From the category archives:

Pricing

Will lowering your prices increase profits?

Revenue is down and you need to take action. In a slow economy, it’s reasonable to assume that if you were to lower your prices, you’d sell more and increase revenue and profits. But is this always true?

Maybe, or maybe not.

The untrained business person might feel that this was the best pricing strategy, but Economics 101 tells us that the answer to this question is a definite maybe.

It depends on your demand curve.

If you had the chance to study basic micro economic theory in college (who didn’t?), then you know that the slope of your demand curve tells you how sensitive your market is to price changes.

If your demand curve is perfectly inelastic, customers will purchase the same volume from you at a higher price (and at a lower price). If, on the other hand, it’s perfectly elastic, they’ll buy nothing from you if you raise your price. The reality is that 99.99% of companies fall somewhere in between.

Examples courtesy of Sparknotes.

How can you determine your demand curve without hiring an economist?

Estimate How Your Market Responds to Price Changes

The answer is estimate. If you’re considering a pricing strategy change and you don’t know how your market will respond, survey your market to predict the results.

Select a group of current customers and lost prospects with whom you established a relationship during the sales cycle.

You’re trying to determine how many new units existing customers would purchase, and how many new units current customers would purchase, if you increased and decreased your prices by x% (let’s say 5%, 10% and 20%). Finesse the language of your questions based on your relationships and how you decide to position the survey. Shoot for a statistically significant number, and summarize your results.

You don’t need to plot your results on a supply and demand graph to project your optimal price – the one that delivers the greatest profit – but you can still get a feel for how elastic your demand curve is, which is fancy language for saying how responsive the market is to price changes. If you have an elastic demand curve:

When you raise prices slightly, volume goes down substantially.
When you lower prices a slightly, volume goes up substantially.

Conversely, if your volume stays roughly the same when you increase your prices, you have an inelastic demand curve. This can be very powerful, and it typically results from having a premium brand, solid distribution, few competitors or simply being under-priced.

Multiply price by quantity at each new price to determine your revenue and profit projections. Be sure your projections show greater profit before you decide to lower your prices.

We have a tool that can help, so drop me a note if you’d like a copy.

Why Supply and Demand Are Hard to Measure (freakonomics.blogs.nytimes.com)
More on the state of economics (economist.com)

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In a price war? Raise your prices to increase revenue.

in For CEOs, Pricing

Few companies emerge from a price war better off. What should you do if your competitors start undercutting your prices? A knee-jerk reaction is to lower your prices as well. But for some companies, that’s the exact opposite of the correct move–which is to raise prices.

Terry Irwin of TCii Strategic and Management Consultants understands this well.

First, the details: TCii delivers business strategy development and implementation and strategic and tactical help to multinational conglomerates and small to medium-sized businesses (between 10 to 250 employees). Terry is the CEO and heads TCii’s London office. TCii has offices in and serves clients in Europe, Asia, the Middle East, Africa and Australia.

Next, his client’s challenge:

“Our client had enjoyed healthy growth and repeat business, fitting new flooring into retail outlets and other commercial businesses. However, they then started being undercut by competitors but wanted to avoid getting into the downward spiral of a price war.”

Terry’s team was tasked with devising and implementing a strategy that would maintain existing turnover/profit ratios and generate new business in the medium and long term.

TCii’s Solution

To better understand the market, TCii launched a survey positioned as a vehicle to generate feedback to improve customer service. Terry’s team then assessed and interpreted the results of the survey to identify what the client’s customers saw as the greatest value.

For example, where a customer complimented the client for quality of work and on-time completion, TCii worked with the client to understand the consequence of missing the deadline or working faster with reduced quality. The result? The market viewed their client as a premium offering, far more capable than their competitors trying to initiate the price war.

Did it make sense to drop prices to compete with inferior offerings?

Not at all. TCii developed marketing collateral and sales literature that supported a “premium” brand and focused on the “risk” involved with choosing a competitor who could not guarantee the same quality counsel, craftsmenship or delivery.

This strategy contradicts many people’s natural instincts, and Terry’s client was hesitant. Following the path of any good marketer, Terry and his team created a test using 4 non-critical customers so their client could see the results.

The Outcome

Three of the four customers accepted the price increases without significant comment. The fourth initially resisted, but accepted after negotiation. They then rolled out the higher prices to the entire customer base.

Though a few customers defected to the cheaper competitors, the brand supported the higher prices and the company increased its revenue by 18% that year.

