Pricing on Purpose. How to Price for Value & Profit?

Successful companies develop and adopt pricing structures that communicate their value proposition. Chances are, most of your customers aren’t price-sensitive as much as they are value-conscious.  You can positively impact the company’s bottom line and increase market share with the right pricing strategy. 

A recent survey conducted by Bain and Company revealed that most CEOs and small business owners do not have a formal methodology when it comes to pricing their products and services, nor do they have a rational  process for communicating a price increase to existing customers.

• Most companies declare  pricing to be a high priority, but 85% say they have significant room for improvement in pricing.

• Most confirm that product cost drives product pricing.

• Top-performing companies behave differently. They tailor pricing at the transaction level, align sales incentives with pricing strategy, and invest more heavily in ongoing training and tools.

With significant margin upside at stake, companies cannot afford to continue pricing by guesswork or by playing follow the leader. This graphic illustrates the methodology and gains from a formulated pricing strategy:

Mistake #1: Setting price based on costs of goods, not 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.

Costs are only relevant in the pricing process because they establish a lower boundary for the price. When a price is set according to the perceived value of the product or service, sales are brisk, and profits are maximized.  Have you effectively communicated the value of your products and services to the market?

Mistake #2: Failing to segment your customers.

Customer segments are differentiated by the customers’ different requirements for your product . The value proposition for any product or service varies in different market segments, and price strategy must reflect that difference. Your price strategy should include options that tailor your product , packaging , delivery options , marketing message and your pricing structure to particular customer segments in order to capture the additional value created for these segments. It takes research and diligence to clearly define, communicate, and price multiple offerings instead of adopting a single-price model. There are many benefits to extending price differentials to particular consumers. Depending on the product or service you offer, you can be strategic with how you apply customization based on different dimensions.

Mistake #3: Pricing based on the competition.

When you compete on price, it’s extremely difficult to provide exceptional customer service and a quality product – in turn damaging the perception of your products or services in the eyes of consumers. Competitive pricing basically means setting your prices at the same (equivalent/parity pricing), slightly higher or slightly lower than your competitors. Your pricing team will set an initial item price by examining a competitor’s or group of competitors’ prices – this process is known as competition based pricing. Competing on price alone  will not sustain profitability for the long- term. Instead, focus on providing consistent value, and you will be able to increase your prices even while increasing demand.

Mistake #4: Lacking the understanding of true costs.

One of the ways to set the price for your products or services is to use a simple formula, i.e. cost of the product plus profit margin equals the price. However, even if your cost calculation is correct and you build in a healthy profit margin, you might still get the pricing wrong. Make sure you include all costs- fixed and variable, that include, the costs directly tied to the product (materials, time, manufacturing cost, etc.), marketing costs, and the costs of running your business (overhead component).

Mistake #5: Avoiding a price increase based on fear.

Maintaining the same price level to avoid a negative customer reaction could hurt your bottom line and is probably not practical, since for most businesses costs to manufacture or produce will increase over time. Increasing prices involves some risk, but if you handle things carefully you can avoid upsetting customers, while improving your margins.

Make sure you communicate clearly why you are raising prices. Is it simply to make more money or is it because your costs have increased? Often, increasing the price point establishes you as the quality leader in your industry.

Existing customers who recognize the value in your products and services will most likely still stay with you, even in the face of a reasonable price increase.

These mistakes may not be new to you, but it’s a great reminder to constantly focus on providing value to your customers. Continuously monitor your prices and your underlying profitability on a monthly basis.

Focus on the profitability (or lack of profitability) of every product you sell. If you’re looking for ways to improve profitability and efficiency, a strategic approach to your pricing model is a perfect starting point.

Source: 1. Bain and Company https://www.bain.com/insights/is-pricing-killing-your- profits

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