POCKETING THE PROFITS

Posted on May 19, 2011 by andrew.gregson

(With thanks to McKinsey the following is a reprise of an article they published in 2003.)

Pricing right is the fastest and most effective way for owners to increase profits. Consider the average income statement of most companies: a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits—an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labour and more than three times greater than the impact of a 1 percent increase in volume.

Unfortunately, the sword of pricing cuts both ways. A decrease of 1 percent in average prices has the opposite effect, bringing down operating profits by that same 8 percent if other factors remain steady. Owners may hope that higher volumes will compensate for revenues lost from lower prices and thereby raise profits, but this rarely happens. Volumes would have to rise by 18.7 percent just to offset the profit impact of a 5 percent price cut. Such demand sensitivity to price cuts is extremely rare. A strategy based on cutting prices to increase volumes and, as a result, to raise profits is generally doomed to failure in almost every market and industry.

Following the pocket price waterfall

Many companies can find an additional 1 percent or more in prices by carefully looking at what part of the list price of a product or service is actually pocketed from each transaction. Right pricing is a more subtle game than setting list prices or even tracking invoice prices. Significant amounts of money can leak away from list or base prices as customers receive discounts, incentives, promotions, and other giveaways to seal contracts and maintain volumes.

A hole in your pocket.

Many on- and off-invoice items can easily lead to price and margin leaks. Here we provide a non-exhaustive list:

Annual volume bonus: an end-of-year bonus paid to customers if preset purchase volume targets are met.
Cash discount: a deduction from the invoice price if payment for an order is made quickly, often within 15 days.
Consignment cost: the cost of funds when a supplier provides consigned inventory to a wholesaler or retailer.
Cooperative advertising: an allowance paid to support local advertising of the manufacturer’s brand by a retailer or wholesaler.
End-customer discount: a rebate paid to a retailer for selling a product to a specific customer—often a large or national one—at a discount.
Freight: the cost to the company of transporting goods to the customer.
Market-development funds: a discount to promote sales growth in specific segments of a market.
Off-invoice promotions: a marketing incentive that would, for example, pay retailers a rebate on sales during a specific promotional period.
On-line order discount: a discount offered to customers ordering over the Internet or an intranet.
Performance penalties: a discount that sellers agree to give buyers if performance targets, such as quality levels or delivery times, are missed.
Receivables carrying cost: the cost of funds from the moment an invoice is sent until payment is received.
Slotting allowance: an allowance paid to retailers to secure a set amount of shelf space.
Stocking allowance: a discount paid to wholesalers or retailers to make large purchases into inventory, often before a seasonal increase in demand. (Thanks to authors Mike Marn and Eric Roegner are principals in McKinsey’s Cleveland office, and Craig Zawada is a principal in the Pittsburgh office.)

Contact Andrew for your next meeting or to arrange a full day workshop:
Andrew D. Gregson B.A., M.A. M.Sc.(Econ)
http://www.pricingstrategies.ca
101-1735 Dolphin Ave.
Kelowna, BC, Canada V1Y 8A6
cell: (250) 859-0752
andrew@pricingstrategies.ca

Andrew Gregson has 15 years of experience as a business consultant to small and mid-size businesses in Canada, the United States and the Caribbean. To date, Andrew has analyzed and assisted over 130 businesses in the service, wholesale, distribution, manufacturing and logistics sectors ad is the author of Pricing Strategies for Small Business.

Full Interview on SPARK: Andrew Gregson on Online Dynamic Pricing

Posted on April 4, 2011 by andrew.gregson

Right now, we’re putting together a special “hot deals” episode of Spark, focusing on the intersection of technology and shopping. As part of it, we’ll look at the trend of online dynamic pricing. A recent Slate article explains:

In its most brazen form, it works like this: Retailers read the cookies kept on your browser or glean information from your past purchase history when you are logged into a site. That gives them a sense of what you search for and buy, how much you paid for it, and whether you might be willing and able to spend more. They alter their prices or offers accordingly.

To find out more about dynamic pricing, Nora interview Andrew Gregson, the author of Pricing Strategies for Small Business. You can hear the full, uncut interview by clicking here, or download the MP3. [runs 12:42]

TIPS TO SUCCESSFUL PRICING. Part 5 of 5

Posted on February 21, 2011 by andrew.gregson

Always when I begin my speeches or my workshops, I tell the participants that I cannot instruct them to price their widget at $4.95. Rather, I plan to teach my audience advanced ways of thinking about pricing and several methodologies to help them make informed and intelligent pricing decisions.

Four tips on making your price non-negotiable.

Use humour. In my former business, we had customers who would brandish a clearly marked item, say $5.95, but still ask “what’s my price?” My best sales person typically responded with “Five thousand dollars but with your discount, today it is $5.95”. We never lost a sale with this approach. The laughter cemented a relationship and brought us referrals.

