“The moment you make a mistake in pricing, you’re eating into your reputation or your profits.” (Katharine Paine, founder and CEO of KDPaine & Partners)
Sometimes in business you can see the end coming from a mile away. Losing your biggest client, conceding market share to a new competitor, or having your product become obsolete are all obvious signs that tough times are on the way. Some killing blows are a lot harder to detect. Perhaps one of the least noticed and most difficult to see coming, even if you are looking for it, is death by your pricing model and it’s easy to understand why.
Some companies accept their pricing models as part of the furniture. They create the prices early on and stick to the models they believe are working for them, all the while potentially missing the tiny signs that bad business is being done and bankruptcy is just over the horizon. We look at why accurate pricing is such a critical part of any business’s success and tell you what to look for to detect that there might be something wrong.
It may seem a simple concept but getting your pricing right is an integral part of any business’s true sustainable success and can be a critical part of its failure too. Bad pricing leads to missed deals if you are too expensive, and lost profits if it you are too cheap. It also leads to painful brand damage as high prices can make your business seem aloof and out of touch, while low prices can make good products seem to be of poorer quality than they really are.
Harvard Business Review says that a 1% improvement in a company’s pricing can make an enormous difference to a company’s bottom line.
“For a company with average economics, improving unit volume by 1% yields a 3.3% increase in operating profit, assuming no decrease in price. But, as Exhibit 1 shows, a 1% improvement in price, assuming no loss of volume, increases operating profit by 11.1%,” says McKinsey & Company pricing expert Michael V. Marn in “Managing Price, Gaining Profit” here.
One study by OpenView of over 400 business pricing strategies, revealed that 84% of respondents reported at least a 10% increase in annual recurring revenue (ARR) after a pricing change and even more dramatically, 25% reported an increase of at least 50%.
How do you know if your pricing model is wrong?
It is clear to see that pricing strategies can have a huge impact and that quite often a lot of money is either being left on the table, or deals are missed because of incorrect pricing. But how do you know if your products have been priced badly? Here are a few of the critical signs to look out for if you don’t want to become a victim of your models.
- You aren’t covering costs
The most obvious sign you have not priced your product correctly is a simple one. You are struggling to make costs. If you have a significant sales book and are still struggling to make ends meet the chances are your pricing model is wrong.
Pricing needs to take into account all expenses and then add a profit on top of that. Making sure you include all your costs in this expense calculation is critical to being able to build a thriving business. While most people will remember to include staff costs, advertising, property costs and the cost of raw goods, there are numerous other costs that must not be forgotten such as licensing costs, shrinkage, employee discounts and seasonal fluctuations in raw product costs. If you are struggling to realise your true financial situation approaching your accountant will be absolutely key to your efforts going forward.
- Pricing by competitor
When it comes time to price your product you should be aware of what your competitor is charging, but do not let it be the be-all and end-all. What happens if you are copying them, and they are pricing themselves out of the market? Work out what your costs are, what a fair profit is and stick to that. Remember, if there is a price difference it may come down to you adding extra value, having a better-quality product or going to places they can’t service. You need to be true to your own unique situation if you want to be sure your prices aren’t going to land you in hot water.
- You don’t know the value of your product
Value and price are two different things. You may know every inch of your product and understand why it’s better than the competitors, but that’s useless if you don’t know what your product is worth in cold hard cash to your customers. If you build an amazing product that’s best in its class but it can only save the customer R100 a month, you are going to struggle to sell that product for R10 000. Likewise, if your product saves a customer R25 000 a month, why are you selling it to them at R1 000? Under-pricing on that scale can lead to the customer mistakenly believing that your product won’t do what you say it will or thinking it’s likely poor quality. Understanding the value your product brings to the consumers goes a long way to knowing exactly what you can charge for it.
- What do you want from sales?
Immediate profit may be only one of the reasons why you price a product low. Initially, your aim may be to claim market share and as such you price your product competitively to ensure you can grab a stake in a tough industry, before moving the pricing to better reflect your costs and profits. Perhaps you need a certain amount of market share to reach economies of scale in which case your current low price may be justified? Or perhaps you benefit from a network effect in which the value of your product increases with the more people that use it? The point here is that you need to understand your motivation for pricing before you can price accurately. If you don’t, then your pricing is probably inaccurate.
- Can you predict the future?
The best business leaders can sometimes seem like clairvoyants who can see into the future. If you understand where your industry is headed and what challenges it may face in the future you will be better able to position your product. Depending on your industry these factors can include changing energy needs, climate considerations, weather patterns or general lifestyle changes. Understanding these challenges will help you foresee which of your products may be likely to lose money in the future and which may grow in demand allowing you to adjust the prices to match. The more intelligence you have on the factors that affect your industry the more you will be capable of weathering any challenges and selling your products.
- You rely on cost-plus pricing
If your business relies on cost-plus pricing, in which the selling price is determined simply by adding a specific fixed percentage to the product’s unit cost, then chances are you are leaving cash on the table. Even a simple corner store owner can make more money from milk if he is the only one in the suburb that sells it. Being aware of your market and your customer’s needs and demands will ensure you take advantage of your strengths to maximise profit.
According to Bain & Company there are three main behaviours in pricing that pinpoint the top achieving businesses. Those companies that make the most profit do so by:
- Aggressively “employing tailored pricing at an individual customer and product level,”
- “Aligning incentives for frontline sales staff with the pricing strategy” and
- “Investing in ongoing development of sales and pricing teams through the use of training and tools.”
What is clear is that in this space there is no call for cost-plus pricing.
The savvy business owner does not leave their pricing to chance. The rands and cents that you let leak away through missed deals or profits not taken could one day be the difference between a booming organisation and bankruptcy.
Disclaimer: The information provided herein should not be used or relied on as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your professional adviser for specific and detailed advice.