“Almost every company chooses its customers. It can join the race to the bottom, or it can distinguish itself in some way, and serve a market vertical willing to pay a higher price for more value.
Pricing is more than just a number. It is process and structure. Its tentacles reach to almost every nook and cranny of your company; sales, product marketing, production, product management, finance, executives and maybe even to the board.” Per Sjofors, Founder/CEO Atenga Inc.
My mantra is that it is not the volume of sales that’s important in determining the profitability of your business, but the volume of Gross Profits. And that will depend on your pricing strategy.
Most small and medium businesses I know don’t put much rigour into their pricing strategy, yet it is so important to their profitability and cashflow.
In his “personal reflections on pricing”, Per Sjofors discussed pricing strategies, and various options for optimising price. I have posted a number of times on pricing, and the links to these blog posts are given at the end. I found these “reflections” very valuable and have endeavoured to give you an abridged version here.
Every company has a pricing strategy. It may be simple like adding a fixed margin to the cost. It may be pricing based on a competitor’s price list. Or, it may be something more elaborate.
Simple pricing strategies have advantages. They are easy to understand, they are easy to implement and it does not take a lot of company resources to develop, maintain and communicate them. But they also have some serious flaws; they reduce the company’s sales level, they leave money on the table, they accelerate commoditization. Overall they decrease a company’s ability to compete and grow. In short, companies with simple pricing strategies are never the market leaders; they are nearly always the underdogs. They always struggle, never having enough resources for sales, marketing and product/service development. Never having enough resources to innovate. They struggle with profitability.
In fact, price-savvy companies are usually the market leaders. They are the companies others aspire to become, the companies who earn the most money and grow the fastest. They are the companies with resources to innovate. And those are the companies that generate the highest shareholder value.
These price-savvy companies use more a more sophisticated pricing strategy. An optimized pricing strategy. In the context of pricing, this is what it means: The price of your product or your service provides you the opportunity to capture a portion of your customers’ willingness to pay. When your pricing strategy is optimized, you make the best use of that opportunity - you are capturing the maximum possible of that willingness to pay.
An optimized pricing strategy is built around a pricing structure that supports various pricing actions and strategies; it:
• has optimized pricing levels,
• has discounting polices that specifically support the company’s strategic goals,
• guides the company to the portion of the addressable market with a higher willingness to pay, and
• influences sales compensation and sales training.
Let’s look at some pricing options.
The pricing structure is key to an optimized pricing strategy. As an optimized pricing strategy is built on various tactics and strategies that increase customers’ willingness to buy and willingness to pay. Unless the pricing structure supports these actions, companies simply cannot do these, and therefore cannot use price to influence willingness to buy and willingness to pay. They end up leaving the customer in control of the company’s pricing.
Per suggests six tools you can use.
For just about any item in the price list, having a good-better-best offering allows a company to capture buyers with different needs and different willingness-to-pay levels. It simplifies sales and enables a salesperson to direct a customer to “lower” level of offering instead of giving a discount.
But the good-better-best structure has other benefits too. There are always customers who want “the best,” and they can be served here with the “best” offering. And also, the way price imaging works (see below for more details) is to frame the “better” offering to appear more affordable.
Another key element of the pricing structure is bundles and unbundles. In fact, in some cases the good-better-best strategy is just that, different bundles of the same offering. The importance of unbundles is, just like with the good-better-best strategy, these unbundles allow a salesperson to offer an unbundled offering instead of giving a discount.
So what is an un-bundle? Almost everything we buy is a bundle of some sort. Unbundling splits these apart, and prices separate components separately. Unless the pricing structure supports this unbundling, where there is a line item for the device with and without the program, the salesperson has no choice but to give a requested discount - and this, of course, affects the company’s profitability. But also, this sets a long-term precedent for continued discounting to close every deal.
Another key element of a pricing strategy is price imaging. We, as humans, look at different offerings and unconsciously compare them. Price imaging takes advantage of this fact. An effective way to increase the willingness to buy and to pay for a product or a service is to offer something substantially higher in price than the product you really want to sell, in the same category. As the buyer compares the two prices, the less-pricey alternative becomes, in their mind, more affordable and has greater price-value.
A high-priced offering has another, longer-term effect. Items we buy often have a reference price. We “know” what a product or a service “should” cost. Above that reference price, willingness-to- buy and -pay decrease rapidly and substantially. By providing an offering at a substantially higher price, with unique features or functions, over time, it is possible to educate the buyers to the fact that the reference price is higher than they originally thought.
Price imaging also works from the other side. By offering something really cheap, but with very limited functions and features, the relative value of what you really want to sell is increased, and so is willingness to buy and pay. But of course, this needs to be done in consideration of the marketplace and competition.
Options are also part of the price structure. They provide important opportunities for up-selling. Once your customer has decided to buy your main product or service, he or she is already in “buying mode” and it is relatively easy to continue to add options, many times simply because options may add a level of convenience that, at the time, add considerable value to the buyer.
If what you are selling is highly commoditized and there is a plethora of competitors with very similar products or services, one way to differentiate the offering is to price it differently. Introduce another variable into your price levels. This is makes it difficult or even impossible for a potential buyer to compare two offerings on price alone.
Whatever (small) differentiator you're offering has becomes more noticeable and you will be able to capture a portion of the market that prefers just your pricing structure. But even with a differentiated pricing structure, the price needs to make sense to the buyer.
Despite all of this, the good-better-best, bundles and unbundles, the price imaging, the options and a “different” price structure, the price structure also needs clarity.
Some companies come up with elaborate and complicated price lists because they say it “hides” the true price. The companies believe they can fool their customers, and realize higher prices without loss of sales volume. This is completely wrong thinking. A price list that generates confusion in your customers’ minds has the opposite effect. A confused prospect rarely makes the buying decision in favor of the confuser.
Thank you Per
In my next post I’ll share Per’s thoughts on how to optimise your price levels, and a process and structure to do so.
I’ve written many times on pricing. Here are a few links if your would like to learn more:
When clients approach me for coaching, so often, they are troubled by their profitability, or lack of it.
Their pricing strategy is usually simple, and not differentiated from the competition.
For more than 29 years I’ve been helping small business owners plug the profit leaks in their business and restoring their cash flows by assisting them understand where there profits really come from, where they’re leaving money on the table, and where their sales are costing them profits.
If you would like to discuss with me how you might do that, book a Strategy Consult here.
© Copyright 2017 Adam Gordon, The Profits Leak Detective
Some profit losses are pretty obvious - so you fix them.
BUT, what if you don't know profits are leaking, cash out the door?
Possible leaks could be anywhere.
Are there some clues or symptoms that are tell-tales?