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.