Here is a list of ten of the most common mistakes companies make when pricing their products and services:
1. Basing your prices on costs, not customers’ perceptions of value. Prices based on costs invariably lead to one of two scenarios: (1) if the price is higher than customers’ perceived value, the cost of sales goes up, sales cycles are prolonged, and profits suffer; (2) if the price is lower, sales are brisk, but companies leave money on the table, and therefore don’t maximize their profit.
2. Basing your prices on “the marketplace.” The marketplace is often cited as the “wisdom of the crowd”—i.e., the collective judgment of a product’s value. But by resorting to marketplace pricing, companies accept the commoditization of their product or service. Instead, management teams must find ways to differentiate their products or services so as to create additional value for specific market segments.
3. Attempting to achieve the same profit margin across different product lines. Some financial strategies support a drive for uniformity, and companies try to achieve identical profit margins for disparate product lines. The iron law of pricing is that different customers assign different values to identical products. For any single product, profit is optimized when the price reflects the customer’s willingness to pay.
4. Failing to segment your customers. Customer segments are differentiated by the customers’ different requirements for your product. The value proposition for any product or service varies in different market segments, and price strategy must reflect that difference. Your price strategy should include options that tailor your product, packaging, delivery options, marketing message and your pricing structure to particular customer segments in order to capture the additional value created for these segments.
5. Holding prices at the same level for too long, and ignoring changes in costs, competitive environment and customer preferences. Most companies fear the uproar of a price change and put it off as long as possible. Savvy companies accustom their customers and their sales forces to frequent price changes. The process of keeping customers informed of price changes can, in reality, be a component of good customer service.
6. Changing prices without forecasting competitors’ reactions. Any change in your prices will trigger a reaction by your competitors. Smart companies know enough about their competitors to predict their reactions, and get ready for them. This avoids costly price wars that can destroy an entire industry’s profitability.
7. Incentivizing your salespeople on revenue generated, rather than on profits. Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price. This mistake is especially costly when salespeople have the authority to negotiate discounts. Companies should define their sales staff’s job as maximizing profitability and then work to incentivize that profitability.
8. Using insufficient resources to manage your pricing practices. Cost, sales volume and price are the three basic variables that drive profit. Most management teams are comfortable working on cost reduction initiatives, and they have some level of confidence in growing their sales volume. Many companies, however, only utilize simplistic price procedures.
9. Failing to establish internal procedures to optimize prices. In some companies, a hastily-scheduled “price meeting”—a last-minute discussion to set the final price for a new product or service—can become a regular occurrence. The attendees are unprepared and research is limited to a few anecdotes about a competitor’s price list and a financial officer’s careful calculation of the product’s cost structure across a variety of assumptions.
10. Spending a disproportionate amount of time serving your least profitable customers. Know your customers: 80% of a company’s profits generally come from 20% of its customers. Failure to identify and focus on these 20% will leave companies undefended against wily competitors. Such failure also deprives the company of the loyalty that more attention and better service would provide.
This content is excerpted from the Natural Products Field Manual, Sixth Edition, The Sales Manager’s Handbook, written by Bob Burke and Rich McKelvey. To learn more about or purchase the Natural Products Field Manual, visit the Natural Products Consulting Institute website.