Plan B. If the customer finds the price too high, offer a bit of respect for the financial position. If the first item has 16 features, is priced at $300.00, but the customer does not buy because of the price then go to plan B. Re-direct the customer to a lesser item with only 12 features – pointing out what features are lost – but with a smaller price tag, of course. You are not yielding margin dollars here, just directing the client to a price point he can afford.

Be brave. Price is often an indicator of quality. German made cars are not really any more costly to manufacture. Diamonds can be found in beach gravel in Angola. So why the high prices? In a Nielsen study conducted many years ago, focus group participants chose the more expensive of 2 identical items over 57% of the time. A further study showed a strong correlation between high prices and fashion goods. If you have teenagers, why can’t you convince them to wear cheap sneakers instead of those $150 high tech track shoes?

Have a clear understanding of what benefit the customer is trying to purchase and direct your sales effort at that point. In 1954 Dupont introduced a new polyethylene resin used in pipe manufacture. Until that time, all polyethylene pipes had been made from an off-grade resin. While pipe produced from the new resin looked exactly like pipe made from off-grade resin, it had a longer life than competitive pipe and could withstand greater pressure. It sold at 1.9 times the price of the original pipe. The secret for success in selling the more expensive pipe was highlighting the costs of digging up burst pipe for replacement.

Be brave. In a sliding market your company must stand out, must be unique and must offer especially desirable benefits for the customer.

Contact Andrew for your next meeting:
Andrew D. Gregson B.A., M.A. M.Sc.(Econ)
http://www.pricingstrategies.ca
101-1735 Dolphin Ave.
Kelowna, BC, Canada V1Y 8A6
toll free: (888) 959-0752
Andrew@pricingstrategies.ca

TIPS TO SUCCESSFUL PRICING. Part 4 of 5

Posted on February 14, 2011 by andrew.gregson

Having a Unique Selling Proposition is the first step in knowing how to improve your prices. After all, if your business is the same as all the others on the street then you will compete only on price and prices will inevitably grind down to the lowest possible level.

What is a Unique Selling Proposition? First, each advertisement must make a proposition to the customer – Buy this product, and you will get this specific benefit. Second, the proposition itself must be unique – something that competitors do not, or will not, offer. Third, the proposition must be strong enough to pull new customers to the product or service. Fourth, it must paint a gripping picture.

These are some unique selling propositions that were pioneers when they were introduced:

Domino’s Pizza: “You get fresh, hot pizza delivered to your door in 30 minutes or less — or it’s free.”
FedEx: “Your package absolutely, positively has to get there overnight”
M&M’s: “The milk chocolate melts in your mouth, not in your hand”
Wonder Bread: “It helps build strong bones 12 ways”

How can the small business owner apply alchemy into cash?

Here is a quick test. Open your local Yellow Pages or any advertisements and check out the competition. What are they doing to make themselves stand out in the crowd?

Have you been servicing the local market since 1899? Do you demonstrate reliability and longevity and are not a fly by night operation. Do your servicemen vacuum after themselves? Do you have the only ‘trendy” colour scheme in town or the fastest snowmobiles?

What makes your business unique and does it fit the above criteria? If all you can offer is “we have better service” then you are in the commodity market. And if you are offering the same product as everyone else – snowmobiles from Yamaha, software from Microsoft or roofing tiles from DuPont – you can still find ways to differentiate the way the company delivers the undifferentiated goods. Do you offer what the competition cannot offer? Do you offer service in the home? Or on Saturdays?

Make yourself special by offering something that makes you stand head and shoulders above the crowd and then charge for it.

TIPS TO SUCCESSFUL PRICING. Part 3 of 5

Posted on February 7, 2011 by andrew.gregson

Paint a Picture

Customers will ask you the price at some point in the sale. You can choose to present the price in its raw form or with a tasty dressing.

30 years ago, I was present at an early morning sales training meeting conducted by a heavily overweight Maytag salesman. He was struggling to explain to a sleepy crowd of salespeople why the price of the Maytag was justified. He took the engineering approach and explained the special alloys of the springs and other technical details that caused many eyeballs to roll upwards in boredom. All the while, the trainer moved a small stairstep to the side of the washing machine and stepped up and into the open mouth of the washing machine. As surprise washed over the assembled salespeople, he held his hands above his head and cried out, “This is heavy duty”.

A bit of homespun, down to earth drama in the presentation of a quality difference goes a long way to building value in the minds of the customer before you present the price.

Moreover, the price needs accessories. Present your price by sandwiching your price between value and benefits. Value, then price, then value.

