While the slow economic recovery certainly affects the profitability of producers of many goods and services, a reluctance to “optimize” prices is a trend that could have far-reaching negative consequences for companies in most sectors of commerce.
The vast majority of companies have spent years achieving gains through cost cutting, outsourcing, process reengineering, and the adoption of innovative technologies. However, the incremental benefits from these important activities are diminishing, and companies need to look at other areas to improve their business results.
Perhaps the area most commonly overlooked—an integral part of the marketing mix—is pricing. A recent study by Atenga Inc. (Woodland Hills, CA), a strategic pricing consultancy, found that a bewildering 82% of CEOs felt that price was not a high priority for them.
“Cost cutting has been the mantra in the business world for decades,” says Per Sjofors, Atenga’s president. “We found that people think they have cost cutting under control. What they don’t have under control is sales growth, and to an even greater extent, pricing. While an optimized pricing strategy has the greatest impact on increasing sales, profitability, and market share, many companies are guessing at what their pricing levels should be, or use a simple rule of thumb, like adding a fixed margin to their cost. They don’t actually know what their customers are willing to pay, and may be very timid about raising prices in the present economy.”
Sjofors adds that one of the reasons why some companies are timid about pricing is because they have accepted to become commoditized, allowing buyers to have the ability to instantly compare prices for many products and services online. Another reason is that a company’s own sales management or distribution channels may be telling senior management to aim for increased sales through volume discounts, which often have a negative impact on profitability.
By shifting its policy to optimized pricing, companies shift the battle to where their strengths lie, in their ability to deliver unique benefits, said a business review by MIT’s Sloan Business School of Management in a 2010 Wall Street Journal article. Optimized pricing is defined as having four components: identify value opportunities; choose which ones to prioritize; align their value and price; and constantly communicate to the customers the value being provided.
Two examples of the performance pricing may be found in Netflix’s recent price increase and Best Buy’s innovative Buy Back program.
Netflix chose to separate its formerly bundled price for ordering movies as DVDs or watching a large selection streaming on personal computers, raising the price for both by 40%, but giving the customer the option to buy either, if they so choose. Although the bundled price increase has stirred controversy, Netflix will most likely hold its customers since the company offers more streaming movies than any competitor and while also offering a similarly wide selection of new movies on DVDs as other providers. Hence, its existing customer base is likely to be willing to pay the price increase.
In the case of Best Buy, its Buy Back program assures customers that they can upgrade their consumer electronics purchases anytime within two years from the purchase date (four years for TVs) based on a scheduled trade-in value. While customers have to pay a premium for the program (similar to an extended warranty), it encourages many consumers to shop at Best Buy simply because of this differentiating option.
Atenga, which works mainly with companies in the $50 to $500 million range, views optimized pricing as both creative and analytical. Specializing in the pricing of new and existing products and services, as well as life-cycle pricing, the firm uses an in-depth analysis of market: Company and customer information are used to measure the true value a product or service provides to its buyers through a process called Optimized Pricing Process (OPP). Using quantitative research and qualitative analysis, data are provided to client companies, giving them realistic criteria on which to determine pricing decisions.
“This OPP approach enables pricing managers and company executives to avoid the many pitfalls in internalized pricing decisions,” Sjofors explains. “Many mistakes occur mainly because companies are not actually used to gathering the complete range of pricing criteria.”
One such mistake made by many company executives is the failure to segment its customer base. For example, a client had developed an innovative software product, priced at $79.00 per seat, a figure that “felt right” for the executive team; yet sales stagnated, although OPP research showed that there were two distinct market segments for the software: consumers and professionals.
“The $79.00 price was too high for the consumers who were interested in purchasing the product, and too low for the professionals,” Sjofors says. “It communicated ‘not a serious tool’ for the professionals who were interested in its value proposition. As a result of this research, the company decided to focus on the professional marketplace. The company raised the price to $129.00, and sales soared.”
In another example, a company was persuaded by its sales staff to reduce the price of its keynote component from $2,400 to $1,800. The staff believed, and persuaded management, that lowering the price would drive sales volumes proportionately higher.
“This is a common error,” Sjofors says. “The result was catastrophic. Sales volume over the following year declined almost 40%, as customers and channel partners perceived that the lower price signaled a lower quality. That lower-quality perception prevented the company from reversing the price increase, and it was not until a new product was designed and released—18 months later—that the company began to recapture its former price point, and sales volume.”
Sjofors cautions that many other mistakes to pricing are common, and that making the right decision is difficult when dependent on internal data and opinion. He says that, in addition to comprehensive research and qualitative analysis, an educational process is also required to educate company executives and their staffs, particularly the marketing and sales teams, on defending new price increases.
All indications at Atenga are that price optimization is invaluable and helps prevent a brand from becoming a commodity. The firm has done an extensive study on public companies that have optimized their pricing versus peer companies that have not. Among the findings were that companies that optimized pricing had twice the growth rate, twice the profitability, and four to five times higher shareholder value.
“It’s worth it,” says Sjofors. “By being superior to your peers on pricing, you will grow more quickly, you will be more profitable and you will be more competitive. You will also have more resources to develop new products or services, more resources to innovate and serve your customers better, and more resources to market your company. It will become a self-reinforcing cycle.”