Not many companies would characterize themselves as having an obsession with pricing, and yet pricing represents one of the most attractive and most overlooked opportunities out there to increase profit.
There have been a number of studies over the years that have highlighted the importance of pricing as a key lever in driving profit increase. Large consulting firms such as A.T. Kearney, Boston Consulting, and PwC have published a vast array of data that have indicated pricing as the fastest and the most efficient way to improve your bottom line. Perhaps the most often quoted example, the McKinsey study, found that a 1 per cent price increase, if the demand remained constant, would result in an average of an 11 per cent increase in profits.
The graph below shows that pricing has more leverage than reducing costs or growing sales volume. It is also an area that relatively few companies focus on. Mastering how to set prices can give your company a competitive advantage.
Where Are We Today?
Buyers have become far more knowledgeable about how to extract pricing concessions from sellers; they understand multi-tiered discounts, a myriad of promotion programs ranging from lump sum commitments to per unit discounts, and the concept of using information as leverage.
Attitudinally, most companies struggle with the idea of a price increase based on volume risk. Even maintaining current pricing is a challenge in our hyper-competitive realm of bricks and mortar big box retailers, off-shore competition, and cyberspace-based virtual stores.
Organizationally, the responsibility for pricing can be varied as it is linked to many aspects of the business. This can cause a nightmare scenario in some companies, with one group responsible for setting invoice prices, another team handling allowances and perhaps even a third group managing rebates/ performance based discounts. Lots of numbers, lots of data, little unified focus and/or direction.
How To Set Prices
I wish it were as simple as applying a 1 per cent increase across the board and reaping the 11 per cent gain at the bottom line. As I’m writing this, I’m thinking of the number of times this has been included in the business plan, always with the good intention of coming back and scouring pricing to deliver the bottom line. In my experience, this seldom happens.
Pricing is a large and complex issue for many companies, but there is profit upside to taking a focused approach. I generally think of a four stage process for how to set prices, directed against a key product, category or group.
revolves around data collection, both internally and (often) externally. This stage is meant to not only identify margins at the transaction level, taking into consideration the current pricing structure, but also to gather insights by the channel of distribution and competitive research.
is analytical in nature and is designed to turn big data into knowledge. This stage addresses the concept of leverage. It asks, are there potential pricing opportunities based on a particular brand’s equity? Or is there value in redefining a particular channel?
brings together the learning in a way that allows strategy development.
has a focus on pricing policy, executional guidelines and timeline for implementation.
Control is a theme of the process, both in terms of input and output. Since responsibility for pricing actions, as well as the resultant data, can rest with a number of managers across the company, having some form of centralized leadership and control will be critical to success. Similarly, establishing policy and monitoring execution will also be added to ensure a controlled implementation.
It’s true that pricing represents the fastest way to grow the bottom line. It provides more leverage than reducing costs or growing sales volume does. You’ll need to apply analytical rigor and strategic objectivity to this complex area, but the rewards of a pricing focus will emerge quite quickly.