7 Fundamental Rules of a Profitable Pricing Strategy

July 14, 2016

Pricing plays a huge part in profit growth. After all, once you get your customers to pay more, you have more left over in your pocket.


If only it were that simple.


Pricing strategy has gotten so complicated that enterprise-level businesses have hundreds of professionals focused solely on identifying the perfect price for each transaction.


Fortunately, small to mid-size companies can maneuver their businesses into a profitable position by just following the fundamentals. You can start with these seven basic rules of a profitable pricing strategy.


1. Avoid the Tired Cost-Plus Pricing Formula


Many companies take the easy way out with a cost-plus pricing formula. They have a baseline cost, add a certain percentage to it, and voila! They have their final price. It’s simple, drives short-term profit, is easy to explain to customers, and takes very little time to implement.


But it’s a major pricing strategy mistake. It completely devalues your business and its services. It ignores specific customer needs. This archaic and formulaic approach alienates customers and makes it impossible to increase prices in the future.


Instead, focus on value when building your pricing strategy.


2. Understand and Leverage What Your Customers Value


Your offering is not a commodity. It doesn’t matter what you sell. You should never believe it’s a commodity. If you do, your ability to sell on value is lost. Once that’s lost, your ability to turn a profit is also lost.


Work with customers to determine why they choose to do business with your company. Is it your high-quality products, your superb customer support, or your always-on-time delivery? Identify these value propositions, and then make them the cornerstone rationalizations for your pricing strategy.


Once you can articulate and quantify value increases, you have a much stronger foundation for asking for a proportional price increase and defending your existing pricing in the face of competitive pressures.


Your sales and account management teams shouldn’t emphasize value only during deal negotiations and price conversations, though. They should sell value constantly, emphasizing it at least once in every conversation. This puts customers in a value, not cost, mindset. Their appreciation for your unique offering grows, and their reluctance to pay for these perks wanes.


3. Implement Price Increases Slowly


Your team can’t just wake up one morning and decide it’s time for a price increase. Launching a successful price change takes months of planning and research. Companies should start thinking about their next price increase as soon as they implement a new one.


First, they must start with research at least six months to a year out. This is crucial to a successful increase. Unfortunately, McKinsey estimates fewer than 15% of companies commit to pricing research. Give yourself a leg up on the competition by studying up beforehand.


Then identify which products and customer segments are ripe for an increase. A good place to start is with accounts and products requiring few, if any, price negotiations. If your current prices are going through with little resistance, it’s a sign you could increase them. During this time, focus on adding more value propositions to your offering. These additions justify higher pricing.


If you feel ready to move forward, it’s time to test your most loyal customer segments with an increase. Pay close attention to their reaction. If they barely bat an eyelash, it’s time to move forward with a full launch. If they do balk, emphasize value you’ve added throughout the year. If your most loyal customers still resist, it may be time to go back to the drawing board for a different pricing strategy.


But make sure you give your existing customers time to react and plan for the increase. They have their own budgets to handle, and you don’t want to catch them off guard. Prioritize transparency.


4. Slow and Steady Wins the Race


Everyone wants big margins, so they often go for big price increases. It’s a dangerous and often unnecessary pricing move. Many businesses run into problems with it.


Instead, focus on small, incremental price increases. After all, according to Harvard Business Review, a 1% price improvement results in an 11% profit improvement.


You could increase your prices 3% every three years, or you could increase your prices 1% every year. To which strategy do you think your customers will respond best? A minor but well-planned price increase results in major margin growth for your business. Take small steps in pricing to keep customers on board and engaged.


5. Segment Your Way to Pricing Success


Your customers, product lines, and market areas are all different. They should have equally unique prices to achieve their maximum profitability.


Some companies seeking simplicity within their pricing strategy apply a “peanut butter” approach. This applies the same pricing to all customers or all products. It’s easy, but it rarely works. Businesses often end up falling short of their margin potential by neglecting to set higher prices for some customers as well as losing customers who seek a lower price.


Some companies customize pricing by customers but not by buying situations. This strategy still falls short, because every customer values every buying situation in a unique way.


Planning prices customer by customer, product by product, and by buying situation requires much more effort but it also returns much larger long-term margins. Segment your prices as narrowly as possible to maximize your revenue and build customer loyalty with personalized deals.


6. Discount Responsibly


Some businesses put all of their energy into identifying and launching profitable pricing strategies only to shoot themselves in the foot later with terrible discounts. According to research from Vantage Partners, almost 60% of companies reduce pricing for half of their deals. 25% of companies include price cuts on almost all of their deals.


Why work so hard to find your most profitable target prices if you’re just going lower it during deal negotiations?


Massive discounts damage more than margins too. They put customers in the driver seat on pricing strategy, minimize possibilities for future price increases, and can even trigger price wars if they get completely out of control.


Motivate your sales teams to avoid discounts by adding target price achievement to their incentive programs. Build an incentive formula that measures how close your sales reps close deals to target prices. Price-focused incentives keep unprofitable discounts at bay. They train sales reps to sell on value and convince customers your company’s products are worth more than the market-assigned cost.


Put alerts in place that catch deals with unprofitable discounts before the customer signs on the dotted line.


7. Analyze, Adjust, Repeat


The best way to build a successful pricing strategy is to keep a close eye on it and its effects on margins. Then tweak prices as needed to increase success and profitability in the long run.


Closely monitoring pricing performance helps teams understand the intricate details of pricing challenges, successes, failures, and opportunities. It promotes early corrective action and minimizes unprofitable strategies.


Measuring price increases can get difficult. You must review actual price achieved, customer by customer and product by product. You have to look past discounts, rebates, and customer mix. This effort requires powerful yet intuitive analytics. Your teams must strive for ongoing evaluation and optimization, though, if you want to develop a successful pricing culture for your company.


Profitable pricing starts with a commitment to both thoughtful planning and powerful sales data analytics. Learn more about how to sustainably grow margins with better pricing practices in this white paper titled “A Complete Guide to Managing Your Pricing Strategy.”

Business & Finance Articles on Business 2 Community

(17)