If we look at the three variables in company profitability – sales volume, price and costs – the one that has the greatest impact on profits is price. And yet many businesses place their highest emphasis on the other two areas, leaving money on the table, in effect.
Some years ago, McKinsey looked at this issue among Global 1200 companies and showed that an increase of 1% in sales added an average of 3.3% to profits. Reducing costs by 1% saw the increase in profits jump to 5.5%, but increasing the price (or reducing discount) by 1% generated a huge 11.3% jump of pre-tax profitability among these companies.
Yet another study, done more recently among US CEOs, found that 82% of them believed sales was the best way to increase profitability. It seems that this is due to the focus on market share that drives many, and so the primary driver for them is sales – even if it means they’re leaving money on the table.
Of course, simply raising prices, or reducing discounts, is no simple task (what in business really is?) but done correctly you can manage pricing successfully without losing sales.
Many years ago, when I was leading the region’s largest and most profitable business in its sector (IT distribution), we were faced with pricing issues on a daily basis. This was a highly competitive market, with multiple sources for the same hi-tech products and very low average gross margins (driven to a large extent by the manufacturers).
However, though a combination of ensuring that it was as painless as possible for our customers to work with us and tight inventory management, coupled with a then-unique loyalty program and a range of value-added services that really helped our customers retain profitability, we were not only able to aggressively grow the business to become the dominant player, but deliver average pre-tax profitability levels twice that of our main competitors. And we did so without having to lead on price, as our competitors at the time tended to do.
As Warren Buffett said during a 2010 interview, “The single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.”
So, how can you set the optimal pricing level for your products and services? There are three main factors to consider:
- Your ideal target customers – truly understanding your ideal customer is the first cornerstone for success. Bear in mind that your ideal customers might be different to many of your current ones, depending on the markets and price points you are currently addressing.
- Your competitive landscape – the second cornerstone is knowledge of the competitors for your products and the companies that represent these. And don’t forget to look at emerging competition from other areas, too – they can be very disruptive.
- Your product differentiation – the third cornerstone is understanding what benefits you offer over your competitive products and companies. Here, remember to focus on benefits, rather than features. Although it’s easier to talk about features, these are not what your customers are buying – understanding their needs and pain points, and how you’re able to address them will highlight the benefits.
Once you have a clear picture of these, you can determine the value of your products and services relative to the alternatives. Clearly, if your products are identical to those offered by competitors, your pricing will need to depend on how you can differentiate yourself in terms of other factors – perhaps you can deliver more quickly (and that is important to customers), maybe there are prestige factors associated with your brand (again, understanding whether this has value to customers), or there might be other benefits you offer such as a loyalty program of some kind. Always, though, remember that value is something your customer is prepared to pay for, not simply what you believe has more value.
Of course, the topic of pricing has a number of models that are used: cost-plus, value, economic value, market, competitor, dynamic, feel-good, and so on. All have their proponents and detractors, but all are, in my view, too one-dimensional. When it comes down to it, matching your pricing to your customers’ willingness to pay is the most sustainable strategy, and recognising that this will change from time to time with conditions and circumstances.
Also, it’s important to recognise that customers have differing needs and abilities to pay, so market segmentation is important if you are to maximise the opportunities available. Consider the needs of each of the segments and whether such approaches as bundling (or unbundling), subscription services and others make sense.
And then, of course, your marketing and your sales campaigns need to match your segmentation and pricing, and be aimed at your ideal customers.
These issues are all highly dependent on the nature of your business and the products and services you offer and require each company to develop its own models and strategies.
As you can see, pricing accurately is a highly complex task but one which, when done properly, can give a significant boost to the business – not only in terms of profitability, but often through increased sales volumes, too, which further enhance the profitability gains.
It’s well worth the investment of time and money to get this right, and ensure you don’t leave money on the table.
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I work with high-performance owner-led businesses to enhance their growth, profitability, cash flow and business value.
If you’d like to have a conversation about your business, pricing models and strategy, culture or any business challenges or concerns, book a free 30-minute call with me here. I’d be delighted to talk with you.
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If you’ve enjoyed this post, you might find these related ones worth reading, too:
- Defining Your Ideal Customer Boosts Profits
- Measuring the TRUE Value of Your Customers
- “There is only one boss. The customer. And he can fire everybody in the company from the chairman down, simply by spending his money somewhere else.” – Sam Walton
- “Wonder what your customer really wants? Ask. Don’t tell.” – Lisa Stone
- “In the end, all business operations can be reduced to three words: people, product and profits. Unless you’ve got a good team, you can’t do much with the other two.” – Lee Iacocca
- “What business strategy is all about – what distinguishes it from all other kinds of business planning – is, in a word, competitive advantage.” – Kenichi Ohmae
- 4 Elements of a Great Business Strategy
- Does Your Business Strategy Match Your Company Culture? The Risks of a Mismatch.
- “A company is only as good as the people it keeps” – Mary Kay Ash
- “Leading isn’t a position; it’s an action.” – Adam Contos
If you’d like more information on this topic, I can recommend the book “The Price Whisperer” by Per Sjöfors’ who I heard interviewed recently on Judith Germain’s The Maverick Paradox Podcast. You can listen to it here if you’re not already subscribed to the podcast.