Fairfield County Business Journal
by Arun
Sinha
Markets
are efficient. Margins are lean. Customers are sophisticated. The competition
never sleeps. How then do you price for maximum profits?
Let's
start by looking at the relationship between price, volume and profits.
Price
affects volume, and hence profits. This is obvious enough. But it pays,
literally, to know how changes in price would trickle down to affect profits.
Let's say you raised a price by 3 percent. If your volume stays put at previous
levels, that 3 percent increase goes straight to your bottom line. If volume
falls, you may still see an increase in net profits. How? Because as your volume
decreases, so do your variable costs.
In
general, the larger your variable costs in relation to your fixed costs, the
more likely it is that a small drop in volume will still result in higher
profits. Testing various price levels and the attendant profits will tell you
how far you can raise prices before profits suffer.
Price and value. A price increase cannot occur successfully in a vacuum.
Every time you increase a price, your customers start looking for options that
will reduce their dependence on you. So you will need to modify your marketing
and sales efforts to convince customers that you are still the best choice for
them. You could do this by raising the level of your customer-related activities
in ways that don't increase incremental costs.
Perhaps
you could bundle services, or give the customer more control over scheduling, or
focus your sales and service efforts on your more profitable accounts, or simply
do a better job of re-positioning yourself against your competitors.
It is
important that customers are made aware of the extra value that you provide.
Smart customers are always weighing price versus value, and as long as the
scales are tipped towards the "value" side, they will accept your price.
A good
example is the pricing history of Lexus' LS400 model, which was priced at
$35,000 at its introduction in 1989. Its competitors had products priced several
thousands higher. Lexus established itself as a terrific value for the money,
outclassing its legendary rivals in every way. With its "value proposition"
secure, it began raising prices, so that by 1996 it cost upward of $50,000 to
buy an LS400 – a 43 percent increase in seven years.
Knowing Your Customer. The key to raising your prices, then, is to
understand the value of your product to your customers. Find out how customers
use your product, what problems it solves for them, and how it affects their
P&L. Try to put a dollar amount to the benefit they gain from it. Know what it
would cost the customer to buy from one of your competitors. Or to do in-house,
what you're doing for them. Or how not buying your product at all would affect
their business.
Most
customers will not readily part with information that would answer the above
questions. However, through skillful research using focus groups, conjoint
analysis of your major customers' preferences, qualitative and quantitative
analysis of past buying behavior, insights from your sales force, and knowledge
of your customers' businesses, you can understand the value and, hence, how much
a customer would be willing to pay for your products.
Admittedly, this method of arriving at a price requires a lot more time, money
and judgment than a "cost plus margin" method based on cost and volume data that
are readily available. But the resultant understanding of your customer's needs
will tell you what you need to do to increase your value – and price – to the
customer. Your profits will then depend on how well you can reduce expenses
while maintaining the market's perception of your value, or by how successful
you are at enhancing your value and raising prices accordingly.
An
alternative to the value-oriented approach is to price your products as dictated
by the market. Your competitive situation may force you to do so. To drive
profits, you will need to devote more of your attention to controlling costs
and/or building volume.
Managing your prices takes a lot of hard work. Done right, it can prove to be
the difference between survival and prosperity.
# # #
Arun Sinha is founder and
president of Access Consulting, a marketing communications and technical
writing firm based in Stamford, Connecticut, USA. Sign up for Access
Consulting's One-Minute Communication Tip at www.AccessConsultingInc.com.
Once a month, you'll receive an actionable idea or technique on an
aspect of business communications, distilled into about 150 words.
