As companies seek ways to grow faster and increase profits, they are finding that some of the strategies they have favored in the past are not as effective as they would like. When companies are focused on cutting costs to meet financial targets for the next quarter, it can have negative consequences for employees and company culture, and it doesn’t usually lead to growth. Although developing new products is important for growth, it is difficult to predict when the next breakthrough innovation will occur. It may take several years for investments in other strategies, such as branding and new distribution channels, to become profitable. However, pricing is a different story and executives are quickly learning that it can be their most effective strategic weapon.
In fact, a recent A.T. A study by Kearney of North America’s largest companies shows that a price increase of one percent leads to a profit increase of more than seven percent. In addition, a one percent price increase is three times as effective as a one percent cost reduction, making the case for increasing prices quite compelling.
Pricing has the advantage of being immediate. The company Wal-Mart responded to not having many shoppers during the holiday season by cutting the prices of popular items. By taking such quick action, it regained lost ground and reported an average same-store sales increase of 4.3 per cent over the previous December. It regained lost ground by taking quick action and reported an average increase of 4.3 percent in same-store sales from the previous December.
Other benefits, however, are just as important. By changing your price structures, you can improve relationships with customers and also get rid of unprofitable customers. This means that a company is more likely to see an increase in profit from a price increase than from a cost reduction.
But there are complications. Pricing is an emotional exercise for a management team. The chief of marketing is concerned that a value increments will cause customers to flock away. The CFO is scared of losing revenue and how complicated it would be to implement a new pricing policy. The CEO believes that losing any customer is bad for business.
To develop a new pricing strategy, you need to understand how customers perceive the value of your product or service, and how much they are willing to pay. Value is a subjective concept that is best described on the surface. It is impossibly vague at worst. The most difficult part of creating a pricing strategy is figuring out what the customer is willing to pay. If the seller does not know the full value their product or service brings to customers, the set price will be inaccurate. The same goes for customers who are unfamiliar with the product or its value. If they’re not given a good reason to invest in the product, they’re not going to buy it.
In order to be successful in value-based pricing, there are three key principles that need to be focused on.
A. The definition of value must come from the perspective of the buyer and not the seller. Many companies make the mistake of overemphasizing the features of their products, when they should instead focus on the hard and soft benefits that their customers perceive. A product that is not part of a larger system is not usually strong enough to be worth the value pricing. Value-based pricing is a pricing strategy where companies charge based on the perceived value of their product or service. This can be done by enhancing products with services or offering flexible financial solutions. Improved products not only generate more customer value, but they are also customized for particular customer groups.
B. The offering’s value must be much better than competing alternatives or else the price will be set by the least knowledgeable competitor or the most pushy. And, in either case, the competitor will undercut you on price, making it hard to compete and effectively destroying the market. If a company cannot differentiate its product or service, it will not be able to use value-based pricing.
C. The company must be certain that it has found all of the ways that it can provide value to the customer, and it must communicate these advantages to the customer in a way that makes sense to them. What would happen if you brainstormed with your senior management team to come up with the highest possible price you could charge for your product? You might be surprised by the sources of value you come up with. The process of understanding your business customers’ models and aspirations, as well as the economics of their processes, can become complicated in business-to-business markets. The company needs to assess how a product or service is going to be beneficial to a customer before it can present that information clearly and accurately.
Pricing Smarter with E-commerce
eCommerce provides companies with new opportunities to test prices, segment customers and respond to changes in supply and demand. I’m sorry that so few companies are taking advantage of the opportunities available to them.
Two very different approaches to pricing—neither optimal—have dominated the sale of goods and services through the Internet. Some start-ups offer very low prices in order to get an advantage over their competitors. This has caused many incumbents to simply transfer their prices from offline to online. Some companies believe that their brand is strong enough that they don’t need to compete on price. Others feel pressure to have an online presence, but are not prepared for the complexities of pricing across multiple channels.
Transparency and efficiency go both ways. It is easy for companies to compare prices on the internet and adjust prices based on customer behavior.
Both approaches cause companies to miss a big opportunity. The Internet enables companies to pricing more accurately than they could offline, and to generate substantial value in the process. Transparency and efficiency, after all, go both ways. Companies can easily track customers’ behavior and adjust prices accordingly, just as customers can easily compare prices on the Internet. Organizations must act quickly to change their online policies before it becomes too difficult or disastrous.
