Pricing for Long-Term Profit and Growth (Part 3 of 3)
Ultimately, the optimization of both everyday prices and promotions leads pricing managers to focus on segmentation. More effective segmentation, as well as a pricing structure that responds to the needs of specific segments, provides an opportunity to improve both growth and profit in the long-term – the “Holy Grail” of pricing. There is a range of potential impacts that a pricing move can have. A move that takes the company up the vertical axis (such as a price increase) can increase profits but does not improve value and may, in fact, hurt the long term future of the business. Similarly, a promotional move that entices new customers, (e.g. temporary price reduction), but does not link customers to the value of the brand can grow the customer base, but possibly trains these customers to wait for future promotions leaving them unprofitable.
Pricing Solutions Newsletter
Summer 2009 – Vol 2 No 1
Pricing for Long-Term Profit and Growth
Frugal is the New Black
Research Practice Update
Pricing for Long-Term Profit and Growth (Part III of III)
By: Jim Saunders
In Parts I and II, we established the framework for performing price optimization to maximize long-term profit, by looking at the Customer Lifetime Value and the impact of pricing on the possible future outcomes. We also discussed how the “Price/Volume/Profit Tool”, a vital element for achieving Level 3 of the World-Class Pricing framework (www.pricingsolutions.com), links to this model. In addition, we also delved into the available margin pool and extracted a number of factors that could affect future profitability from a pricing management stand point. In this newsletter, we will discuss how to grow volume profitably in a long-term price optimization model (see the profit/growth model in Figure 3).
Ultimately, the optimization of both everyday prices and promotions leads pricing managers to focus on segmentation. More effective segmentation, as well as a pricing structure that responds to the needs of specific segments, provides an opportunity to improve both growth and profit in the long-term – the “Holy Grail” of pricing. Figure 3 (page 2) shows the range of potential impacts that a pricing move can have. A move that takes the company up the vertical axis (such as a price increase) can increase profits but does not improve value and may, in fact, hurt the long term future of the business. Similarly, a promotional move that entices new customers, (e.g. temporary price reduction), but does not link customers to the value of the brand can grow the customer base, but possibly trains these customers to wait for future promotions leaving them unprofitable.
While many companies in recent years have adopted initiatives to improve pricing management – typical starting points include implementing price increases or more effective management of promotions and other discounts – the real opportunity lies in the ability to segment customers based on their willingness to pay, and introducing a revised pricing structure that caters to the needs and constraints of each. If we return to the example of the bank savings product, the bank had taken a “one-rate-fits-all” approach. However, analysis of the cost structure revealed that high-balance customers were extremely expensive to replace if they were to leave. A change to the bank’s pricing structure allowed it to offer premium savings rates to premium clients. The reduction in lost volume led to a healthy growth in assets, while a reduction in the required acquisition costs improved the bottom line.
If we think about price structure changes in terms of “willingness to pay,” the opportunity becomes clear. Figure 4 (to the right) shows a simplified demand curve where we have plotted willingness to pay as a function of different market segments. In the simple case where the company has one offering at one price, the available revenue is represented by the blue rectangle. The revenue “left on the table” is represented by the two triangles (above and to the right of the rectangle). These are the customers who were willing to pay more but were not given that opportunity, and the customers who did not buy because the offer was too expensive, respectively. If, through effective segmentation and price fencing, the company can offer a new price structure, as shown by the addition of the green, purple and yellow rectangles, the revenue opportunity will grow, and the money left on the table will shrink. A pricing manager should structure the offers so that costs to service customers decrease with decreasing willingness to pay – but that’s a topic for another article.
In this article, we have presented examples and a framework for maximizing long-term profit and growth. Unfortunately, too many pricing managers fail to consider more than one of the trajectories in our profit-growth model. Yet, our work has consistently demonstrated that innovation in pricing structures offers one of the most powerful opportunities for a business to grow and be profitable in the long run. To access the entire article, visit the “Newsletters” section of www.PricingSolutions.com.