The Takeaway

This strategy won’t work for everyone. If you’re a commodity or only use price to differentiate your offering, raising your prices isn’t a smart move. But many SMBs don’t understand the true value that they deliver to their market, or understand how to capitalize on it.

Take extra care when considering a price increase, especially during price wars or a down economy. Check out the detailed steps Parker Hannifan took before making a price change.

And, here’s an 8 step pricing strategy how-to that will help you decide whether this will work for your company. If you’re a consultant, pickup some tools to help you determine price elasticity.

Or better yet, give Terry a call and let his team of experts handle it!

UK Head Office:
+ 44 (0) 20 7099 2621

info (at) tcii.co.uk.

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Test a new pricing strategy

in Pricing

Our last post about Parker Hannifin’s pricing strategy brought up a lot of great questions from our readers and colleagues.

To recap, Parker Hannifin (a $9 billion company) was struggling with their profit margins, so they modified their pricing strategies.

They grouped their 800,000 products into categories based on their level of differentiation in the market. For their most highly differentiated products with little or no competition, they raised prices substantially. Then they implemented less dramatic increases for more competitive categories. As a result, they generated an additional $200 million in operating income.

Their story offers a great case study on pricing strategy. But the question we’re hearing is “How do I evaluate whether I can truly increase prices without jeopardizing my sales volume and profitability?”

After all, a price increase can be very risky. As we all know, when you increase prices, you should expect a drop in sales volume. But the real question is this: By how much will that volume rise or fall?

For example, if you raise prices 10% and your volume drops 20%, you’re in trouble. But if it only drops 5%, you’ll generate more profit at the higher price point.

The same is true if you’re lowering prices – if your volume increases at a greater rate than your price cut, you’ll generate more profit at the lower price.

So how can you measure this price sensitivity? It’s difficult to calculate accurately unless you have plenty of historical price and volume data and an economist on staff.

However, you can use these eight steps to generate a general estimate and test your new theory before you roll out a new pricing strategy.

1. Know your value proposition. If your pricing strategy and value proposition aren’t aligned, you’re contradicting yourself, confusing the market and limiting your opportunities.

2. Group your products/services into categories: Commodities, partially differentiated, substantially differentiated, custom. And remember that your opinion may be different than that of your target market – while you may view your products as “highly” differentiated, they may think “partially.”

3. Evaluate your competition for each group of products. How do your prices compare to those of your competitors?

For many B2B companies, this step is easier said than done — you’re less likely to find specific pricing info for your competitors. If that’s the case, you can try to “secret shop” your competitors, ask prospects for feedback or just estimate a range.

4. Talk to your sales reps. If they’re very close to their prospects and customers, they may be able to provide solid estimates.

Give them a chart and ask them “If our price was X, how many incremental deals do you think you could have won (or lost)?” Provide 3-5 values for X.

5. Survey your lost prospects and customers. As in the previous step, you’re trying to project the number of deals you could have won or lost at different price levels.

You can have your sales reps contact prospects and customers or you can use an independent third party or formal survey. Your goal is to find out whether they would have bought from you (or whether existing customers would buy more/less) at different price points.

6. Calculate your total estimated profit at each price point. First, calculate your total current profit at your existing price(s).

Units sold * (Price – Cost of Goods Sold) = Total current profit

Then look at your surveys and estimates and calculate the number of additional units you could sell (or lose) over the same time period.

(Existing units sold + incremental units sold) * (New price – Cost of Goods Sold) = Total projected profit

7. Test your theory. If possible, before you implement a company-wide pricing change, set up a statistically valid test to evaluate your new pricing.

8. Develop a communication plan. If you’re raising prices, your sales reps and materials will need to easily overcome any objections they face. Consider giving existing prospects a window of time to buy at the current price. And if you’re lowering prices, it’s a great time to plan a major campaign to announce your news.

Know other good resources, case studies on pricing strategy, price elasticity and/or testing? Add a comment below or send us an email – we’ll share it with our readers.

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Pricing strategy: Capture more revenue

How does your company determine the price of your products and services? Do you try to maximize revenue with prices based on value, or do you use a formula where you add a desired profit margin to your cost?
Consumer product marketers generally try to set prices based on what the market will bear. They’ll define [...]

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How to keep billing mistakes from getting pricey

What would you do if you received a phone bill for two hundred trillion dollars? (Yes, trillion!) As unbelievable as it sounds, it actually happened — Reuben Swartz tells the story in his Dollars and Sense blog.
Yes, mistakes happen. But pricing reflects your brand and invoicing errors can erode it. Think about the mistake from [...]

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