I recently spoke to Dennis Brown, who is a partner at California-based Atenga Inc. Atenga is the nation’s leading pricing authority to commercial and industrial companies worldwide, helping to improve clients’ profits by optimizing prices and improving price performance. Their most surprising finding has been how often price optimization can raise prices and improve sales volumes at the same time.
The vast majority of companies have spent years achieving gains through cost-cutting, outsourcing, process reengineering, and the adoption of innovative technologies. “[Price strategy] is emerging as the most important resource for companies to increase their competitive advantage,” he says. However, the incremental benefits from these important activities are diminishing, and companies are looking at other areas to improve their business results.
All too many companies 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.
The following is a list of 10 of the most common mistakes Brown says companies make when pricing their products and services.
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.
Basing prices on “the marketplace.” Management teams must find ways to differentiate their products or services to create additional value for specific market segments.
Attempting to achieve the same profit margin across different product lines. Profit is optimized when the price reflects the customer’s willingness to pay.
Failing to segment customers. The value proposition for any product or service varies in different market segments, and price strategy should reflect that difference.
Holding prices at the same level for too long, ignoring changes in costs, competitive environment, and customers’ preferences. Savvy companies acclimate their customers and their sales forces to frequent price changes.
Incentivizing salespeople on revenue, rather than profits. Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price.
Changing prices without forecasting competitors’ reactions. Smart companies know enough about their competitors to predict their reactions and prepare for them.
Using insufficient resources to manage pricing practices. Cost, sales volume, and price are the three basic variables that drive profit.
Failing to establish internal procedures to optimize prices. The hastily called last-minute meeting to set the final price for a new product or service has become a regular occurrence.
Spending a disproportionate amount of time serving your least profitable customers. 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 their prices.
Salespeople can readily identify those anecdotes that advance their interests, i.e., 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. www.mercantilemergersacquisitions.com
Dennis Brown can be reached at firstname.lastname@example.org or www.atengacorp.com