So, this washing machine is the heaviest duty on the market and has seven cycles. The price is $700.00 and that includes delivery, installation and removal of the old machine.

The hearing aid you have been looking at has directional microphones so you can hear your grandchildren in crowded noisy rooms. It costs $2000 and will be custom fitted to your ear canal by a licensed audiologist.

My final comment is to avoid presenting your price until you have sufficiently built up the value side of the ledger. If the price is presented first, the potential customer has been instructed by you to focus on price to the exclusion of all other factors. If your price is not the lowest, there will be no sale.

TIPS TO SUCCESSFUL PRICING. Part 2 of 5

Posted on January 31, 2011 by andrew.gregson

How does everyone else do it?

The answer to this question reveals how much businesses find the path of least resistance but at the most important juncture of the business.

In so many small businesses pricing goods and services is often based on guesswork. These are the WAG, SWAG and STICK methods of pricing.

WAG is a highly technical, time-honoured acronym for a pricing method used by practitioners with long experience in the industry or trade. This is an experience based method for pricing where trial and costly errors have already taken place. If for the past ten years, it has cost $5000 to renovate a bathroom then presumably it will always cost $5000 to renovate a bathroom. That is why WAG is the acronym for Wild Ass Guess.

Faced with creeping labour costs or perhaps sudden spikes in the price of plumbing fixtures, this method is frequently unable to cope. There is simply too much information that must be kept in the estimator’s head to stay current and remain competitive and profitable. Estimators are also human and tend to respond to the last comment they had from a customer. If that comment was negative because the customer thought the price was too high, then the price on the next job will drop.

The SWAG method, is also an acronym - a scientific wild-ass guess. As the name implies, there are some numbers to back up the experience based approach. “OK, so that job will take 4 men 5 days to complete and I pay them $20 per hour. With labour cost at $3200 and add 1/3 for materials and then 1/3 for profit, that should be about it.” This rough and ready method frequently misses hidden costs.

Finally, the STICK method is the name given to the clumsy and time consuming method of working out the costs of each nail, foot of strapping, 2 by 4, pot of paint and labour to the nearest 15 minutes to arrive at a total cost.

STICK is, in fact, an adaptation of industrial manufacturing cost accounting methods to service providers and custom builders. I have seen some very elaborate spreadsheets meant to cope with the vast amount of information. The advantage to this method is that, having gone to the trouble of detailing every aspect of this “virtual build”, you have a bill of materials for the purchaser and a plan for the carpenters.

There are two principal disadvantages to the STICK method. First is the speed factor. You will appreciate that this is an immensely time consuming method. Second is that, having committed so much time and effort to the quote, the price is not easily altered to reflect customer expectations. In other words, if the quote is $7000 and the customer’s budget does not extend beyond $5000, you cannot easily and quickly find the savings to meet the value expectation. There is simply too much information on the table to alter the quote simply and easily. The only line item that can easily be altered is the bottom line – the profit line.

In article ONE, I explained how most businesses follow the herd to their disadvantage. This article lays bare current pricing methods and their profit disadvantages.

TIPS TO SUCCESSFUL PRICING . Part 1 of 5

Posted on January 24, 2011 by andrew.gregson

Don’t follow the crowd!

For most small businesses, the everyday pricing regime starts with checking the competition’s rates and prices, and then following the crowd. This is even the recommended strategy in many popular guides for small business.

During the days of prohibition, 25 of Chicago’s top bootleggers were rounded up in a surprise raid. During their arraignment, the judge asked the usual questions, including the occupation of each suspect. The first twenty-four were all engaged in the same activity. Each claimed to be a realtor. “And, who are you?” the judge asked the last prisoner. “Your honour, I’m a bootlegger,” he said. Surprised, the judge laughed and asked,” How’s business?” “It would be better”, he answered, ‘if there weren’t so many realtors around.”

The upside is that this strategy is simple and easy. You don’t spend all that work, that time or your money to develop a unique selling proposition to command the full value for your services or product and you don’t have to go out of your way to be better than all the rest.

But following the crowd is a lazy strategy that leads to mediocrity.

Money is probably left on the table since the business is now just one in the herd and the product or service is sold at a price which is the average- where half of the competition is losing money. Remember that price is an indicator of quality in many customers’ minds. A standard service at a standard price does not compel a potential customer to buy from you.

Don’t get pushed around by the last customer you served. Being told that a competitor is selling cheaper can panic some business owners. Altering the price can lead to a permanent slide in margins and profits.

Rewarding the last complaining customer with a price reduction punishes the good customers who have supported your business by paying the full price willingly and uncomplainingly.

Remember that competing on price alone caters to the worst customers who show no loyalty and will hunt endlessly for the lowest price in town. My suggestion – find a way to make your company stand out and price accordingly.

