It may sound like hyperbole, but because it directly impacts both the top and bottom lines, pricing will invariably make or break a business. Yet despite its importance as a growth lever many businesses continue to overlook the importance of a well-thought-out pricing strategy.
Whether it is because of resource constraints or lack of dedicated pricing management, ignoring pricing can have serious repercussions on a business’s financial health, market share, sales performance, and customer relationships.
A robust pricing strategy requires solid research, careful analysis, testing, and adjustment. Here are five compelling reasons why you should take pricing strategy seriously.
1. Top off your revenues and profits
Price is directly correlated to your top line bottom line simply because revenue = price🞨quantity, and profit = revenue – cost. In fact, even incrementally increasing your price provides a much higher ROI on your margins than cutting costs (that often entails a whole lot of scarce time and resources, technology investments, and risk from loss of skilled employees and low morale among those who stay).
Multiple studies have shown that a 1% price increase can result in an 8% to 20% increase in operating profits, depending on the industry and the cost structure and assuming no loss of volume (see discussion below on price elasticity).
2. Maximize your monetization
A fraud-prevention software client sold licenses per user. However, similar-sized customers derived very different value from the software. One customer with 25 licenses saved $2.2 million. Another with 25 licenses saved $5.8 million. The per-user model was clearly suboptimal.
A price model is made up of a price metric (i.e., price per license, price per user, etc.), price level (i.e., the dollar value), upcharges (e.g., value-added features and services, response time, etc.) and discounts (e.g., based on volume, length of contract, customer attributes such as loyalty, and cross-sell or product bundles).
A cost-plus price model covers costs and then some to attain an (often) arbitrarily set margin goal. This setup is is rarely optimal because it fails to capture what the customer is actually willing to pay (which may be significantly more). A carefully developed and well-implemented value-based price model (see below) on the other hand ensures no revenue dollar is left on the table.
3. Sell on value, not price
To be successful, your product’s price must reflect its value, perception, and positioning in the market. An inferior product at a high price is unlikely to sell much. Conversely, a superior product at an unexpectedly low price confuses customers and makes them question its quality. While doing customer research for a manufacturing client, one of their customers summed it up, “I need a product that does what I need. If it’s more expensive I will still buy it. I’ve tried cheaper ones and it’s very much you get what you pay for.”
A price based on your perceived value (called “value-based” pricing) means your sales conversations focus on the incredible things your products can do for your customers and prospects. Which means price takes a backseat. As do unnecessary discounts.
4. Increase your price with confidence
We often work with clients who, fearing a tide of customer churn, have barely or never changed their prices in years, only for us to discover that their customers are happy to pay as much as 20% to 40% more.
Price elasticity measures how customers will react to a price increase or decrease. Will they continue with their current consumption, or will they buy fewer units? How likely are they to switch to a competitor?
Understanding and quantifying price elasticity gives you the assurance to increase your prices on a regular basis. It can also help predict customer behavior and improve your financial impact forecasting from proposed price changes.
Price elasticity is also an important indicator for investors. As Warren Buffett once put it, “The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”
5. Plug revenue leaks
Here’s a thought experiment. Think of two similar customers located in the same geographic region. They buy from you roughly the same volume across the same products, give you the same amount of business in a year, have been with you for a similar number of years, etc.
How confident are you that both customers get the same unit price? If you are absolutely certain, you are part of a rare and rarefied minority; the prize is yours. For those shrugging your shoulders, all is not lost. In fact you have only revenue to gain.
Of the two customers, the one who got away with the lower price created what we call revenue leakage. Think of it as a missed opportunity that can yet be realized.
A solid pricing strategy proactively prevents revenue leakage by properly structuring discounting policies. It provides the necessary pricing implementation guidance and a price monitoring and governance framework to prevent unauthorized or ad hoc discounts that erode both your top and bottom lines.
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There are of course, many other reasons why pricing must never be an afterthought. For example, when entering a new market or launching a new product, pricing should be a key consideration. And, if you have customer relationships that span years, the price you set today can significantly influence the customer lifetime value (CLV).
A well-constructed pricing strategy therefore not only helps with customer acquisition but also in retaining them for the long term, thereby maximizing CLV.