Ten tips to better pricing: Start generating new profits and growth

By Rafi Mohammed, Ph.D

Pricing is one of the most powerful – yet underutilized – strategies available to businesses. Illustrating the power of pricing, using data from the National Restaurant Association and Deloitte Restaurant Industry Operations Report, if full-service restaurants raised their prices by just 1 per cent, and demand remained constant, on average their operating profits would roughly increase by 17 per cent.1 Just as important, price is a key attribute that consumers consider before making a purchase.

The following 10 pricing tips can reap higher profits, generate growth, and better serve customers by providing options.

Stop marking up costs

The most common mistake in pricing involves setting prices by marking up costs (“I need a 30% margin”). While easy to implement, these “cost-plus” prices bear absolutely no relation to the amount that consumers are willing to pay. As a result, profits are left on the table daily.

Set prices that capture value

Manhattan street vendors understand the principle of value-based pricing. The moment that it looks like it will rain, they raise their umbrella prices. This hike has nothing to do with costs; instead it’s all about capturing the increased value that customers place on a safe haven from rain. The right way to set prices involves capturing the value that customers place on a product by “thinking like a customer.” Customers evaluate a product and its next best alternative(s) and then ask themselves, “Are the extra bells and whistles worth the price premium (organic versus regular) or does the discount stripped-down model make sense (private label versus brand name). They choose the product that provides the best deal (price versus attributes).

The foundation for every restaurant’s pricing strategy is to set prices that capture the value of their offerings. This involves thinking like a consumer. Consumers evaluate a restaurant relative to their next best alternatives. Is a “best of” winner worth the premium or does the lower priced standby make sense? They choose the restaurant that provides the best deal (price versus attributes). Key attributes that affect how diners value a restaurant include number of close competitors, personal taste for cuisine or restaurant type, and income. The value customers place on a restaurant’s offerings has little to do with its operating costs. Four steamed shrimp dumplings are priced at $4.50 at Hai Hong located in upstate Ithaca, N.Y., (low real estate costs) but only $3.50 at Chau Chau City in downtown Boston. The reason why Hai Hong can charge a 29% premium is because it provides significant value: it is the only dim sum restaurant in Ithaca while there are many in Boston.

Create a value statement

Every company should have a value statement that clearly articulates why customers should purchase their product over competitors’ offerings. Be specific in listing reasons – this is not a time to be modest. This statement will boost the confidence of your frontline so they can look customers squarely in the eye and say, “I know that you have options, but here are the reasons why you should buy our product.” Key statements can be along the lines that we won a “best of” award or testimonials from customers.

Reinforce to employees that it is okay to earn high profits

I’ve found that many employees are uncomfortable setting prices above what they consider to be “fair” and are quick to offer unnecessary discounts. It is fair to charge “what the market will bear” prices to compensate for the hard work and financial risk necessary to bring products to market. It is also important to reinforce the truism that most customers are not loyal – if a new product offers a better value (more attributes and/or cheaper price), many will defect.

Realize that a discount today doesn’t guarantee a premium tomorrow

Many people believe that offering a discount as an incentive to trial a product will lead to future full-price purchases. In my experience, this rarely works out. Offering periodic discounts serves price sensitive customers (which is a great strategy) but often devalues a product in customers’ minds. This devaluation can impede future full-price purchases. Promotions should generally be thought of as a method to serve price-sensitive customers – keep “they’ll return and pay full price” expectations low.

Understand that customers have different pricing needs

In virtually every facet of business (product development, marketing, distribution), companies develop strategies based on the truism that customers differ from each other. However, when it comes to pricing, many companies behave as though their customers are identical by setting just one price for each product. The key to developing a comprehensive pricing strategy involves embracing (and profiting from) the fact that customers’ pricing needs differ in three primary ways: pricing plans, product preferences, and product valuations. Pick-a-plan, versioning and differential pricing tactics serve these diverse needs.

Provide pick-a-plan options

Customers are often interested in a product but refrain from purchasing simply because the pricing plan does not work for them. While some want to purchase outright, others may prefer a selling strategy such as rent, lease, prepay, or all-you-can-eat. A pick-a-plan strategy activates these dormant customers. New pricing plans attract customers by providing ownership options, mitigating uncertain value, offering price assurance, and overcoming financial constraints.

Offer product versions

One of the easiest ways to enhance profits and better serve customers is to offer good, better and best versions. These options allow customers to choose how much to pay for a product. Many gourmet restaurants offer early-bird, regular, and chef’s-table options. Price-sensitive gourmands come for the early-bird specials while well-heeled diners willingly pay an extra $50 to sit at the chef’s table.

Implement differential pricing

For any product, some customers are willing to pay more than others. Differential pricing involves offering tactics that identify and offer discounts to price-sensitive customers by using hurdles, customer characteristics, selling characteristics, and selling strategy tactics. For example, customers who look out for, cut out, organize, carry and then redeem coupons are demonstrating (jumping a hurdle) that low prices are important to them.

Use pricing tactics to complete your customer puzzle

Companies should think of their potential customer base as a giant jigsaw puzzle. Each new pricing tactic adds another customer segment piece to the puzzle. Normal Norman’s buy at full price (value-based price), Noncommittal Nancys come for leases (pricing plans), High-end Harrys buy the top-of-the-line (versions), and Discount Davids are added by offering 10% off on Tuesday promotions (differential pricing). Starting with a value-based price, employing pick-a-plan, versioning and differential pricing tactics adds the pricing related segments necessary to complete a company’s potential customer puzzle. Offering consumers pricing choices generates growth and increases profits.

Since pricing is an underutilized strategy, it is fertile ground for new profits. The beauty of focusing on pricing is that many concepts are straightforward to implement and can start producing profits almost immediately.

What better pricing windfall can your company start reaping tomorrow morning?

About the author:

Rafi Mohammed, Ph.D is the author of The 1% Windfall: How Successful Companies Use Price to Profit and Grow (HarperBusiness).

1 According to the 2007 – 2008 National Restaurant Association and Deloitte Restaurant Industry Operations Report the median operating margins for full service restaurants with average checks per person of less than $15, between $15 and under $24.99, greater than $25, and limited service are 5.6%, 3.6%, 4.1%, and 9.7% respectively. I used the average of 5.75%. Thus, on average, full service restaurants bank 5.75 cents out of ever dollar that they collect. If they raised prices by 1% (charged, say, $1.01 instead of $1.00), they would earn an extra penny per revenue dollar (profits would be 6.75 cents instead of 4.4 cents). This extra penny translates into a 17% increase in operating profits (1 extra cent per 5.75 cents of profit). This calculation, of course, assumes demand for products remains constant at the elevated price.

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