The Reality of E-Pricing
In the absence of hard data, companies are using intuition and supposition to drive their Internet pricing strategies. Observers insist that the internet will make it so prices are driven down to the lowest possible level and that customers will only choose the option with the lowest prices because of the Web’s transparency. In the end, they argue that price will be the most important factor that differentiates products and services for on-line consumers, and that it will outweigh quality, service, and reputation. When asked, online consumers say that the most important factor motivating them to buy online is lower prices.
But their behavior tells a different story. A study recently done by McKinsey & Company has found that most on-line buyers do not shop around very much: 89% of on-line book buyers purchase from the first site they visit; so do 84% of those buying toys, 81% buying music, and 76% buying electronics. About 90% of North American consumers in a separate study do not turn out to be aggressive bargain hunters. Many people stick to the same websites when they shop online.
Nor is price the main consideration for corporate buyers. The main reason businesses buy things online is to reduce the amount of money they spend overall, but price is not always the biggest factor in how much something costs. Only 30% of B2B purchasing managers identified lower prices as the key benefit to buying online. The main advantages of e-commerce come from lowering transaction and search costs, such as reducing paperwork, and from automating purchasing information to track inventory and make better purchasing decisions. buyer said they expected prices to go down, which would reduce supplier profits. This is contrary to what they said, that both buyers and suppliers should have reduced transaction costs.
In business-to-business settings, buyers are more likely to follow through on what they say they will do in surveys, compared to individual customers. Reverse auctions have not been especially popular, despite all of the press they have received. Fifteen percent of companies that make purchases over the internet have tried them. If these statistics are accurate, it seems that very few business-to-business buyers prefer reverse auctions to other approaches, and even fewer intend to use them in the next year. Despite the lower prices that could be acquired through reverse auctions, half of the companies who use this method do not choose the low bidder. Additionally, 87% of those companies stay with their current supplier despite the higher prices they could be paying.
There are three main ways that companies can use the Internet to improve their pricing strategies: making pricing more precise, being more adaptable to changes in supply and demand, and segmenting customers more effectively.
There is a range of prices that customers are indifferent to, meaning that prices within this range will not impact purchase decisions. Percentages for branded consumer health-and-beauty products can be as high as 17%, while percentages for engineered industrial components are usually only 10%. For some financial products, percentages are as low as 2%. If a company is at the top of their respective field, they are more likely to be profitable than companies who are not as successful. If a financial services company increased the interest rates on personal loans by 2%, they would see an 11% increase in operating profits.
Finding the limits of these areas of neutrality in the physical world is tough, costly, and time-consuming. Traditional price-sensitivity research can be expensive, costing up to $ 300,000 for each product category. Additionally, it can take a long time to complete, taking anywhere from six to ten weeks. This research is not common among North American companies, with only about 25% having done it. Companies adjust prices according to changes in the market to keep them within a reasonable range, but this does not help identify the exact minimum and maximum prices.
On the internet, you can test prices in real time, and get customer responses instantly. If a company wants to see how a 3% price increase would affect sales, they could test it by increasing the price for every 50th customer and seeing how many still purchase the product. The company can use these tests to predict how much the volume will change if the price changes outside of the range that the customer is indifferent to.
Changing prices in the physical world takes time. It may take several months to a year for business-to-business markets to communicate changes to distributors, print and send out new price lists, and reprogram their computers. In consumer markets, pricing is not as flexible as it could be, but changes are still costly and time-consuming to carry out. For example, in stores, signs often need to be manually revised every time a price changes. Online pricing is more efficient for companies, as it allows them to make changes quickly and take advantage of small changes in the market, customer demand, and competitor behavior. Think of the ticketing business, for example. Typically, the cost of pre-printed tickets is finalized well in advance and cannot be modified later. This company adjusts their concert ticket prices based on supply and demand which has allowed them to generate more revenue per event.
Some people will pay more for a product than others because they value the benefits that the product provides more. It is difficult to give different prices to different customer segments in the retail market in the real world. A person who enters a store is usually unknown to the store and their motives are unknown. Sales staff are not aware of what the customer has purchased in the past, what would make the customer purchase an item, whether the customer generally buys items at full price or only when on sale, or if the customer needs an incentive to buy an item. The mystery is cleared up on the Internet. Online companies can segment their customers quickly by using a variety of data sources, including information about the current online session and customers’ buying histories.
Old Versus New Pricing Organizations
In traditional companies, pricing decisions are made instinctively and universally. The internet allows companies to price with more accuracy, speed, and flexibility.
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