Your Highest Leverage Strategy for Boosting Bottom-Line Performance
There’s no escaping it: pricing is one of the most important aspects of any business. Get it wrong and you can find yourself out of business.
But get it right, and you can achieve a step-change in profitability, generating the free cash-flow needed to turbo-charge your growth.
Pricing is the single-most important driver of profitability for most businesses. We have seen clients drive massive value from a couple of simple changes to their pricing structure.
But what is the right price? And how do you set your own pricing strategy?
The Pricing Success Formula is the culmination of 20 years’ of working with clients on pricing optimisation. Our comprehensive pricing methodology goes beyond the demand curve, combining multiple pricing disciplines and customer research techniques.
Our clients have boosted margins and customer profitability, without suffering the decline in volume and overall revenue that can come from headline price changes.
Why Price Strategy Matters
Pricing is the single most important lever you have. But don’t just take our work for it. A seminal article in the Harvard Business Review compared the impact on profit of a 1% improvement in a range of key business drivers.
For a company with average economics, improving unit volume by 1% yields a 3.3% increase in operating profit. But a 1% improvement in price goes straight to the bottom line, and increases operating profit by 11.1%.
What Do We Even Mean by Price?
When people think about price, their immediate reaction is to think of the headline rate that they are paying for a particular product or service. But for many businesses, the pricing structure is far more complex than this, as you can see.
An effective price structure is the optimal combination of each of these pricing components to maximise revenue.
Not every component will be relevant for every business. But the chances are, if you are purely focused on the headline rate, you are leaving plenty of margin on the table.
When done well, pricing structure can be an incredibly powerful tool. The US airline industry, for example, went from a position of losing money in aggregate to becoming profitable again almost entirely on the back of adding check-in fees for a second bag.
How Do You Work Out The Optimal Price
When setting a price structure, there’s a few key things you should do to ensure it’s set optimally.
Research the market
Having good intel into competitor pricing (and how they structure prices) is key.
Is your pricing in line with other players? If not, does the difference reflect underlying differences in the product or service?
Do competitors offer ancillary products or services, or incorporate other elements of the pricing structure that you are missing?
Understand your customers
An in-depth understanding of your own customers is also very important. You need to know what aspects of the product or service matter to them, and how important price is in their consideration.
The more you learn about their behaviour and attitudes, the easier it is to identify cross- or up-sell opportunities that might work.
Reviewing their responses to previous price changes can also give you insights into their level of price sensitivity.
For most businesses, their customers are not all identical. Often, you will need to segment your customers into different groups based on relevant factors (e.g. demographics, attitudes, price sensitivity). This may reveal additional pricing opportunities that can be targeted to specific segments.
Analyse past sales
Another way to identify cross- or up-sell opportunities is to review historical spending patterns. In particular, you should be looking out for products / services that have been purchased in the past.
Are there additional opportunities to promote these cross / up-sells to customers? Are their product bundling (or un-bundling) opportunities that might work given past spending patterns.
Most businesses these days have a lot of data on past sales, and kn0wing the right questions to ask can reveal many opportunities to increase transaction value and customer profitability.
Understand product / service profitability
Before making any pricing decisions, you need to be able to work out the likely impact on your overall profitability.
This depends on (at least) two factors.
- The unit economics of the product (or service), and the impact that changing the price has on these unit economics. Because profit is the residual once all costs have been deducted, a change in price can have a substantial impact on the unit economics.
- The expected response to a change a price (the elasticity of demand). You need to determine whether the likely change in the volume of sales outweighs any benefit from improved unit economics. For example, doubling the price might make the gross margin of a product extremely attractive, but overall you could be a lot worse off if demand collapses.
Ideally, you want to making price changes that improve unit economics without triggering a big volume response.
This is where a full understanding of the possible components of the pricing structure is so helpful. For example, it is common for headline price changes to be a lot more noticeable than changes to other elements of the pricing structure.
Develop a price execution plan
Once you’ve developed your price strategy, you need to have a plan to make sure that everything goes smoothly.
Depending on your business, this might involve all or some of the following elements:
- Legal review of customer contracts (if applicable) to assess timing of price changes
- Updating price lists, websites, any other material where price is shown
- Updating pricing systems used for invoicing and accounts
- Updating internal training materials and training customer-facing staff on new price structures and reasons for changes
- Developing communications plans to notify customers (if necessary)
Communicate the price change
Once the plan is in place, you can then notify customers if you need to. This may not always be necessary. It will depend on the nature of your business and customer expectations. But it may be necessary for many B2B businesses, or consumer businesses that rely on recurring regular payments from repeat customers.
Where you are communicating price changes, it is important to be up-front and honest about the price changes, why they have been made, and what it means for customers.
Implement and track the price change
Finally, having done all the hard work, you can implement the plan. Provided you have done the ground-work, and understand your customers, it should go smoothly, and lead to increase margins and overall profit.
But there is always some risk in changing prices. You can manage that risk effectively in most cases by following a disciplined approach to pricing strategy, but tracking is still important.
