Below is a summary of the article "The Top Five Myths of Strategic Pricing." This article By: John E. Hogan and Joe Zale is one of PPS' favorites from its Pricing Advisor Newsletter Archives.
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Across the board, managers have absorbed these “worst practices,” and they unknowingly make poor decisions that undermine their businesses. A common reason for such poor decision making is that managers carry those rules and techniques from one competitive environment into another.
What may work in one situation becomes merely myth in another. Are you buying into any of the following myths?
Myth 1: You can’t raise prices and volume at the same time.
In many companies, executives believe demand curves (i.e., price and volume) are fixed. This leads into the trap of thinking that optimizing price and volume is the only hope for driving profit. However, price optimization is only a small piece of the answer. It’s actually possible to hit multiple points on a demand curve with one product that will drive both volume and price simultaneously. This can be accomplished by creating tiered offerings that break products and services into different bundles that attract different customer segments.
Instead of a one-size-fits-all product offering and price, multiple product offerings and price points can be created. The result is higher prices for premium offerings and higher volume for the standard offerings. The net effect, if orchestrated properly, is significantly higher overall profits.
Myth 2: Pricing more profitably means having to raise prices.
Structuring prices to encourage cost avoidance is another way to price more profitably without actually raising prices. Big opportunities to improve profits lie in areas not often considered in the realm of pricing. By that, we mean service features that often get wrapped into a company’s offering, such as rush orders, financial terms, warehousing and technical support.
Instead of bundling services into a product offering like an “all you can eat” buffet, positioning them as a la carte upgrades can help improve profits through cost avoidance. Customers will think twice about paying for services they don’t actually value. The net effects are to lower cost-to-serve and increase share from customers who forgo services, and increase revenue from those who value these services. When you add it all together, this approach can yield big dollars in profit improvement.
Myth 3: Prices should be set to cover total cost plus some target margin.
The goal of pricing is not to cover total costs. Our clients often struggle with this challenge because the concept is counterintuitive and the mistake so pervasive in companies. Instead, the goal of pricing is to maximize total contribution (i.e., unit price minus unit variable costs).
Why? Because the portion of price that affects profitability is contribution margin. Whether that contribution exceeds or falls short of profit objectives is not a pricing issue. In other words, allocating fixed costs within the price does not help make better pricing decisions because those costs are not actually incurred when making additional sales.
Myth 4: You should drive volume in a high fixed-cost business.
On the surface, this statement is true; however, there is a trap. We see many high fixed-cost businesses becoming more variable over time, and yet they are not adjusting their management thinking to reflect that change.
Myth 5: The prices you can charge are proportional to increases in product performance (e.g., quality, speed, costs).
While it sounds simple, many people fail to remember that product improvements are not proportional to the value they deliver. Superior performance can command superior pricing.Product managers often get fixated on a customer’s willingness to pay and worry too much about a product’s pricing history.
In particular, we find market researchers guilty of this mistake, providing recommendations
that leave significant value on the table for their clients.
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