Jim Saunders is a Partner at Pricing Solutions Ltd. To reach Jim please call 416-863-0685, ext. 114 (as of July 15, 416-943-0505, ext. 114).
Frugal is the New Black
By: Paul Hunt
Positioning your company as the smart choice in the tide of consumer and corporate thrift.
Conspicuous consumption is passé. Nowadays, frugal is the new black. Cheap is chic.
The value calculus for making purchases has changed. There is a much sharper focus on price. People are re-evaluating everything before laying out their hard-earned cash. Consequently, it’s a dangerous time to be the high-priced player in any category, as Starbucks is learning the hard way. While the once high-flying chain is closing stores and trying to figure out how to avoid being seen as an unnecessary luxury, consumers are flocking to McDonald’s for its inexpensive, yet tasty, coffee.
The story is no different in corporations. Finding ways to conserve cash and still get the job done is the new modus operandi. Insurance company AIG, the current poster child for corporate excess, has not grasped this concept, and is paying the price for its arrogance. Holding corporate events at four-star resorts and doling out hundreds of millions of dollars in bonuses while at the same time accepting taxpayer bailouts has provoked public outrage. It’s like wearing bling to a funeral – ostentatious and insensitive.
In the B2B market, every purchase and expense is now viewed in the context of: “could we have done that cheaper?”; or, “rather than outsource that requirement, could we have done that ourselves?” The focus is on preserving cash and, in turn, jobs. Companies are still making purchases for “strategic initiatives,” and if you are fortunate enough to be selling something that is defined as strategic, you may still get top dollar. But don’t count on it; these products and services are few and far between.
The much wiser approach is to “ride the rapids” of frugality, to make sure that you’re the new black and, in so doing, position your company as the smart choice.
Here are some ways to accomplish this:
- reposition your value proposition to demonstrate why it is frugal to buy your offering (e.g., unbundle, provide tiers of offerings with a sweet spot for the frugal buyer);
- sharpen the focus of your messaging (i.e., would Scrooge approve?)
- reward loyalty (e.g., reward your best customers with unique ways to save money).
Paul Hunt is President at Pricing Solutions Ltd. To reach Paul, please call 416-863-0685, ext. 121 (as of July 15, 416-943-0505, ext. 121).
Pricing Research Practice Update
Greg Thomas, Leader, Pricing Research Practice, reports that Pricing Solutions is experiencing high client demand for our pricing research services. According to Greg, “Our new and existing clients recognize the need for pricing research to be conducted by highly specialized pricing experts such as Pricing Solutions, particularly in this challenging economy with changing consumption patterns.”
The Pricing Research Practice is also proud to announce the successful completion of the Marketing Research and Intelligence Association’s Gold Seal Certification Review process, http://www.mriaarim.ca/MEMBERSHIP/CorporateGoldSealProcess.asp, and our new designation as a Gold Seal-Certified Corporate Research Agency. The Gold Seal Certification is one of MRIA’s primary mechanisms for
developing and delivering world-class professional standards and ensuring member compliance. This achievement demonstrates Pricing Solutions’ continued commitment to excellence.
To discuss how we can apply our pricing expertise, innovation and collaborative approach to your research projects, please contact Greg Thomas, Leader, Pricing Research Practice at 416-863-0685, ext. 120 (as of July 15, 416-943-0505, ext. 120) or email him at email@example.com.
Avy Punwasee has recently joined Pricing Solutions Limited as a Senior Consultant, focusing on pricing management and strategy.
Prior to joining Pricing Solutions, Avy was responsible for pricing management in the service parts business of a major domestic automotive company. In this capacity he managed over 400,000 SKUs and $700 million of revenue to a diverse customer base. In addition, he was a key contributor to developing and implementing the organization’s long-term strategic vision and financial business plan.
Avy has a wealth of experience in numerous operational areas including channel pricing, competitive realignments, promotional pricing, input cost negotiation and change management. Over his pricing tenure he has added tens of millions of dollars in profit while still maintaining a focus on increasing sales.
To reach Avy, please call 416-863-0685, ext. 105 (as of July 15, 416-943-0505, ext. 105).