Competitive pricing is one of the most effective profit building strategies known to modern-day businesses. It is also one of the least understood strategies in business today. It’s easy for businesses to get caught up in the idea that they need to maintain a certain profit margin on each of their products – a concept that can lead to stagnant pricing, the use of stale pricing practices and market analyses that don’t always reflect what the market will actually bear. While running your business this way may lead to a steady profit stream, it doesn’t necessarily maximize the level of profits that your company could be generating.
In a study published by McKinsey & Company of the Global 1200, it was found that if a business increased their prices by just 1% and demand remained constant, the average increase in operating profits would be an increase of 11%. With this same increase in pricing some companies even saw exponential growth in terms of the percentage of profit: Sears saw an increase of 155%, Tyson saw an increase of 81% and Whirlpool saw an increase of 35%, simply by raising their prices by 1%.
All of these numbers got me thinking: how can business owners learn to more effectively price their products to maximize profit? And then it hit me: it’s all about helping business owners figure out the price that their market can bear. You see, most businesses price their products based on very black and white numbers. They set up an ideal profit of X (which sets the price of the product at its regular retail price) and a minimum profit of Y (which sets the price of the product at its discounted or sale price). While this strategy does create successful businesses, it can leave profits on the table for the company – something that could be corrected by simply implementing a more modern and interactive pricing strategy.
The easiest way to develop a more profitable pricing strategy is two-fold. The first piece of the puzzle is to think about the basic principles of supply and demand: when consumer demand for your product rises, supply decreases and – at least theoretically – the price on that product should go up. The second piece to the pricing puzzle is to think like a customer. As a consumer, you know that there are certain attributes that can set similar products apart. You also know that you’re willing to pay more for a product that offers you a greater value. This value to the consumer could be due to a variety of reasons, such as the manufacturing process the company uses to make a particular product, emotional ties to a specific product or simply the brand power of a product.
A great example of the supply/demand pricing concept is the holiday demand for the Tickle Me Elmo doll in 1996. This doll as the most sought after children’s gift of the season. As the product demand increased, so did the price – and because of the emotional value of the product, consumers were willing to pay a premium for this doll. The product that was given a suggested retail price by the manufacturer of around $30 began selling for hundreds of dollars at different locations around the country. These shop owners recognized the opportunity to maximize their profit on this particular item. After the holiday rush, demand for the Tickle Me Elmo doll diminished and the consumer value of the doll decreased right alongside it – which pushed the price back down as well.
As you can see, effective pricing is key to maximizing your company’s profit margins. In part two of this concept, we’ll examine how to develop an effective pricing strategy for your business.