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 prices after reviewing loads of market research on market share, competition, consumer behavior, focus groups and brand strategies.
But many business-to-business companies still use the old “cost plus” method. They’ll take their wholesale cost, add a flat percentage and viola – the price.
Unfortunately, this strategy could leave substantial revenue on the table. Under this model, your profit margin is always the same, even when customers are willing to pay more. There’s no reward for lowering your costs and you miss the opportunity for earnings growth.
Donald Washkewicz, the CEO of Parker Hannifin Corp., found himself in this rut in 2001. Tuesday’s Wall Street Journal (page 1) chronicles how he changed his company’s pricing strategy and boosted operating income by $200 million since 2002.
Parker Hannifin is a $9 billion, 89 year-old industrial parts manufacturer headquartered in Cleveland. And while Mr. Washkewicz knew they needed to re-price their products, they have 800,000 of them — no easy feat.
They started by grouping their products into five categories that reflected the level of differentiation and value those products provided to the market.
Once they’d grouped their products, they adjusted their prices for each category:
|Product category||Explanation||Price adjustment|
|1. Core products||Commodity-type products in a highly competitive market||Aligned prices with market. Changes were -3% to +5%.|
|2. Partially differentiated group A||Some differentiation adds value for customer||Increased prices up to 5%|
|3. Partially differentiated group B||Niche products with no exact competitive matches||Increased up to 9%|
|4. Differentiated products or systems||Highly engineered solutions||Increased up to 25%|
|5. Specials and classics||Custom-designed products or one-of-a-kinds||Increased over 25%|
It was a massive undertaking but well worth it – an additional $200 million in operating income and a jump in the company’s return on invested capital from 7% in 2002 to 21% in 2006.
This story is a tremendous example of how to move away from formulaic pricing. Even if you only have 8 or 800 products, a strategic pricing adjustment can help you capture revenue that you’re leaving on the table.
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