How to Improve Profit by an Average of 11.1%
Climb the Value Pyramid.
The title isn’t clickbait: a study of hundreds of companies concluded that you can improve profits by more than 11% through a 1% improvement in pricing. (Yes. Pricing.) We’ll get to the data in a second, but first we need to get something straight: pricing is the biggest problem you’re currently ignoring. That goes for any industry, location or product; from enterprise SaaS in my home town of Austin, to live music ticket sales in Virginia, to B2C services in Seattle.
Maybe the problem is that you set pricing years ago and haven’t adjusted it since. Or maybe you recently launched a product and made an educated (or not so educated) guess on price. Either way, if you don’t have a repeatable approach to improving your pricing, you are leaving money on the table. So let’s talk about price in a way you can actually use.
The importance of price.
A 1992 study from the Harvard Business Review found that the right pricing changes can drive revenue and profit improvements faster than any other growth lever — faster than increasing the volume of sales or decreasing costs.
Let’s break this down. The study spanned hundreds of companies and concluded that a 1% improvement in pricing resulted in an average profit improvement of 11.1%. And yet, how often do you actually think about your prices? (Never?) Instead, you’re likely spending your time thinking about new customer acquisition (increase in volume) or you are thinking about optimizing salary or production costs.
At Thinktiv, we found these results as hard to believe as you probably do, so we ran a modern study of our own, looking at 75 companies across multiple industries. The results were even more dramatic: a 1% pricing improvement delivered >15% potential increase in operating profit. Our work confirmed the old HBS study and underscored an important truth: getting pricing right can drive massive value for your business, while getting it wrong erodes revenue and profit in a significant way.
So. Setting the right price is crucial. But how do you actually do it? Luckily, pricing is low hanging fruit. It’s not particularly hard to get right, you just need a few strategies.
Finding the right price.
The first step to improving your pricing is understanding that it doesn’t happen in a vacuum. Looking at pricing by itself is divorced from how your buyers, customers, and users actually think about price. In truth, customers see price as the last piece of a larger puzzle, not the whole puzzle. They see price through a consideration path of: company, product positioning, product packaging, and then price. This probably isn’t news to you, but you’d be surprised how many organizations fail to consider price in the same context their customers do.
By the way, every customer considers your product this way. Sometimes it happens quickly and subconsciously, and sometimes it happens as a deliberate assessment, but it always happens.
So instead of just thinking about price, we encourage clients to think about price as a hierarchy of communication, with your company’s market position as the firm foundation and pricing as the capstone.
The net impact of all this is that any conversation about price without the other pieces will never yield full success. You simply can’t address price without the others. At best, you will achieve a local maximum — an improved outcome that misses significantly more meaningful changes and opportunities. At worst you will destroy hard earned revenue and/or profit. Don’t make that mistake. Let’s take each step, one at a time.
Understanding price in context. Questions you must answer to improve your profits.
To help improve your pricing (and profits), I’ll lay out a few of the questions we use with our clients. For each of these steps along the Value Pyramid, you should be able to answer the questions with a defensible position, including market data, sales data, or customer and prospect feedback. Facts and market data is key — hunches and gut responses are rarely sufficient to improve your pricing architecture. Let’s start at the beginning.
1. Company Positioning
The first question that every customer asks when considering you is, “Who are these people?” They ask questions like: Who is this company? What do they stand for? What are they similar to? Do I like them?
This stage of the game is where components like brand identity, corporate narrative, market perception, history of delivery, and other factors come into play. This is the foundational step upon which everything else gets built, so it’s important to have solid answers here.
- Do you have a clear understanding of your buyers and target markets? Who are they? Describe them.
- What is your external market narrative and does it allow customers and investors to recognize your value?
- Does your company clearly stand for something good and/or valuable? Can you articulate that value in a couple of sentences?
- How is your company positioned to encourage positive pattern matching with competitive or substitute solutions?
2. Product Positioning
The second question that every customer asks is, “What is this product or service?” At this stage, a buyer starts assessing your product or service against their set of needs and all other known solutions for their needs. Customers want to know: is this solution the best choice for fulfilling my need? Again, sometimes this happens subconsciously, sometimes methodically. But it always happens.
The most important part of this step is not simply that you are different, because that’s not enough. Instead, it’s crucial that your customers understand and care about your difference. Targeting the right audiences and speaking the right language (their language) is critical for improving this layer of the pyramid. The following questions should help you begin assessing your product’s position in market:
- What are the core differentiators of your product or service? How do they compare to your competition? Why do they actually matter to your customers?
- Do you have patents or IP wedges that create defensible moats around your differentiation?
- What strategies do you employ to ensure that your market understands your core differentiators?
- Are you focused on the right segments of the market? Are you getting rewarded for a narrower market focus?
3. Packaging
Assuming your company and product qualify as useful in your customer’s mind (company and product positioning), the natural follow up is, “How do I use or consume this product?”
In physical products, packaging is tangible: a carton of a dozen eggs has a dozen eggs. In software, services, or more complex product offerings, the packaging can get significantly more complicated. Fortunately, buyers are always asking just one question at this stage: can I find a package that I understand and obviously fits my needs?
To get a sense for whether you are answering that core customer question, ask yourself:
- Is your product or service packaged in a way that makes sense to your customers? What evidence do you have?
- How is your packaging aligned with the way your customers buy and consume your product or service?
- Are there clear differences in value between your packages? Why do those differences matter?
- How do your various product packages encourage upsell and expansion as a customer relationship grows?
4. Pricing
Finally, we’re talking about pricing. If we’ve done our job correctly, pricing should start to look a little easier to divine. We have the context of company positioning, product positioning, and packaging to base our work off of.
Customers that make it this far are asking the penultimate question: “Given what I know, will this solution provide me more value than the dollars I am about to part with?”
The following questions should get you started considering price. Remember — a 1% improvement here results in an average net income increase of more than 10%.
- Is your pricing aligned to product packaging structures and customer usage patterns? Where might it be misaligned?
- How does your pricing relate to marginal costs of production or service? Are you appropriately covering cost of production and delivery?
- How does your pricing relate to relevant competitors? How do your customers perceive this comparison?
- Are your prices set at values customers are willing to pay? What evidences do you have to support this conclusion?
Rubber, meet road.
Not to beat a dead horse, but having real market backed positions for each of these questions is critical to arriving at the right answer. It’s worth your investment to survey the market, ghost call your competition, talk to your customers, or run a pricing study. For most businesses, improving pricing represents the best ROI profile of any investment you could make.
All of this information is great and helpful, but only if it turns into action. (And no, that action is not searching for “pricing tricks” on Google.) Take a question from the list above and have a conversation within your company. Survey the market. Call a customer and start a conversation about value. You don’t have to have all the answers to start making progress. (And remember, 1% better makes a big difference.)
In the meantime follow along here, drop us a line, or email me directly at ajwatson@thinktiv.com. As an innovation firm based in Austin, Texas, we thrive on helping companies create, transform, realize and profit from the value they create in the market. We’d be all too happy to help you too.
