“A financially healthy company is a result of a series of small daily financial wins, not one big moment. Profitability isn’t an event; it’s a habit.”
Mike Michalowicz, Profit First
Profitability Drives Growth
In simple terms, there are 6 ways a business can look to increase growth:
- Sell more to existing customers
- Sell to new customers
- Sell new products or services
- Sell existing offerings with upgraded features or added-value benefits
- Sell products or services in a new way; for example through new channels or with new business models
- Sell the same stuff at higher margins
A business embarking on a growth strategy will typically focus more on the first four or five approaches on this list and pay less attention to the last one. Perhaps that it because it seems less strategic or impactful than the others, or maybe it is considered to be more difficult to manage.
When a push for higher margins comes under the spotlight, unfortunately the focus is usually just on driving costs down.
Don’t get me wrong, purging unnecessary costs out of the system is good for efficiency. But if not carefully managed it can easily become detrimental to a business by negatively impacting quality, productivity, customer service, and not to mention the effect on the morale of employees.
Of course, the other lever for increasing margins is to raise prices.
Increasing pricing is a very attractive prospect as it immediately delivers profitable growth – revenue added to the top-line falls straight through to grow the bottom-line. A Harvard Business Review study showed that typically a 1% improvement in price increases the operating profit by 11.1%.
With such an immediate impact on the financial health of the business, raising prices should be intrinsic to any growth strategy.
Why Raising Prices Is Difficult
Pricing is often poorly managed and competing forces within an organisation can make it tricky to reach consensus. An initiative to raise prices becomes a balancing act between the desire to secure the sale and retain the customer base, while striving for stronger financial performance and sustainable profitable growth.
It is the lack of a structured pricing process that lets down many businesses. Pricing decisions are taken randomly and tend to rely more on intuition than data analysis.
Companies scramble to react to competitive pressure and customer requests, but seldom do they take a routine and pro-active approach. The exception is perhaps during the development and commercialisation of new products or services, but that focus can slip once the market launch is in the rear-view mirror.
The sensitivity of pricing on a company’s performance merits a methodical approach and should be part of a long-term strategy managed at a high-level in the organisation.
Restructure To Focus On Pricing Discipline
Pricing plays such an integral role in the earnings performance of a company, it needs to be managed by a single individual, not a committee. The focal point role has the responsibility to coordinate competitive information, customer insights and analysis, acting as the coordinator between the sales, marketing and financial teams.
The pricing manager can add-value by taking ownership for driving commercial excellence for the organisation. This critical position is the gatekeeper during the sales proposal stage and at contract review, tasked with instilling a culture of pricing discipline while maintaining a strong value proposition for the customer.
Careful thought should be given to selecting the right person and reporting line for the role. If the pricing manager exists within the sales team there may be conflicting pressure to meet sales targets while trying to achieve profitability improvement goals.
Pricing initiatives will have a much greater chance of success if employee bonus schemes reflect the company’s profitability ambitions. Incentives for executives as well as the sales, marketing and operation teams should be linked to pricing improvement and margin growth, rather than solely based on revenue targets.
Create Pricing Processes and Tools
Moving an organisation from ad-hoc pricing decisions to a culture of pricing discipline requires a thorough and systematic approach. A structure needs to be built with processes and tools to track valuable metrics that enable informed, analytical decisions.
The data gathered must be useful for the business in question and it must capture relevant levels of granularity – by product line, by account or by geography for example. A focus on the quality of the data will avoid making poor decisions based on flawed analysis, i.e. ‘garbage-in-garbage-out’.
Where good data and supporting information is absent, it makes sense to start with a small-scale pilot project. Focusing on a specific customer account or a product line will help iron-out any problems with the methodology before implementing throughout the organisation.
Pricing software technology may suit some companies and there are many options available. Resources will be required to customise and implement the system for the unique business needs, then perseverance is necessary to ensure employees are well trained and are using the tools effectively.
