Pricing is one of the most powerful levers available for driving profit. At the same time, if you get your pricing strategy wrong, you can rapidly destroy the value of your business – or even find yourself out of business. In its most detailed form, understanding pricing requires complex analytical methods to be applied across vast quantities of historical data. However, keeping in mind a series of high level concepts can yield much of the benefit that such deep analytical analysis provides. In the end, pricing should be a relatively simple concept – and is as much around understanding the psychology and motivations of your customers and competitors as anything else.
1. Don't give away something for nothing
It seems like an obvious concept – if you give something, you should get something of at least the same value in return. A surprising number of companies don’t keep this in mind – and revert to providing discounts when pressured by their customers. If you feel that you have to give a discount, develop a plan for what you want in return.
If you’re negotiating a contract, ask for a longer contract period – or an exclusivity arrangement. If you’re selling goods, introduce a minimum buy quantity to stretch the sales size. If you’re selling a membership, require a customer to sign up then and there in order to receive the discount – and so mitigate against them shopping around. Most of all, ensure that what you’re asking for is worth at least the cost of the discount.
2. Don't reward customers for doing something they already do
Many loyalty schemes provide the best examples of rewarding customers to do what they already do. If you operate a coffee shop without local competitors, it’s highly likely to be a bad idea to introduce a loyalty scheme to offer a free coffee for every 10 purchased. Most of your customers will be loyal, regular customers – and you’ll just be rewarding them for doing exactly what they’d do at any rate.
The biggest impact will be to your bottom line – and it won’t be pretty. If you introduce a loyalty scheme, take the time to do the basic maths. How many incremental customers will you need to break even? And what’s the probability of that happening? Often times, the investment simply won’t pay off – and once you start down this track, it’s very difficult to stop without upsetting your customers later in time.
3. Think it through - what would your competitor do?
It’s surprising how many companies make their pricing decisions in isolation – without thinking through how their competitors are likely to react. When you’re thinking about making a pricing decision designed to steal market share from competitors, put yourself in their shoes and think, ‘how would I react?’ Because your answer is highly likely to represent how they will react.
If you operate a gym and you lower your rates, chances are that all of your local competitors will do the same. If you introduce a loyalty scheme, chances are that your local competitors will do the same. If this happens, there are two implications: first, you won’t realize the upside you expected; and second, you won’t be able to reverse the decision without putting yourself at a competitive disadvantage. Take the time to think it through from the standpoint of your competitors.
4. Beware of the value offering
Particularly in tougher economic times, many companies introduce ‘value’ offerings designed for highly value conscious customers. These can work well when properly thought through – but there are several traps that can be extremely costly and need to be avoided. First, don’t make your value offering too cheap – or of too high a quality - compared with your standard products. The last thing you want is to down-trade large numbers of your existing customers. Your value offering should be less expensive than your regular products – but not too much cheaper.
Second, try not to formally brand your value offering as its price. ‘The $1 cheese burger’ might sound catchy – but how do you increase its price later in time? ‘The $1.10 cheese burger’ doesn't have quite the same ring In the same way, don’t irreversibly print your prices on any permanent point-of-sale merchandise or signs. You’ll want to increase your prices at some point – and having to order new, expensive items branded with the revised prices is something you should plan to avoid.
5. Compete on value before price
Stress the value of the products or services that you offer – pointing out their many features and points of difference compared with competitors. In this way, you can justify your ability to charge higher prices by clearly demonstrating the superior value of your product and services. No-one expects to pay the same price for a BMW as for a Kia. Similarly, if in contract negotiations and you’re asked for a lower price, offer additional add-ins instead. It’s a common tactic used by car dealerships, which often have a standard set of ‘optional’ accessories that they’ll add to the deal in lieu of further price discounting. Importantly, those accessories have high perceived value – but much lower actual cost to the dealership.
Plan your strategy, and have a list of value-adds and enhancements that you can use in negotiations. Determine their perceived value to your end customer (NOT the cost to you,
which should be considerably lower). Always aim to add value ahead of reducing price.
6. Contain your Ego
Initiating or participating in a price war is probably the most rapid way to destroy your business. If a competitor drops its prices, you may need to follow if it impacts your business – but don’t pour fuel on the fire by significantly undercutting them. You’re likely to get the same response from your competitor, and the ego cycle begins, with emotions running high as the various players attempt to ‘win’ the pricing battle. The problems are many. First, at the end of a prolonged price war, you can’t simply put your prices back up – particularly if you’re supplying to other businesses which have become accustomed to the lower prices and have built them into their forecasts.
Second, your profitability is likely to have been shredded. A price war is like a nuclear war – you may win, but if you do, what you’re left with may well be not worth having.
7. Put your prices up
If you have strong products and haven’t taken prices up for a while, consider doing it. In fact, you should plan to take regular, moderate price increases. CPI rises by 2-3 per cent a year. Average weekly earnings typically increase at an even faster rate. Consumers are used to prices going up. And with a price increase, all of the incremental revenue flows straight through to your bottom line. If you’re concerned about the impact on customers, then phase your price increases gradually over time, assessing their impact on sales. You’ll likely be surprised just how low the impact on sales is – and how much more profit you have to spend on that well overdue family holiday in the Maldives…
On the whole, pricing is largely about common sense. Get your pricing strategy right and you’ll see significant ongoing improvements in the profitability of your business.