Considering how critical pricing policy is as a component of a business’s design, it is surprising how many companies of all sizes often make pricing decisions in a reactive, inconsistent way as opposed to being directed by a thoughtful, long-term policy tied to corporate purpose, vision, and values. The potential negative results can include:

·         Failing to optimize retail price points

·         Encouraging retail buyers to always bargain your price down

·         Destroying credibility with buyers

·         Communicating a lack of confidence in a product’s potential

·         Undermining the value perception of consumers

·         Inability to sustain consistent overall profit margin because of profit disparity between customers

A well-crafted policy should address both how you initially set your base prices product by product as well as how you vary prices for the same product customer to customer. This is a complex topic that I can only touch on briefly in this blog. But, let me give you some suggestions from my own experience that might help you improve your profitability.

1.       Set base prices for products based on consumer perceived value not cost. Money is often left on the table by not pricing products high enough when you have the added value to support it. Consumer surveys and/or focus groups comparing your offering to the competition, if any, can help you get a sense for consumer perceptions before you finalize the price. The results may surprise you. On new products, if in doubt, go out at the higher price. You can always come down but you can’t go up. Remember that the price you set communicates both to retailers and consumers the level of quality and the confidence you have in the product. 

2.      Understand current marketplace reality. You’ve got to do your homework long before you start walking into those lions’ dens known as buyer’s offices. Retailers tell me they are shocked at how poorly prepared company personnel or sales reps often are. If you can’t offer a retailer pricing that allows them to meet their margin requirements while being competitive at retail with their principal competitors, maybe you shouldn’t be presenting the product to them at all. If you don’t have at least a sense of what your competition is charging for comparable products, you could be embarrassed. If you don’t know the retailer’s requirements up front with respect to sales allowances, special requirements, and other deductions, you might be pricing too low from the get go. 

3.      Assume that buyers and employees are going to change companies. Being able to sleep nights was always one of my priorities and I assume it’s one of yours. There’s no reason why you can’t or shouldn’t establish a pricing policy that can be justified no matter who becomes aware of it. You should expect that the prices you charge different customers for your products are going to become public at some time. And, trying to explain it by saying to buyer B that buyer A got a better price because she threatened to drop the product is not going to make anyone happy. Does that mean you have to charge everyone the same? No! But there ought to be an acceptable rationale, a set of guidelines, to justify the differences. Any customer that meets the guidelines should get the same price.

4.      Aim to equalize profitability by customer. Arguably the best basis for price variation by customer is equalization of profit contribution percentage*. It’s also the fairest. Why shouldn’t every customer contribute proportionately to your bottom line? Why should customers that pressure you for extra allowances, are costly to service, or abuse return policies get a better deal than other equal volume customers? Instead, build these costs into your price. Of course, you typically want to give better prices to your larger customers. Profit contribution-based pricing justifies and enables that because economies of scale reduce direct costs. Another benefit to equalizing profit contribution by customer is that you won’t find your margin suddenly eroding because the balance of your sales shifts to lower profitability customers. 
* Profit Contribution Percentage = (Sales – Direct Costs) ÷ Sales

5.       Be willing to walk away.This is a tough one, but if you or your salesmen are routinely lowering prices strictly based on pressure from customers, you’ve got serious problems. If you can’t set and hold to fair prices for your products, you better take a cold hard look at your competitive advantage product by product and your overall business model. Personally, I think you need to establish a reputation with buyers that the price you quote is the price they pay—unless the buyer is willing to work with you to pull some cost out of the product in some way so profit contribution is maintained (package change, minimum quantities, etc.). If you simply crumble under the pressure, guess what’s going to happen every time you quote a price to that buyer for evermore? You may lose some business in the short term with this approach but you’ll be better off overall by far!

6.      Proactively add value to your products. Products have a life cycle. You should enjoy the widest profit margin when the product is new and your competitive advantage is greatest. But, as you know, nature abhors a vacuum and competitors will flock to grab a piece of the action. Don’t wait for this to happen and then react. Create a product improvement process, if you don’t have one, and systematically improve especially your higher volume and most profitable products at least annually so that you can preempt competition without having to lower price. Don’t let your products become commodities.

Establishing an effective pricing policy can have an enormous impact on your level of business success. It’s well worth taking the time to think it through with your staff, document it, communicate it, and enforce it. Have you done this yet?

Questions? Comments? Let me know what you think.

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