Stop marking up costs.
The most common mistake in pricing involves setting prices by marking up costs (“I need a 30% margin”). While easy to implement, these cost-plus prices bear no relation to the amount that consumers are willing to pay. As a result, profits are left on the table daily. Parker Hannifin claims that abandoning its practice of setting cost-plus prices helped lift net income from $130 million (2002) to $673 million (2006).
Set prices that capture value. The right way to set prices involves focusing on capturing the value that customers place on a product by “thinking like a customer.” Customers evaluate a product and its next best alternative(s) and then ask themselves, “Are the extra bells and whistles worth the premium (organic vs. regular) or does the stripped down model make sense (private label vs. brand name). They choose the product that provides the best deal (price and attributes). Manhattan street vendors understand the principle of value-based pricing. The moment that it looks like it will rain, they raise their umbrella prices. This hike has nothing to do with costs, instead it’s all about capturing the increased value that customers place on a safe haven from rain. Convenience stores often charge more for refrigerated 20 ounce bottles of Pepsi (relative to cold 2 liter bottles) because consumers place a higher value on immediately quenching their thirsts.
Understand that customers have different pricing needs. In virtually every facet of business (products, marketing, distribution), companies develop strategies based on the truism that customers differ from each other. However, when it comes to pricing, many companies behave as though their customers are identical by setting just one price for each product. The key to developing a truly effective pricing strategy involves embracing (and profiting from) the fact that customers’ pricing needs differ in three primary ways: pricing plans, product preferences, and product valuations. Pick-a-plan, versioning, and differential pricing tactics serve these customer needs.
Provide pick-a-plan options. Customers are often interested in a product but refrain from purchasing simply because the pricing plan does not work for them. While some want to purchase outright, others may prefer a selling strategy such as rent, lease, prepay, or all-you-can-eat. A pick-a-plan strategy activates these dormant customers. New pricing plans can attract customers by providing ownership options, mitigating uncertain value, offering price assurance, and overcoming financial constraints. Costco’s two part pricing strategy (annual membership fee + product prices) has created a unique model. With Costco’s membership revenues almost equaling its operating profits, members in essence pay for the right to purchase products at its costs. NetJets, a Berkshire Hathaway company, generated strong growth in the private jet industry by offering fractional ownership. Instead of owning an entire jet, lower usage customers can purchase an ownership share and have NetJets take care of the maintenance and staffing.
Offer product versions. One of the best ways to enhance profits and better serve customers is to offer good, better, and best versions. These options allow customers to choose how much to pay for a product. Many gourmet restaurants offer early-bird, regular, and chef-table options. Price sensitive gourmands come for the early-bird specials while well-heeled diners willingly pay an extra $50 to sit at the chef’s table. Ford offers several versions of its Mustang with prices ranging from $21,395 to $51,725.
Implement differential pricing. For any product, some customers are willing to pay more than others. Differential pricing involves offering tactics that identify and offer discounts to price sensitive customers by using hurdles, customer characteristics, selling characteristics, and selling strategy tactics. For example, customers who look out for, cut out, organize, carry, and then redeem coupons are demonstrating (jumping a hurdle) that low prices are important to them. Apple employed the standard differential pricing technique of lowering prices over time by discounting its iPhone from $599 to $99 in two years.
Use pricing tactics to complete your customer puzzle. Companies should think of their potential customer base as a giant jigsaw puzzle. Each new pricing tactic adds another customer segment piece to the puzzle. Normal Normans buy at full price (value-based price), Noncommittal Nancys come for leases (pricing plans), High-end Harrys buy the top-of-the-line (versions), and Discount Davids are added by offering 10% off on Tuesday promotions (differential pricing). Starting with a value-based price, employing pick-a-plan, versioning, and differential pricing tactics adds the pricing related segments necessary to complete a company’s potential customer puzzle.
Since pricing is an underutilized strategy, it is fertile ground for new profits. The beauty of focusing on pricing is that many concepts are straightforward to implement and can start producing profits almost immediately.
What pricing windfall profits can your company start reaping tomorrow morning?