You need to track the outcome of a price change, especially in the initial stages. It may be that some customer segments are more sensitive than you assumed, or there have been other unanticipated impacts on cross- or up-sales. Tracking allows you to course-correct as required before any real financial damage is done.
Pricing Strategy Blueprint
Boosting margins and revenue through a Pricing Strategy review can be much easier than you think. Many people simply don’t know the correct steps or complete range of factors to take into account. This makes them take far longer than they need to.
We’ve done all the hard work for you, so all you need to do is follow our step-by-step Pricing Success Blueprint and you’ll see increased profitability in no time.
You won’t just save time either. When you follow our advice closely, you are also much more likely to get the benefits of increased customer revenue without the risks that come with pricing changes than you would ever be able to achieve on your own.
For more information, and to arrange a free 30-minute strategy session to review opportunities for your specific business, please use this link to schedule a consultation.
Pricing Strategy Recap
Pricing strategy sets out the pricing approach within a business, and how this is used to determine specific prices for products and services. The pricing strategy takes into account the demand characteristics in the market, as well as the costs of production. Given the demand characteristics (i.e. customer demand curves and competitor prices), the pricing strategy considers how pricing will affect demand and what price points will maximize profit.
Pricing strategy should also take into account any discounts or other incentives that impact the price level, as well as potential cross- and up-sell opportunities to increase transaction value.
Pricing strategies can have a significant impact on your business, so it is important to choose the right pricing strategy for your products and services. Consider your target market, the level of competition in your industry, and your production costs when making pricing decisions.
There are four main pricing strategies that businesses can use:
Cost-plus pricing is when you add the cost of making the product plus some extra money to make a profit. This pricing strategy is often used by businesses that want to make sure they are making a profit on their products. Cost-plus pricing is used in industries with high costs of production that can vary significantly, for example construction, manufacturing, and engineering.
Competition-based pricing is when you set a price for your product based on what other companies are selling their products for. You want to make sure that your product is priced lower than the competition, but not so low that you are not making any money.
This pricing strategy is often used in markets where there are many substitutes and buyers have a low level of disposable income.
Penetration pricing is when you set a low price to get more people to buy your product. The pricing strategy is used to increase market share and reach a point where you can charge more. The low price may not cover the costs of production, but it will help you gain market share quickly.
This pricing strategy is often used by businesses when they are first starting out, or when they are introducing a new product to the market. For example, when Uber first started, they used penetration pricing to get people to try their service.
Value-based pricing is when you set a price for your product based on the perceived value of the product by customers. You want to make sure that the price you set is in line with the perceived value of your product.
This pricing strategy is often used for products that are unique or have a high level of customer satisfaction, for example, luxury goods, pharmaceuticals, and other specialty products.
To develop an effective price strategy, you need to do the following:
- Research the market – how does your pricing compare with competitors? Do they price on the same basis?
- Understand your customers – What do they value? How price sensitive are they? What other products / services do they need that could be ancillary revenue opportunities
- Analyse past sales data – what products / services are typically sold together and could be cross- or up-sell opportunities
- Understand the product / service unit economics – What is the cost structure? How much do you need to charge to cover your costs (both variable and overhead)? What is the impact on the unit economics of a change in the price?
- Understand the overall impact of price on your profitability – How are customers likely to respond to a change in price? Will the change in volume outweigh the impact of the price change on the unit economics?
- Develop a price execution plan – You need to set out all the things that need to be done, both internally and externally, to ensure that the price change goes smoothly
- Track the impact of price changes – Not everything goes to plan. Make sure you pick up on any early signs that customers are not responding the way you expected. Make adjustments as necessary, and incorporate into your learning for the next price change
Firstly, decide whether you need to communicate a price change. Not every change to the price structure requires proactive customer communication. It really depends on the nature of your industry. Generally, B2C businesses with customers on recurring billing arrangements will need to explain changes in price or any terms and conditions. B2B businesses with large customer contracts will also need to be proactive in explaining price changes.
If you are communicating a price increase, it is important to be transparent and explain why prices are going up. Customers are more likely to understand and accept a price increase if they know that it is due to increased costs or improved quality. You should also let your customers know what steps you are taking to minimize the impact of the price increase.
If you are communicating a price decrease, be sure to highlight the benefits of the lower prices. Customers will be more likely to take advantage of the lower prices if they understand how it will save them money.
You should also make sure that your employees are aware of the pricing change so that they can answer any questions that customers may have.
Get the Full Report
This presentation summarises our top tips for businesses about to undertake a cost reduction program. It draws on insights from our Agile Cost Advantage report.
Over the last 20 years, we have supported businesses of all types in undertaking cost reduction programs. In this article, we look back on some of these successful programs, and share some key tips for ensuring the success of your own cost reduction program.
Although cost reduction programs can deliver a powerful mix of financial, strategic, and organisational benefits, the failure rates of these types of programs are very high.
In this article we consider some of the main reasons why cost reduction programs are so difficult to get right.