Is Your Price Strategy Putting You at Risk?

As I was writing about risk management practices I ran across an interesting blog post by CEB’s James Fitzmaurice on why you should audit your corporate strategy.  In it he cites a destructive price war (6% of the time) as one of the reasons that led to a market cap decline of over 50% in top 20 fortune 1000 companies, so it represents a strategic risk.  Other key factors include:

• Decline in core product demand (16% of the time)
• Competitor infringement on core market (13% of the time)

What does this have to do with pricing?  Plenty.  According to Frank Cespedes, Elliot Ross and Benson Shapiro’s recent article Raise Your Prices, many companies look to price as a demand lever in tough economic times, mistakenly believing you have to cut prices to gain volume.  As they point out, if you’re not the cost leader, it rarely works.  Instead they recommend competing on performance and pricing on value, where customers willingly pay higher prices for that value.  I highly recommend reading the article as well as Sean Silverthorne’s follow-up Q&A on the topic, Yes, You Can Raise Prices in a Downturn.

There’s no Easy Button for finding the value customers are willing to pay for.  It takes discipline, hard work and collaboration across many functional areas of your company.  So, now you’re probably wondering is it really worth it?  The answer is absolutely.  Pricing decisions can build or destroy value faster than any other decisions you can make.   On average, a 1% increase in price translates to a 12% increase to your bottom line and this isn’t just some future earnings potential with a payback measured in months or years.  It’s usually in the form cash that drops to the bottom line immediately and, now more than ever before, cash flow is extremely important.  Still not convinced?

Let’s look at a recent client example.  This particular client supplies a variety of high quality products to distributors and retailers across the country.  One of their largest customers was a major discount retailer.  They had determined that they were losing money on the account and the amount was rather significant.  They decided to investigate further.  They found that their products included a high value (and costly) custom finishing, yet they were being positioned against commodity products at a much lower price point.  In this case, neither the retailer nor their clientele had placed any value on the custom finishing being provided with the product.   Instead of firing the customer, they offered to substitute a product that didn’t include the custom finishing because they had determined their customer had not assigned any value to it.  This one decision alone more than paid for the investment they had made in the analytics that provided them with the necessary information to identify the problem and place a value on process applied to the product.  In addition, they did a little market research by visiting the retailer to see how their products were being sold.  Finally, they communicated their findings to the sales team, who then worked with the customer on a more appropriate product mix.  They used this as a learning opportunity to educate their sales team.  The results have been remarkable.  They’ve managed to gain market share and achieved record profits even though their overall revenue dropped by almost a third.  Not bad for a company in an industry that was hit the hardest by the recent downturn.    

So, where do you start?  One of the best things you can do is get a better understanding of gap between your customer value and your cost (and cost in this case is all costs, not just gross margin) because, as Benson Shapiro points out, you want to maximize this gap.    There are often dramatic differences in the customers’ perception of value and a detailed cost analysis will help you identify what those are.  One of the best ways to analyze these differences is by using a price waterfall analysis, where you identify the differences between the list price and what’s called your pocket price, which includes all discounts and the cost of value-add services you’re providing the customer.  

 

The results may surprise you, but it’s the first step towards understanding the potential price segments each of your customers belongs to.  As markets change, you’ll need to adjust these segments or even develop an entirely new segmentation strategy.  However, without this detailed analysis, you’re essentially flying blind and that’s exactly why your pricing strategy presents such a huge risk to your company.  It’s what you don’t know that can often kill you because you won’t find out until it’s too late.  

I realize this is an oversimplification and there’s a lot more to it than I just outlined, so I encourage you to download a white paper I wrote on the subject: Effective Pricing Using Profitability Insight – A Best Practices Guide.  You have more pricing power than you may think, even in this downturn.  You just have to find the right levers.  You will have to work at it a bit, but with the right tools, you can accomplish results that will surprise you even if you don’t opt for the total remodel  our client did.  Your biggest risk is not doing anything.