Or Profits?

In the last two blog posts I discussed the first five common mistakes as expounded by Dennis Brown from Atenga Inc. (www.atenga.com), a consultancy which specialises in developing price optimisation strategies for businesses. 

These mistakes come from their article “Ten Common Mistakes Companies Make in Pricing their Products or Services”. 

In my experience their comment “With the right pricing strategy, sales will increase, discount requests can be effectively deflected and lowering your price will no longer be necessary to win the business” is so very true; a formula for increased profit, which after all is why you are in business.

The first five mistakes were:

Mistake #1: Companies base their prices on their costs, not their customers’ perceptions of value.

Mistake #2: Companies base their prices on “the marketplace.”

Mistake #3: Companies attempt to achieve the same profit margin across different product lines.

Mistake #4: Companies fail to segment their customers.

Mistake #5: Companies hold prices at the same level for too long, ignoring changes in costs, competitive environment and in customers’ preferences.

Now onto their next three common mistakes

Mistake #6: Companies often incentivise their salespeople on revenue generated, rather than on profits.

Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price. This mistake is especially costly when salespeople have the authority to negotiate discounts. They will almost always leave money on the table by:

(1) selling lower priced products, and

(2) dropping prices to “clinch the deal.”

When their “job” is to get the deal, regardless of profitability, salespeople will do exactly that. And, as a result, your profitability will diminish.

Companies need to redefine the salesperson’s “job” as maximizing profitability, and incentivise profitability, while also providing the salespeople the necessary “tools” to do so. These tools include information on profitability on each of the products your company sells, strict control of the awarding of discounts.

One Atenga client was persuaded by its sales staff to reduce the price of its keynote component from $2400 to $1800. The staff believed – and persuaded management -that lowering the price would drive proportionately higher sales volumes.

The result was catastrophic. Sales volume over the following year declined almost 40%, as customers and channel partners perceived that the lower price signalled a lower quality.

That lower-quality perception prevented the company from reversing the price increase, and it was not until a new product was designed – 18 months later -and released that the company began to recapture its former price point, and sales volume.

Mistake #7: Companies change prices without forecasting competitors’ reactions.

Any change in your prices will cause a reaction by your competitors. Smart companies know enough about their competitors to forecast their reactions, and prepare for them. This avoids costly price wars that can destroy the profitability of an entire industry. Savvy companies understand that any significant lowering of your price – which may drive increases in volume – will provoke a reaction from your competitors.

One Atenga client dominates its marketplace for a specific type of internet web services. As they prepared to move into a new market for the services, smaller competitors were already selling into it with a different form factor.

Atenga research showed that the new form factor would be preferred by the entire market – including the client’s existing customers. The new entrants were financially weak, however and a low price point by the client would put pressure on the competitors that they would not be able to stand.

At the end of the Atenga engagement, the client purchased one of the competitors, and went on to dominate the market in the new form factor, as well.

(Note:  Australian subscribers will be aware of the costly impact the price war between our two major grocery retailers, Coles and Woolworths, are having on their suppliers.  AG)

Mistake #8: Companies spend insufficient resources managing their pricing practices.

There are three basic variables in a company’s profit calculation: cost, sales volume and price.   Most management teams are comfortable working on cost reduction initiatives, and they have some level of confidence in growing their sales volume.

But good price setting practices is seen as a “black art.” Consequently, many companies resort to simplistic price procedures, while the same companies use highly sophisticated procedures and technologies to track and control their costs in minute detail and in real time.

Likewise, companies believe they know what effect marketing campaigns and “the number of feet on the street” have on sales volume. Managers feel comfortable with these two hard data sets. Therefore, they spend nearly all their time on the issues of sales volume growth and cost control, overlooking the vital role of pricing strategy.

They erroneously believe that pricing is not important, or that hard data and rigorous methods are not available to enable them to control pricing. In fact, pricing is of outmost importance, and a key element of the marketing mix.

Good pricing strategies use hard data generated by modern methods such as Value Attribute Positioning, Conjoint Analysis or Van Westendorp’s Price Sensitivity Meter, to generate accurate hard data on the perceived value of a product or service, thereby enabling mangers to maximize their profits by optimizing their prices.

One Atenga client managed prices by reviewing the prices of their competitors and making adjustments to their own accordingly. The primary data input to the pricing decision was the stories customers and salespeople told them about how competitors were offering lower prices.

Atenga research showed that a significant segment of the customers desired a particular set of services along with the product, and that if our client, as opposed to its competition, offered those services, they would be willing to pay significantly higher prices, as their overall costs would decline.

Setting price levels and strategies based on competitive information was missing important profit opportunities.

Here are the takeaways:

  • Your sales team incentives should be based on maximising profits, not sales.
  • Rightly or wrongly, price has a role in shaping people’s perceptions of quality; the lower the price, the lower the quality.
  • Any change in your prices will cause a reaction by your competitors. Forecast their reactions, and prepare for them. This avoids costly price wars that can destroy profitability.
  • Business spend nearly all their time on the issues of sales volume growth and cost control, overlooking the vital role of pricing strategy.  Pricing is a key element of the marketing mix.

I’ll pass on the final three mistakes next week. After all, you can only make so many mistakes bwfore yoy go out of business.

In the meantime, pour yourself a coffee or a cuppa and take 10 minutes to consider whether you are making any of these mistakes.   You could be leaving money on the table, money which is all profit.

What is your pricing strategy?

Do you face that dilemma, trying to reconcile the need to improve profitability with the threat of losing customers if you do raise your prices?  If you would like to discuss how you could generate a continuous stream of profitable customers, keep those customers and minimise customer churn through an improved pricing strategy, contact me.  There’s no cost for a consultation.  It is my gift to you.

© Copyright 2016 Adam Gordon, The Profits Leak Detective 

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