In my opinion, most companies use a too simplistic pricing strategy. It may be cost-based i.e., the company calculates the cost of a product or service and then adds a margin on top to ensure that it does not sell at a loss. Different industries typically use margin uplift based on a rule of thumb in their industry, and companies also apply that margin uplift equally to all their products or services irrespectively if they are commodities or unique, differentiated products or services.
Or, companies try to find out the competition's price and then use that as a reference. Finding the price might be possible if the competition has its prices available online or on store shelves. If not, it can be almost impossible to obtain the competition's price. And even if the competition's prices are open to the public, it's difficult to understand what kind of deals, specials and bundles they have. Making the information indicative, at best.
And, finally, there is guessing, gut feeling or, as some say, "market price." For reasons mentioned above, companies do not know the market price unless it is published like it is for commodities such as grain, oil or pork belly. What these three pricing strategies have in common is that they have nothing to do with their customers' value perceptions and, therefore, inevitably leave money on the table. Neither do they in any way guide a company on how it can differentiate itself in meaningful ways to gain pricing power, which is the ability to charge higher prices at the same time as sales volume is unchanged or increases. I believe from the highest viewpoint, a company's profit comes from only three variables. It's the total cost, total sales volume and the price of what is sold. Of these three, the price has the highest leverage on profits. In fact, the average company increasing price has about three times the profit leverage compared to increasing sales volume and about twice the profit leverage compared to cutting costs. This fact was established back in 2003 by McKinsey & Company in a study called "The Power of Pricing." The reason price affects profits more than cost and sales volume is simple. If sales volume increases, so does cost. And reducing cost works on a smaller number than the higher price number; thus, for the same percentage, change is less effective in driving profits. More update about company's profits.
In my experience as a founder and CEO of a pricing consulting company, I've noticed that many executives and business leaders intuitively know this yet fail to act accordingly and succumb to using the simplistic pricing strategies mentioned above, thus leaving unnecessary money on the table profits the company should rightfully earn.
How Can Companies Make Pricing a Centerpiece of Their Pricing Strategy?
First, keep in mind that the actual pricing strategy should be based on what the company's customers are willing to pay and stratified in such a way that it makes sense to its customers and minimizes sales friction. Make sure the company's leadership and anyone in the company who can influence price, cost or sales volume are aware and constantly reminded of the above. Further, those in management positions need to know the specifics regarding percent margin and how price and discount changes affect the company's profits, not only globally but also for particular products/services, product/service categories or families, sales channels and territories. And so forth anywhere that the company can affect its price. This awareness by itself can change behavior, and many seemingly small decisions can be focused on pricing for profit. This can lead to the sales organization being less prone to discounting and compensation policies focusing on profits, not revenue or sales volume.
