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April 7, 2004

Pricing decisions are some of the most perplexing that marketers face. It is truly like walking across a mine field. Faced with cost increases, competitors giving their stuff away, and fickle customers, it is easy to become cynical. Simplistic pricing schemes and knee-jerk reactions can cripple a company. This month, let's consider some of the basics of pricing strategy as it relates to profitability. Perhaps some of these concepts will help you respond better to the pricing issues you may face as our economy continues to pick up steam. 

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IN THIS ISSUE

> Changing prices is like walking across a mine field

> Smiles make the day!

> Amazing facts...

Changing prices is like walking across a mine field

Is your price too high?
Maybe, maybe not. Pricing is like setting a screw...a little resistance is a good thing! Seemingly small changes in your price can blow up in your face!

If your sales force must expend huge effort to sell a few more units, your price may be too high. A small reduction (or temporary allowance) that gains substantial volume indicates your standard pricing is a bit high. When a larger price concession only nets a small volume increase, pricing is probably not your problem.

Firms must constantly monitor customer acceptance of competitive offers and make factual comparisons. Companies sometimes view their offering as only the product itself at a price. Customers, on the other hand, generally view a company's offering as the product plus all the other components of their total experience in dealing with the company. Customers place a value on quality, availability, delivery reliability, credit terms, return policy, technical support, friendliness, company reputation, habit, relationships, and many other factors. Are customers selecting a competitor because of price? Are product quality, availability issues, or other policies involved? What are your customers actually buying? 

Price cuts versus gross profit dollars.
Rarely do sales people understand the effect of a price reduction on gross profit. Simple break-even analysis can quickly tell you how much additional product must be sold to return the same dollars of gross profit. The answer varies based on your profit margin percentage. For example, if a company enjoys a 30% margin, a five percent price reduction will require a 20% increase in unit sales to net the same gross profit dollars. If the company only has a 20% margin, the same five percent price reduction will require a 33.3% increase in unit sales to return the same gross profit dollars. The point is, the relationship is not linear! It takes a substantial increase in unit sales volume to make up for relatively small price cuts. The slimmer your margin, the greater the sales increase needed to earn the same amount of profit. Yes, it's a cruel world!

Conversely, however, a small price increase of two percent that is made without the loss of unit volume is equal to an 11.1% increase in unit sales when your gross margin is 20%. Or, if that same firm can raise its price by only one percent, while reducing its variable cost by another one percent, the result will also be equal to an 11.1% increase in unit sales volume! A company can even afford to lose a little volume in order to install a price increase. In this case, a two percent price increase with a volume loss of, say 5% will still yield a higher dollar gross profit. Often, selective price increases on slow-moving items (or those not commonly stocked by competitors) can be quietly introduced without any sales loss. In fact, slow-moving items incur added costs and should carry a better margin than the fast selling items. 

Special Note: You will find a chart showing "Sales Increase Needed to Earn Same Gross Profit" on my web site in the Articles Library.   

Announcing price changes.
Price increases should be justified. Changes in the cost of raw materials, improved and updated products, added features, new models are good reasons for altering prices. Most customers expect advance notice of a price increase so that they can make their own price adjustments, or buy ahead. Prior notice shows fairness and good faith. Industry practices vary widely on announcements. Some are handled orally by sales representatives. Other industries rely on written announcements or new catalogs.

Price reductions are the least disruptive to profits if they are not across-the-board. Selective reductions in certain cases do less harm than heavy-handed rollbacks. Once you announce a justifiable price increase, competitors often quickly follow. If they do not follow immediately, resist the urge to rescind your increase (shows weak price leadership) and instead consider providing customers with a "temporary competitive allowance." The temporary allowance keeps you in the market, allowing your competitors time to assess their costs and eventually follow your lead. Once the competitors raise prices, you can quietly cancel your "temporary allowance" and go to your previously announced new pricing. 

Conclusion.
If you rely on one very simple pricing formula, chances are you are leaving money on the table. Your pricing is always on trial. Even if you think your price is right, customers may disagree...with disagreeable results. Some customers are never satisfied and require special deals or modification of your terms. That's normal, so be ready to respond. Competitors, suppliers, and customers all try to gain an edge. You must continually review your pricing assumptions and actions in your marketplace.

There is no one 'right price' and certainly no magic margin percentage you can rely upon for long. Be alert to changes that affect your pricing decisions, but don't act in haste. Make sure you know the impact of recommended price changes before you walk into that mine field! Keep in mind how much more you must sell to recover the profit dollars lost to the lure of price cutting.  

        

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Smiles make the day!
ABOUT PROGRESS...

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> Begin where you are. But don't stay where you are!

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