Pricing Methods: 5 Things People Say When They Do Not Get “Pricing” 🏆
Pricing methods, how do you remove the misconception? There is an old saying that “many a true word is spoken in jest” – a statement apparently attributed to Chaucer. In this short blog, we take a lighter approach to highlight common misconceptions that pricing professionals often hear. This could even be thought of as a way to learn by asking questions – in the Socratic style. Then, we suggest you keep a bingo card and tick them off if you have heard them. If you have heard them all before in your career – you can pat yourself on the back. Of course, the next step and much more challenging is to try to win over the person to the side of pricing and revenue management.
Note: we do not intend to belittle the common queries made by non-pricing professionals, as of course, they can be valid concerns when not answered with a clear and comprehensive solution.
Pricing methods – how many of these statements have you heard before?
– You can not just increase prices
This is one of the first that you often hear – and is based on a fundamental misunderstanding of the pricing profession and pricing methods. Hence, we listed this one first – as if you can not get past this one, you have no chance of getting buy-in our implementing pricing optimisation. A good answer to this question will enable you to move on to more complex questions such as below. See our blog on premium pricing strategy.
Pricing Methods – Is this some sort of pseudoscience – with magic numbers?
This one can come up – or a variation on it when the concepts of psychological pricing, relative pricing, anchoring or numbers such as $5.99 are brought up. This should be viewed as a good thing as it opens the door for more discussion.
– Our sales force will never accept this price testing method
This is a great indication as to how the business is actually set up and who carries power. It can also give you a great insight into why margin erosion may be appearing. At this point, it may be a smart idea to think about how sales teams are incentivised.
Pricing Methods – You need to know our costs – or drive our costs down more
This one follows directly from the one above – if not a sales-driven organisation, it may adhere loyally to a strict cost-based pricing strategy. Do the finance team have a large say in pricing strategy? This gives a great indication as to where your work should begin
– It will not work for us – as our industry is different
We left this one to last – as it is probably one of the most common comments. The funny thing is that we have not seen an industry yet where pricing improvements can not be made.
With that in mind, let’s explore what can be improved:
Your sales team defines price as what’s on the invoice. The CFO defines price as ‘what we take to the bank’. Your customer says the price is too high. Your pricing manager says that price doesn’t match our standard terms. The distributor says they can’t make any money on your line. And it’s still Monday morning!
So what does define and indicate price? Can you improve net price realisation and take more money to the bank?
I prefer price as what goes to the bank, after all, discounts, returns, warranties, commissions and other deductions before determining the final price.
There are several elements to price management. The first is achieving the optimal price for each good or service. The second is managing your product mix and services to achieve the optimal price for a set of customer transactions.
For many firms, the difference between what’s invoiced and what’s banked is over 10%, made up of co-op, early pay, volume rebates, freight allowances, returns and other factors, defined and imagined. The difference between list price and invoice price is often over 20%.
For a firm with a 10% operating profit, capturing a 1% price improvement falls through to operating profit and expands operating profits to 11%, a 10% improvement. Do you spend as much time thinking about price as you do thinking about costs?
Here are 6 steps to consider that can improve your pricing methods and profits.
Have a clear, executive-level pricing proprietor.
Most organisations do a great job of managing pricing execution and deals flow through the building smoothly. Your pricing manager may be doing a good job tactically, however, they should also be thinking strategically. Having a capable and experienced owner of pricing strategy who can think ahead into what to do more in the future.
According to a study published in the MIT Sloan Review, fewer than 15% of companies have any systematic pricing review.
What to do: Delegate one of your executive team, most likely the VP of Marketing or CMO, with building a pricing team and enabling them to develop a pricing improvement plan and process.
Optimise your product range.
If you have classified your customers and understand which ones truly price sensitive. Thus, have a basic price fighter in your range that will meet their needs without disrupting your full product line pricing.
What to do: Look at your product pricing methods vs. your user segmentation again.
Align sales compensation with profit growth.
If your reps paid with basic wages. Not for profits or price improvement; what incentive do they have to fight for the best price?
If you were selling and could make 5% commission on $1000 with little effort, or 5% commission on a $1010 sale with some effort and risk, what would you do? The 1% price lift is worth a negligible amount to them, but a huge amount to your bottom line!
What to do: Consider having, at a minimum, your sales leaders receiving an incentive on expansion of either average selling price or gross margin.
Revisit your ‘price waterfall’ annually.
Check on all price deductions made prior to the final net price.
Are programs such as co-op still pulling their weight as you’ve shifted your pricing strategy to inbound marketing, pulling away from distributors to create demand? Do customers take an early pay discount when paying after the early pay period has expired?
Once you have established your price waterfall, compare it to your leading competitors. Odds you are pushed to match invoice price plus you have more attractive trade terms; which your customers and sales team aren’t discussing in a price negotiation.
What to do: Conduct a review of you and your competitors, pricing methods, selling terms and price structure annually.
Understand what your customers’ value.
Do those who set your prices truly understand what your customers value? Do you have a pricing playbook and value pricing method which continuously reinforces the value of your products? What was the last diagnostic your team delivered about how to improve pricing?
What to do: Ask your customers why they buy from you – value discovery programme.
Set expectations of annual price improvement.
Most of us worried about losing market share. Therefore, creating a culture of price improvement will ensure pricing is always top of mind for your commercial function.
What to do: Establish an annual price improvement goal, and analyse on a regular period.
Price optimisation is not about selling less at a higher price; it’s about eliminating the leakages and practices that enable you to capture improvement in a systematic way in your net price realisation.
How much time is you or your team thinking about these questions? How much time is it worth thinking about to get a 10% expansion in operating profit?