Price strategy is emerging as a critical path for companies to increase their competitive advantage and bottom line. Many companies spend years achieving gains through cost cutting, outsourcing, process re-engineering and the adoption of innovative technologies. However, the incremental benefits from these important activities are diminishing and companies need to look at other areas to improve their business results.
Today, companies are looking to serve well-defined market segments with specialized products, messages, product variants and services, and to earn superior profit margins while doing so. All too many companies, however, use simplistic pricing processes and cannot even identify their most profitable customers or customer segments. The following is a list of 10 of the most common mistakes companies make when pricing their products and services.
Mistake #1: Basing prices on costs, not customers’ perceptions of value
Prices based on costs invariably lead to one of the following two scenarios: (1) if the price is higher than the customers’ perceived value, the cost of sales goes up, discounting increases, sales cycles are prolonged and profits suffer; (2) if the price is lower than the customers’ perceived value, sales are brisk, but companies are leaving money on the table, and therefore are not maximizing their profit.
Mistake #2: Basing prices on the marketplace
By resorting to marketplace pricing, companies accept the commoditization of their product or service. Marketplace pricing is a resting place for companies that are giving up and where profits end up being razor thin. Instead of giving up, these management teams must find ways to differentiate their products or services so as to create additional value for specific market segments.
Mistake #3: Same profit margin across different product lines
Some financial strategies support a drive for uniformity and companies try to achieve identical profit margins for disparate product lines. The iron law of pricing is that different customers will assign different values to identical products. For any single product, profit is optimized when the price reflects each customer’s willingness to pay. This willingness to pay is a reflection of his or her perception of value of that product, and the profit margin in another product line is completely irrelevant.
Mistake #4: Failure to segment customers
Customer segments are differentiated by the customers’ different requirements for your product. The value proposition for any product or service is different in different market segments, and the price strategy must reflect that difference. Your price realization strategy should include options that tailor your product, packaging, delivery options, marketing message and your pricing structure to specific customer segments in order to capture the additional value created for these segments.
Mistake #5: Holding prices at the same level for too long
Most companies fear the uproar of a price change and put it off as long as possible. Savvy companies accustom their customers and their sales forces to frequent price changes. Marketplaces change radically in a short period of time. It is important to recognize that the value proposition of your products changes along with changes in the marketplace, and you must adjust your pricing to reflect these changes.
Mistake #6: Salespeople incentivizing strictly on revenue
Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume, even 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.
Mistake #7: Changing prices without forecasting competitors’ reactions
Pricing strategy cannot exist in a vacuum and must take into account anticipated competitive moves. When making price changes, it’s important to take into account not only likely competitive pricing changes, but to also make an objective assessment of competitive product or service quality.
Mistake #8: Spending insufficient resources managing pricing practices
There are three basic variables in a company’s profit calculation: cost, sales volume and average price. Most management teams are comfortable working on cost reduction initiatives and they have some level of confidence in growing their sales volume. But a good price-setting practice 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.
Mistake #9: Failure to establish internal procedures to optimize prices
The hastily called price meeting is a regular occurrence—a last-minute meeting to set the final price for a new product or service. The attendees are often unprepared, and research is limited to a few salespeople’s anecdotes, perhaps a competitor’s last year’s price list, and a financial officer’s careful calculation of the product’s cost structure across a variety of assumptions.
Mistake #10: Reliance on salespeople and other customer-facing staff for pricing intelligence
Such people are an uncertain source because their information- gathering methodology is often haphazard and the information obtained thereby can be purely anecdotal. A customer will rarely tell the complete truth to a salesperson. Savvy companies employ trained professionals to collect and analyze the data to identify and evaluate the value perceptions of their marketplace.
Pricing offers many companies the most direct route to higher profits, yet particularly in North America, the pricing function often fails to get sufficient attention. We believe a combination of greater management commitment to the art of pricing, along with powerful analytical software tools, can make a significant difference.