Pricing is one of the most powerful strategies to improve profits – more so than reducing costs and increasing sales. Yet it’s also one of the areas of business least understood, and often most neglected. In this blog, we will delve into nine commonly occurring pricing errors and offer practical advice on how to rectify them.
I have never met a sales team that didn’t think they could sell bucket loads more if prices were lower. This is not a dig at sales. I have a lot of sympathy for them. Selling is tough, especially when you don’t win the opportunity, and the message you hear from the buyer is ‘I can get it cheaper from a competitor’. But that’s often just an easy way to close the discussions, not the real reason for not winning.
This is also true in digital sales. I hear the same message – ‘we could sell a lot more, but look at all the competitors who are cheaper’. So what sales tells the company time and time again is ‘we’re too expensive’ and ‘we could massively increase sales if we had lower prices’. My experience is that this is a distorted view of how customers really think about the company, the product or service you are selling, and their perceptions of value and price.
Here is an example:
A soft furnishings online business excelled in customer service by promptly sending out well-labeled samples with valuable information. Customers were impressed and even though some found cheaper options elsewhere, they returned for the exceptional service provided by the company.
The message here is this – research your customers, especially what drives their purchase decisions, and how important price is within that decision (and there are research techniques that work well for these questions).
This is by far the most common mistake I see, and possibly the most fundamental.
What do you want ‘price’ to do for you? Are you trying to exclude a new competitor from the market? Are you launching a new product which is unique and want to build scale as quickly as possible? Or conversely, you want to maximise profit on the new product until competition emerges, and then reduce the price?
The unstated assumption that almost every company I speak to seems to make is that what you want to achieve through pricing is obvious to all the team with any pricing responsibility or authority, and usually, that seems to be ‘maximise sales’.
The action here is to agree this at an executive level and then communicate it to the team.
Some regulated markets require pricing consistency, but for most companies that’s not needed. Yet a lot of businesses use the same approach to pricing (and try to achieve the same margin) whatever they are selling, and whoever they are selling to. They will probably offer discounts for volume orders, but the base per-unit price is the same no matter who they sell to.
A starting point should be to understand how customers use your product or service. There are four broad categories of use in a B2B market – consumables, enablers, strategic and production. For B2C they would be consumables, enablers, lifestyle and self-fulfilment.
The effort the customer will put into buying something strategic (if B2B) or lifestyle (if B2C) is very different to buying a consumable. And the value they attach is also very different. So why use the same pricing approach?
So segment your products and services into different ‘buckets’ depending upon how customers use them, and decide on an individual pricing approach for each which maximises margin.
Basing your prices on your costs plus a markup is a nice and simple way to price your products or services. This does mean, however, that your prices will vary dependent on your input costs, not on the value you are delivering. If you are in a commodity market then that might be appropriate; in any other market you are failing to price according to the value you deliver, and are probably leaving money on the table.
The key action here is to establish what differentiates you, particularly with regard to things that add value for your customers.
Again, if there is little to differentiate you, then matching the competition might be your only option. That’s not the case for most organisations, though. But if you simply match the market price then that’s how you are acting.
Again, the key action is to understand (and charge for) the value you deliver.
If your core market is highly commoditised then you need to find ways to differentiate. I appreciate that that’s easier said than done, but it’s not impossible.
For example, digital print is largely a low-margin commodity market, but there are two printers that I have come across that have found ways to differentiate. One has designed its own range of posters for specialist healthcare, and another has a focus on secure document printing. Both do all the traditional print of posters, booklets, business cards and all the other typical print jobs, and that work covers the cost of owning and operating the equipment. Then they make their profit in the specialised areas.
Let’s not poke the tiger in its cage. If we increase prices, our customers will be prompted to consider alternative suppliers. So goes the thinking in many businesses.
And that might be fine for one year, maybe even two, when inflation is low. But after 10 years of not changing prices, even low inflation has an impact on your cost base, and over 10 years your margin could be completely eroded. This is not a fictitious example – I have seen exactly this, if not worse.
