The top 10 most common pricing mistakes
The vast majority of companies have spent years achieving gains through cost cutting, outsourcing, process reengineering and the adoption of innovative technologies.
However, the incremental benefits from these important activities are diminishing and companies are looking at other areas to improve their business results.
So is it now time to revaluate your pricing policies during tough times?
Recently I spoke to Dennis Brown, a partner at California-based Atenga Inc., one of the leading pricing authorities to commercial and industrial companies worldwide.
The company has resources and processes to improve clients’ profits by optimizing prices and improving price performance. Atenga’s most surprising finding has been how often price optimization can raise prices and improves sales volumes at the same time.
When I asked Dennis about price strategy, he said, “It is emerging as the most important resource for companies to increase their competitive advantage.”
Brown believes that companies are looking to serve well-defined market segments with specialized products, messages, product variants and services – and earn superior profit margins while doing so.
Savvy companies are implementing price optimization schemes and focusing on building their organizations to serve their most profitable customers. Many are seeing improvements by even “firing” customers who are unprofitable.
All too many companies, however, use simplistic pricing processes and some cannot even identify their most profitable products, product lines, customers or customer segments. This lack of information means too many management teams have their sales staff focusing the bulk of their time servicing the least profitable of their customers.
Some companies even embrace policies and pricing strategies that drive away their best customers and then wonder why their profits are not growing.
Over the years, Brown has seen examples of good and bad pricing policies. The following is a list of 10 of the most common mistakes companies make when pricing their products and services.
1. Basing prices on costs, not customers’ perceptions of value. Pricing based on costs invariably leads to prices that are too high or – more often — too low.
2. Basing prices on “the marketplace.” Management teams must find ways to differentiate their products or services to create additional value for specific market segments.
3. Attempting to achieve the same profit margin across different product lines. For any single product, profit is optimized when the price reflects the customer’s willingness to pay.
4. Failing to segment customers. The value proposition for any product or service varies in different market segments and price strategy should reflect that difference.
5. Holding prices at the same level for too long, ignoring changes in costs, competitive environment and customers’ preferences. Most companies fear the uproar of a price change and put it off too long. Savvy companies acclimate their customers and their sales forces to frequent price changes.
6. Incentivizing salespeople on revenue generated, rather than on profits. Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price.
7. Changing prices without forecasting competitors’ reactions. Smart companies know enough about their competitors to predict their reactions and prepare for them.
8. Using insufficient resources to manage pricing practices. Cost, sales volume and price are the three basic variables that drive profit.
9. Failing to establish internal procedures to optimize prices. The hastily called “price meeting” has become a regular occurrence, a last-minute meeting to set the final price for a new product or service.
10. Spending a disproportionate amount of time serving your least profitable customers. Most companies do not know who their most profitable customers are. Know your customers: 80% of a company’s profits generally come from 20% of its customers. Failure to identify and focus on the 20% leaves companies undefended against wily competitors.
Brown thinks that one other big mistake is that “companies rely on salespeople and other customer-facing staff for intelligence about the value perceptions of their customers. Such people are an uncertain source, because their information gathering methodology is usually haphazard, and the information obtained thereby can be purely anecdotal.”
Such information is neither precise nor quantifiable. A customer will rarely tell the “complete truth” to a salesperson, so any information the customer may volunteer will be biased — often to get the company to lower its prices.
Salespeople can readily identify those anecdotes that advance their interests, e.g., lower prices lead to higher sales, regardless of profitability, and those that operate against them.
Savvy companies employ trained professionals to collect and analyze the data to identify and evaluate the value perceptions of their marketplace.
Large companies have entire departments doing this full-time; smaller companies may outsource it to a specialist, such as Atenga.
Mark Borkowski is president of Toronto based Mercantile Mergers & Acquisitions Corp. Mercantile specializes in the sale of mid market companies.