The 1% Windfall
By: Mohammed Rafi
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Most people - including seasoned business executives - are not comfortable setting prices.
There are very few "golden rules" and practical guidance for us to rely on, so most of us resort to the path of least resistance - doing what we have always done, or copying our competitors in the marketplace.
Which is a shame, because creating a better pricing strategy is the quickest path to new profits and growth.
Better yet, pricing is the only strategy that can be implemented on Sunday night and start to produce profits on Monday morning.
McKinsey & Company did a study of Global 1200 companies around the world and found that if they increased their prices by just 1%, they would increase their operating profits by 11.2%. Which is where the name "The 1% Windfall" comes from.
Join us for the next 12 minutes as we explore how to create a better pricing strategy so that you too can start benefiting from the world's most powerful profit making strategy.
Why Pricing Is So Important
Yes, pricing is quick to implement and leads to dramatic results. But how does it tie into other goals your company might have - like market share, operating margin targets and profitable growth?
I'm glad you asked.
Market Share
The traditional thinking around increasing market share is that you decrease prices and thus more people buy more stuff. As we'll explore in the coming sections, playing the game of "how low can we go" rarely leads to optimal results.
Operating Margin Targets
There are two main drivers of operating margins. The traditional focus is cutting costs and increasing efficiency. Of course, increasing prices is the other side of that coin. We'll explore how to do this profitably.
Profitable Growth
Growth at all costs is never a good strategy, unless you are Amazon or Walmart. If you want to keep profiting while you grow, creating a pricing strategy is critical.
Capturing Value by Thinking Like A Customer
A great pricing strategy involves setting prices that capture the value you've created with your product, not how much it costs to produce it.
For example, street vendors (some of the wisest price ninjas on the planet) increase prices based on the current value their product provides. Is it about to rain? That umbrella just went up on price.
Understanding how to create a pricing strategy that works requires you to understand the three primary ways that customers differ:
Customers want a pricing plan that works for them. For instance, sometimes they want to lease your product rather than buying it outright. Understanding which plans work for which customers is key.
Customers have unique needs. For instance, some of your customers might need small doses of your product, and some of them might need it all at once. Understanding how to create different versions of your product that take advantage of this is important.
Different customers value your product differently. Finding ways to charge different customers different prices for the same product is a key element of any strong pricing strategy.
One-on-One and Multi-Customer Pricing
One-on-One Pricing
You should use one-on-one pricing where you are selling one product to one person. For instance, selling a used car, a house, or a custom service.
There are five steps here:
Identify your target customers.
Identify the next-best alternative available to those people and use its price as a starting point.
Determine your product's differentiators relative to the next-best alternative.
Calculate your product’s value based on that differentiation.
Do a reality check on the price of the next-best alternative. For instance, make sure that the price of the next-best alternative isn't too high.
Multi-Customer Pricing
You should use a multi-customer pricing strategy when you are selling many units of a product to a variety of customers. Most companies fall into this bucket.
There are four steps here:
Identify your target consumer’s next-best alternative and reality-check its price. Just like in the one-on-one pricing strategy, this is your starting point.
Determine how your product is differentiated. There are many factors to consider here: your brand, the ease of use of your product, the quality, and the service levels you provide are just a few of the factors.
Create a demand curve based on the idea that different customers will value your product differently. We covered the demand curve in our previous summaries of The Strategy and Tactics of Pricing and Confessions of The Pricing Man if you need a primer on what that is.
Finally, undertake a profit maximiser analysis to figure out the most profitable price. Basically, you calculate the revenues, costs and profits at price levels from high to low, and then pick the one that generates the most profit.
Now that we've covered the basics, let's get into the nitty gritty of how you can create different pricing models based on everything we've learned so far.
Pick-a-Plan
As you start your journey towards a profitable pricing model, you'll uncover that some of your prospects aren't buying because the pricing plan doesn't work for them.
Pick-a-Plan strategies looks to solve this by giving your customers different ways to buy your product.
The first thing you can do is give your customers different ownership alternatives. Ask yourself the following questions:
Interval ownership. Can you divide your whole product into smaller ownership units and sell those units individually?
Leasing. Can you sell the rights to use the product for a period of time?
Rental. Can you sell usage of the product for a shorter period of time?
Subscription. Can you offer a rental that allows customers access to your entire suite of products for a period of time (usually monthly or annually)?
The second thing you can do is create pricing tactics that reduce the risk of using your product. Ask yourself the following questions:
Success fees. Can you charge a base price and get a bonus when a key success metric for the customer is achieved?
Licensing. Can you tie the value your intellectual property creates for your customer to your pricing structure? This is usually relevant in franchising or reseller arrangements.
Auctions. Can you establish the value of your product by accepting bids and selling to the highest bidder?
Future price options. Can you charge a price to give a customer the right to purchase the product in the future for a price that is set today?
