You need to consider a variety of factors when you focus on setting prices that maximize your profits:
1. Relevant costs determine the price floor, or the amount you must charge to cover expenses and remain in business.
2. A customer’s willingness to pay for a product or service determines the ceiling, or the maximum amount you can charge a particular customer and still produce sales.
3. Your competitors’ product of offerings — both substitutes and complementary goods — and their pricing practices affect where you can set your prices so that they fall between the floor and ceiling mentioned above.
To calculate what your customers value about pricing, you should know the difference between what the customer is willing to pay for a product and the price actually charged in the market for that product.
Economists call this difference consumer surplus. Customers, sometimes consciously and sometimes not, make purchase decisions based on the product or service that gives them the highest level of value.
For example, a customer willing to pay $500 for a laser printer faced with two comparable products, the first selling for $450 and the second selling for $475, will probably buy the first printer. That customer feels he’s getting more value at the lower price. The wholesale-distributor with the more expensive printer, however, can still win the game if it’s able to convince the customer that the two products are not comparable and that the more expensive printer provides more value.
Price competition has pretty much dominated the area of pricing strategy for decades. Besides giving over too much power to the market, price wars run the risk of focusing the sales force on volume sales, because management is sending the message that the strategy is to sell, literally, at all costs.
You must find a way to increase prices slightly at the same time you enhance all the value factors associated with your product. A mere 1% increase in price generates an operating profit improvement of 11%. Conversely, every time you lower price by 1%, you will reduce your operating profit.
Your primary action in selling on value, not price: Work with your sales force. Motivate your sales force. Align sales compensation so that gross margin and profitability are emphasized over revenue and sales volume.
Establish more rigid pricing policies that prevent salespeople from leaning on price discounts to make a quick sale. Train them to illuminate the value in your products, and all the value customers gain by doing business with your company.
The sales force needs to position your product’s features and differences and the qualities that make doing business with your company more valuable to the customers.
Your sales force has a great deal of potential in presenting the product to its best advantage . . . an advantage that could lead to profitable pricing.
While all the functions in your company — marketing, accounts receivable, warehouse, transportation — play a role in creating value for customers, your sales force is the link between them and your organization. You must refocus the people in your customer-facing roles to support a value-for-pricing model. With the shift in pricing power to consumers, it becomes even more critical to have a strong understanding about what customers need and what they value.
To give a value-for-price model more power, your company’s goal must be to use customer information to enhance your services and help your suppliers refine their products and how they price them. And you can empower your sales force to close the loop by taking the resulting differentiating information back to your customers.
When it comes to pricing, the role of your sales force should include communicating, creating, and preserving value.
Communicating can begin before you change anything in the way of pricing; the sales force can focus on the existing value and on talking to customers about what they value.
Creating involves taking what they know to your table - supplementing your market information and your business strategies with their first-hand knowledge of the factors that will differentiate your product offerings beyond the price issue.
Finally, preserving value means that your sales force must shift its emphasis from cutting prices to attract high volume buyers to exposing the value of your offerings to build relationships.
Management’s role in this is to adjust performance incentives, rewarding salespeople for attracting and building profitable accounts, not increasing overall sales volume. NEWS
Reprinted by permission from Maximum Sales Velocity, copyright 1999, The DREF, Washington, DC.