To avoid a strategic pricing initiative being seen as a ‘passing fad’, processes need to be rolled out consistently and embedded into the organisation as best practises. Keeping it simple, especially in the early stages will allow it to be easily understood and utilised successfully with minimal friction.
Reports and dashboards that routinely measure pricing trends are a necessary output, allowing line managers to take accountability and responsibility for actions to improve performance.
Look For Value-Pricing Opportunities
Lack of discipline can mean that organisations fall into the simplest forms of pricing, i.e. cost-plus or just following a competitor’s strategy. Some companies have to sell on price, but even these low margin operators always look to sell-up by adding more value such as providing more features or end-to-end solutions.
Value can be subjective and may also vary between customers in the same segment. Its important to understand value perception from the customers perspective, they may emphasise an issue that was not even considered or a pain-point that is indirectly related to the application.
Empowering sales teams to focus on value pricing with their customers requires them to move away from talking about features and generic benefits. They need to develop deeper discussions on the wider-reaching advantages of the value proposition and how it specifically solves the customers own challenges.
In B2B transactions, achieving the best value pricing will usually require reaching out to the various stakeholders early in the purchasing process. A decision-maker will typically be price-sensitive, but this can be mitigated if they are receiving favourable recommendations from key influencers or end-users.
Close The Customer’s ‘Perception Gap’
Almost every business has a small group it can consider as its top customers. These are the best, most loyal customers who keep returning to you time and again. They are usually less price-sensitive because they appreciate your value proposition, they are easier to approach, and they purchase a wider range from your portfolio.
They may even consult with you for advice during the purchasing process because they consider you as a knowledgeable advisor and resourceful partner.
At the other end of the scale are your one-off or occasional customers, they pick and choose selectively to build their solutions from the marketplace and squeeze a hard bargain with demands for lowest price.
But why is there such a wide discrepancy between these types of buyers, one who trusts you and another who doesn’t? Its important to know because if you can improve the trust, you have a chance to lower the price sensitivity barrier.
It could be down to entrenched habits or personality traits that may be too difficult to overcome. But in some cases, it may just be a perception gap that could be closed through targeted, persistent marketing efforts and focused sales support.
It is worth identifying and strategically targeting some of these customers. Becoming a resourceful partner to them will not only drive price increases, but it opens up more sales opportunities through repeat business, up-selling and referrals.
Develop Strategic Pricing
Differentiated pricing for products and services with tiered levels of features or service add-ons is a useful strategy to increase the appeal to both price-sensitive buyers and value-driven customers alike. Customised pricing experiments can be tested this way and the feedback used to validate wider profit margin growth strategies.
A portfolio rationalisation may be necessary from time-to-time to focus on the more profitable core offerings.
However, instead of immediately eliminating all the low-volume or low-margin products that impact overall profitability, try testing increased price levels on customers. If the higher prices are rejected then the product line can disappear, if they are accepted then supply can be maintained with a positive effect on financial performance.
Bundling is another consideration for low-volume or low-margin product lines to incrementally raise prices. Bundling can also be used effectively across the portfolio to create a stronger value perception for the customer and thus support higher profitability.
Also adding support or service components can be used to differentiate a business from its competitors to help push prices higher.
In summary, these are my recommendations for a business that is striving to implement optimum pricing:
- Create a ‘commercial excellence’ focal point with reporting line to the senior executives
- Incentivise relevant leaders and teams in the organisation on profitability improvement
- Embed pricing processes and discipline in the organisational culture
- Develop deeper knowledge of the customers’ wide-reaching challenges and pain-points
- Communicate and collaborate more closely with all stakeholders to maximise value
- Routinely rationalise the portfolio and design pricing strategies for low-margin offerings
- Continuously experiment with pricing levels to capture validated data
I’m a Business Consultant with over 30 years of international experience in start-ups and senior leadership positions in multinationals and Fortune 500 companies. I provide expertise to develop value-driven solutions in Business Growth, Marketing, International Sales, Strategic Planning and Business Transformation.