetts-based company that consults with businesses to help develop and improve their pricing strategy.