I have also had many many discussions with clients, or heard stories when presenting to audiences, where eventually – after much angst and prevarication – prices are eventually increased… and there is hardly a murmur of discontent from customers. In fact, most business lose clients because of either service issues or because the client’s needs change, not because of price. There are some linked actions here.
First, decide what your strategy is with regard to price increases. Should it be annual, for example. Or, if you measure your win/loss ratio for sales or client acquisition, raise it when you start to win too often.
Second, decide what to increase prices by – and it doesn’t have to be the same for every product or service.
Third, decide how to communicate the price increase. This is a really good time to reiterate the value the customer gets from you.
Very few companies I have worked with or spoken to (in fact, it might be no companies, I just can’t be sure if I’ve forgotten one) have ever worked out exactly what the impact of discounts are on their profitability, and how much sales need to increase by if discounting is used to win sales.
Usually that’s because it’s hard to work out true net margin on a per-product basis in real time, whereas gross margin or gross contribution are relatively easy. But the danger is that a lot of customer-facing teams don’t understand overheads, and think that if gross margin is 45% then they can easily discount by 10% to get a sale, if not more.
When I model discount sensitivity for clients, it is usually a shock. There is a wide spread of different sensitivities because the ratio of fixed to variable costs is different for each business, but an average business looks like this: if 5% is the level of discount that is typically used to win business, then that discount needs to drive 20%-25% more sales than if it wasn’t used at all, just to make the same profit. If the discount is 10%, then it needs to drive 50%-60% more sales. The discount sensitivity for some businesses are much worse.
So the two key messages are: first, make sure sales are incentivised on profit (preferably net profit), not sales revenue; and second, work out how hard discounts have to work for you, and put in place appropriate guidelines to make sure discounts are not used indiscriminately.
My focus with clients is to work out how to maximise prices, not reduce them. But sometimes a business might want to drop prices as part of a promotion to drive sales growth and gain market share.
You should be cautious about this approach. If you win customers based purely on a lower price, then either you have to be able to sustain a ‘lowest price in the market’ position or you have to accept you will lose them as soon as you are no longer the cheapest.
If you are following a Ryanair style model where strategically you are aiming to be the cheapest in the market then fine, this can work in the long term. If not, then be careful.
How to handle this?
Make it clear in the marketplace that any discounts are temporary, so that competitors don’t follow you down and stay there (you are now in a price war); even better, use marketplace norms such as Black Friday, Boxing Day Sales or Summer Sales where everyone expects prices to rise again to avoid competitors just dropping their prices permanently instead of offering time-limited discounts like yours.
There are probably people in the organisation responsible for pricing your products or services. Perhaps it is your buying department, or your sales director, or your commercial director. But where are they getting the information on which to make their decisions?
Often it will be based on feedback from the sales team, or a review of what competitors charge.
There are many more aspects to pricing, though. Only a few companies I have worked with have had someone within the company who either fully or partly had ‘pricing’ as part of their role. They spent time gathering market data, understanding customer’s sensitivity to prices, running pricing tests such as price elasticity, modelling the profit impact from prices, training new starters on pricing, or measuring and reporting pricing KPIs.
The action here is obvious: make pricing a role (or part of a role) for someone with appropriate competence.
You may also like this blog article: How to tell if your pricing is wrong and what you can do about it.
Of course, there is much more to pricing than is listed above, such as the importance of brand (and making sure your price aligns with your brand), your marketing communications (and how well you communicate your value), and much more. But these are some of the more common issues, and are a good place for any company to start.
If you are interested in gaining a comprehensive understanding of the science and psychology behind pricing, and wanting to discover some effective strategies for increasing your prices, you can watch our on demand webinar: "The CEO's Guide to the Science of Pricing: How To Price Your Platypus." This is a fantastic opportunity to refine your pricing approach and propel your business forward.
Watch now for valuable insights and practical tips.