This is a GUEST BLOG from Per Sjöfors who is a long-time business associate and friend of mine. He has done work for me and is a trusted expert in the field. Per is a Pricing Strategy Consultant, the Founder of Sjöfors & Partners, and a best-selling author.
Profits drive every company. I know that sounds very fundamental, but, in my experience, is something that many business owners and executives do not consider enough. Consequently, in this blog post, I will provide a few practical tips on how a company can use its pricing strategy to increase profitability.
I know we all know this, but it is worthwhile to be reminded that profits provide the resources for a company to grow. Yes, investors can provide growth capital, but this will not support a company forever. Eventually, the company needs to become profitable. And it is those profits that enable companies to spend more on product development, marketing, and sales and increase competitiveness. To grow the business.
Pricing Has the Highest Leverage on Profitability
Further, consider that profit only comes from three variables. It is the total cost of running the company, the sales volume of what the company sells, and the price of what is sold. And of these three, pricing has the highest leverage on profitability. So, let’s do a thought experiment – changing each of these three by only a single percent; how will that affect profitability? Well, for the average company, it turns out that if sales increase by 1%, profitability goes up 3½%, if costs are reduced by 1%, profitability goes up 5½%, but if the price is increased by 1% or discounting is decreased by 1% profitability goes up with 11.3%. Again, this is for the average company. But no company is average.
I have created something that I called the 1% challenge. It is straightforward. The challenge: did you ever fail to change anything a single percent? Of course not. 1% is tiny.
To find out how this works in your company, we developed a calculator you can access here (registration required).
This profit calculation is valid for Fortune 500 companies, but it’s also equally valid for a hair salon, an accountant, a personal trainer, etc. And any company in between. You only need the top-level revenue and the total cost, and the calculator will tell you how much a percent price increase will increase profits in your company.
When you start to look at your company from a profitability and pricing point of view, a lot will change. You will start thinking, “Do I have to give a 20% discount to close the deal? Maybe I should try with only a 15%, or perhaps only a 10% discount?” Likewise, you will ask yourself, “Which of all my products or services can I increase prices on, even if it’s just a little bit? Which product or service has the lowest nearby competition? Which products or services are unique and not exactly like my competitor, so if I raise the price, I will not see a loss in sales volume?” If the company has a sales force, consider reducing the discounting they can give away!
But, as you consider price increases, I also have one word of caution. There is something called Price Walls. These are psychological price points where sales volume changes dramatically, should you cross them. Price walls are often, but not always, on “even” numbers. Such as 5, 10, 20, 25, 50, 100, 500, etc., and this means that if the price for a product or service already is, say, $87, it is very likely that the price can increase to $97 without any change in sales volume. Likewise, if the price of a product or service is $503, reducing the price to $497 is likely to generate an increase in sales volume that could be pretty substantial. I say “could” because it is impossible to know how severe, or not, a Price Wall is without doing the willingness-to-pay research we do in my company. But you try by changing price, if done carefully.
More on Pricing
We are all familiar with how grocery stores and other retailers many times price “on the 9,” such as $9.99 or $49.99. But there are a few things to consider. First, if the product or service you sell is unique, and the price is aimed to be a message of quality and benefit, pricing “on the 9” denigrates that value. Thus, pricing “on the 9” should only be used for commodities, i.e., products or services that are equal to those sold by the competition. Furthermore, ending on a 7 is more effective in driving sales volume than ending on a 9. Ending on a 6 or an 8 is even less effective.
Finally, consider Price Anchoring. Whenever you expose your price to a customer, ensure they first see a high price, then a lower price. As humans, we cannot not compare numbers, and if a buyer first sees a high price, the lower-priced item will appear more affordable. Since we read from top to bottom and left to right, the high price should be in the top left corner of your price list, menu, or website. It will increase your growth rate by several percent.
There is much more on this topic in my book “The Price Whisperer – A Holistic Approach To Pricing Power.” Here is a link to the Kindle edition.