The third thing you can do is generate options for customers who are sensitive to changes in price. Ask yourself the following questions:
Flat rate. Can you offer a fixed fee for your product rather than a variable rate?
Peace-of-mind guarantee. Can you fix the price of your product for a given period?
All-you-can-eat. Can you offer one price for unlimited usage?
Two-part high/low pricing. Can you charge an up-front price for access to lower-than-general variable pricing? Think Costco.
Finally, the fourth thing you can do is to address financing constraints that your customers might have, either now or in the future. Ask yourself the following questions:
Financing. Can you allow your customers to make their payments over time?
Job-loss protection. Can you offer refunds or payments if a customer becomes unemployed?
Layaway. Can you allow customers to pay in instalments and then receive the product when the full payment has been made?
Prepaid plans: Can you allow customers to pay in advance and then draw down this credit over time?
Now that we've covered a number of ways you can offer plans for your product, let's move our attention to how you can create different versions of your product to extract even more value and profit.
Versioning
Sometimes all it takes is a few small modifications in your product to unlock new value in the marketplace. This strategy can be used to get current customers to "trade up" the value chain, and also find new customers who have unique needs and who value your product at a lower level.
The first thing you can do is add additional features to your product so that you can charge a higher price. Ask yourself the following questions:
Higher quality. Can you add elements to your product that increases its overall value?
Guaranteed access. Can you give your customers a guarantee that they'll be able to use your product or service, even if it's otherwise sold out?
Priority access. Can you offer a version of your product or service that allows your customers to avoid waiting? Think of the FastPass program at Disney World.
Faster product. Many customers value speed and are willing to pay for it. Can you offer a faster version of your product?
The second thing you can do is to offer a stripped down version of your service or product and offer it at a lower price. Ask yourself the following questions:
Lower quality. Some customers are willing to sacrifice quality for a lower price. Can you give that to them?
More restrictions. Can you create conditions to using your product that limit the value the customer will receive?
Unbundling. Can you unbundle the features of your product and sell them individually?
Off-peak. Can you offer discounts for accessing your product or service at times when it's otherwise not busy?
Private label. Can you supply your product under another retailers name and charge a lower price?
Finally, the third thing you can do is add new features to your service that are designed to attract key target customers. Ask yourself the following question:
Package size. Can you offer different sizes for different customer segments?
Extended and enhanced warranties. Can you offer an extended or enhanced warranty?
Monthly clubs. Can you offer new things for customers who value novelty and "being the first?"
Bundling. Can you create new features and bundle them together with existing features to make a brand new offering?
Platforms. Can you allow your product or service to be used on a different platform? For instance, HBO allows cable companies to offer their service, but also has their own stand-alone platform.
Usage purpose. Can you find a different use for your product? For instance, drug makers often create versions of human drugs for pets.
Now that we've covered a number of ways you can offer plans for your product and how to create different versions of your product, let's move our attention to how to create different prices for the same offering.
Differential Pricing
Some customers are willing to pay more than other people. So, if you only have one price, you are leaving money on the table in two ways - by not charging enough to some people, and by people not purchasing at all because they think it's too expensive.
The solution to this problem is differential pricing.
The first thing you can do is create hurdles that customers need to climb over in order to receive discounts. Ask yourself the following questions:
Rebates. Can you create a reduced price for those willing to fill out paperwork and wait for a refund check?
Sales. Can you create discounts every so often to entice people who are unwilling to pay the full price?
Coupons. Can you create discounts for people who are willing to hunt down and redeem coupons?
Price matching. Can you match your competitors prices?
Distribution. Can you offer lower prices at less convenient locations?
Sales cycle time. Can you start prices high and lower them over time to attract the people who are willing to wait?
The second thing you can do is create different prices based on customer characteristics. Ask yourself the following questions:
Geography. Can you vary prices by locations? People in some areas might value your product differently than in others.
Easily identifiable traits. Can you create different prices based on age, status (like student, military member, etc.) and proximity to your location?
Club affiliation. Can you offer discounts to an organisation's members in exchange for marketing benefits?
The third thing you can do is look at the purchasing patterns of your customers. Ask yourself the following questions.
Quantity. Can you offer a lower per-unit price based on bulk purchases?
Mixed bundling. Can you create discounts for people who purchase bundles of your products?
Next-best alternatives. Can you adjust prices based on the competitive landscape? You can charge lower prices in highly competitive markets, and higher prices where there is less competition.
Two-part pricing. Can you have one price for one part of your product, and a different price for the other? Think razor and razor-blade pricing.
Conclusion
So there you have it. A huge list of different ways you can set your pricing that should spark some new ideas to capture more profit.
And remember, pricing is the only marketing tool you have at your disposal that you can dream of on Sunday night, and implement on Monday morning.
That's instant profits, my friends.