Can You Take a Price Increase?

 

Pricing is a traditionally gutsy process and often a responsibility carelessly left in the hands of field sales representatives. In order to move toward their revenue or volume quotas, salespeople will mercilessly cut profit out of a sale if they read the buyer to be hesitant about closing on the deal.

Smart marketers, though, know that market share, gross revenues, and volume of goods sold matter less than profits generated — and taking price down does not necessarily increase volume sold. In BP Petrochemicals' pursuit of market share, it assumed profits would follow an increase in market penetration. Instead, margins fell by as much as 25%. There's no increased profit there. So BP and many other companies have started on the path to eliminating the uncertainty inherent in their pricing strategies.

The benefits to be had can bring on a blush of regret that pricing didn't emerge as a priority sooner. McKinsey research has revealed that a 1% improvement in pricing (a price increase) results in an average 7.8% improvement in profit. For every 1% improvement in volume sold, there is a 2.5% increase in profit. In other words, pricing improvements are more than three times as profitable as volume increases. But cost-plus pricing, the common approach to one of the vital Ps of marketing, focuses on recouping the costs expended on a product or service's development and manufacture and snagging a little extra for the bottom line.

Cost-based pricing thrives because sellers are more certain about their costs than demand, and if everyone abides by the practice, there is less price competition in the marketplace. This approach, however, strips away all competitive positioning. Competitive-based pricing effectively does the same. If Company A prices based on the going rate, based on what it thinks Company B will price, or consistently X% above or below Company B, all hope for marketing effectiveness, no matter what the plan, is lost.

In many industries, the little extra added to the cost to determine retail or list price, also affectionately known as the profit margin, is determined by guesswork, whim, or desire, without a business objective-related footing. It's time to change this. According to Accenture and pricing software vendor Vendavo, improved strategic pricing and policies yield a 1- to 2-point improvement in profit margin; smarter deal making, one deal at a time, delivers another 1- to 2-point margin improvement; and the elimination of errors in pricing communication accounts for a ½- to 1-point margin uptick.

Profit expectations and achievements should be paramount to corporate strategy. And because marketing creates brand positioning, it has a vested interest in seeing that the benefits customers receive in using the products or services sold are reflected in their prices. Marketing, therefore, should have a big beef with cost-plus pricing because it suggests that customers should value the brands they buy for the manufacturers' costs, not the convenience or ease-of-use the product delivers, not the unique features it offers, and not the special services bundled with the product that make it the superior choice in a commoditized marketplace.

One danger of cost-plus pricing is that it ignores customer segments and buying behaviors, potentially missing profitable opportunities. Marketing and sales tactics that accompany cost-plus pricing tend to apply resources generically across the customer population, not deploying them to support specific segments. There are no segmented offers to brag about — higher prices for segments that view the product as a value advantage and lower prices (as well as fewer marketing funds) for segments that view the product as a commodity. Of course, as the market changes and your company advances its marketing sophistication, it creates more compelling reasons to move even the commodity buyers to a value-based purchase.

Different customer segments, however, engage in different price negotiations. You can't stop short with better segmentation and segment-sensitive list pricing, nor is optimization based on price elasticity the answer because it keeps the focus on volume, not profit. Especially when the sales staff receives compensation based on volume/units sold, the final ticket price may vary dramatically customer to customer, salesperson to salesperson. One algorithm-free pricing tool displays all of the discounts and other costs of a sale in one view to define the true price, thus the true profit. This model goes by the moniker Pocket Price Waterfall because it defines what a company puts in its pocket at the end of a sale.

The Pocket Price Waterfall effectively enables simulation — "what-if" analysis of historical pricing as well as development of modern-day pricing scenarios — and optimization. If you know each component of your waterfall, you can negotiate price on each, and consistent negotiations will lead to quicker turnaround of bids and ultimately greater volume.

Margin leakage comes from disjointed functions affecting pocket price or pricing treated primarily as a finance or accounting element. In optimization, you combine supply and demand data with capacity and enterprise resource planning data with a customer lifecycle evaluation to manage pricing. This and other techniques become part of pricing policy and the flow of many organizational inputs.

Price and margin management are picking up speed as self-tuning algorithmic technology takes off, yes, but also as the U.S. economy seems to be making a comeback. And companies have begun product stacking through price measurement, studying how pricing of one product in a line affects consumption or sales of other products in the line. This takes optimization to a new level.

Pricing improvement, like any other striving for marketing accountability, is an ongoing process that requires very deliberate evaluation. Price is a powerful lever to pull for more effective customer response and value, and pricing policies that incorporate company goals need to be tracked for their performance toward their commitments.