Profit Making Through Pricing at OUC with Andrew Gregson

Posted on January 18, 2011 by andrew.gregson

Profit Making Through Pricing
When it comes to your business and selling your product, have you ever wondered if there is just a better way of pricing that would allow you to compete better? Learn how to increase sales without dropping your price. Gain detailed analytical solutions needed to transform a humdrum business into a profit making machine.

This workshop will broaden your understanding of true costs, show you how to pre-determine profits and will teach you to price with confidence.

The workshop provides practical planning tools and processes, with case studies and practice sessions designed to enhance your business skills.

Course code: MGR 283, CRN: 80610
Feb. 22 & 24, Tue & Thu, 6 – 9 p.m.
$135 + HST

MISSION IMPOSSIBLE

Posted on January 10, 2011 by andrew.gregson

MISSION impossible: charge more, sell more and increase customer NUMBERS.

A common mistake made by business owners is to assume that their purpose is to set a price for a product rather than for the customer segment. Identical products or services can be sold at lots of different price and profit levels.

In the 1970’s, a Swedish manufacturer of mining equipment, sold worldwide, could not supply a much needed rubber grommet for its hard rock drills. When the situation became desperate, one resourceful area manager went off in search of an adequate replacement, in order to keep the customers’ drills working. After a few enquiries, the area manager was directed to a rubber component manufacturer in Vancouver. When he produced a much worn example of the grommet and asked if they could make this for him, he was astounded to be told that they had, in fact, made the original he had in his hand. He was even more astonished to learn that the over-the-counter retail price to him was less than 10% of the price he would normally have paid the mother company. Based on cost to manufacture, this small item warranted a low price. But in a drilling equipment application the replacement grommet was costly simply because it was a microscopic portion of the total machine price and an even tinier portion of the dollars per hour lost when the grommet failed and the machine stopped producing. Therefore, the price reflected not cost to make, but need in that market segment.

In a more recent example, the price of rare earth metals has risen as China restricts exports. Niobium is essential in every cell phone on the planet but the sharp rise in price has not had any impact on the price of cell phones. This is because only a ¼ of one cent’s worth of niobium is used in each phone. Sellers of niobium, whose customers manufacture cell phones, have vastly increased prices and profits but the price of cell phones has not risen.

Purchasers can and do evaluate your product or service in terms of reputation, durability, reliability, after-market service, freight costs, installation, inconvenience, and payment terms. Your business and your sales offering, needs to address important factors like these, in a way that means something to the customer. Otherwise price becomes the sole, only and determining factor that makes a customer buy from you instead of the competition.

The following three steps, with accompanying examples, illustrate how to do MISSION IMPOSSIBLE. Every businessman’s dilemma can be overcome using innovative solutions and result in increased sales, increased profits and more customers.

Analyze your customer and press the hot button

In 1954, DuPont introduced a new polyethylene resin used in pipe manufacture. Until that time, all polyethylene pipes had been made from a by-product of off-grade resin. While the new pipe looked exactly like pipe made from off-grade resin, it had a longer life than competitive pipe material and could withstand greater pressure.

After the product’s shaky entry into the market, DuPont developed a strong promotional program for the new pipe which communicated its notable benefits. Sales grew strongly despite the fact that extruders sold the pipe for between $9.50 and $13.00 per 100 feet vs. the $5.00 to $7.00 price for pipe made from typical resin. This price ratio, almost 1.9 is greater than the relative “lives” of the pipe would suggest a price imbalance.

But there was a secret in this strategy’s success. In a typical use of this pipe, a farm application, the pipe goes underground. It is clear that if the pipe bursts, it would have to be dug up- a time consuming and expensive chore. The value or utility of the pipe was greater precisely because the salesman focused attention on the pain of having to dig up burst pipes more often than was necessary now that new pipe was available. The sales programme was successful because it pressed the hot button labelled “dig all day in the cold mud looking for busted pipe”. At that point, the price difference became irrelevant.

market the BENEFITS not the features.

Unless your customer is an engineer, the latest product specifications are gibberish. Your new resin, new alloy or new gadget must answer the WIFM question if it is to be sold. WIFM = what’s in it for me?

It could be new drill bits with titanium points. They are harder and can drill longer without sharpening. But that has to become a tangible benefit by translating from “longer between sharpenings” to 14% more holes drilled. At that point, the potential user will price out his down time for drill changes and then the cost of re-sharpening. Price has become a secondary issue compared to the cost savings.

before setting price levels, examine the customer perception of what is a cost.

One manufacturer of laboratory instruments was plagued by a high number of very small orders for a limited array of repair parts. On analysis, the product manager found that end users were annoyed at having to place these small orders because the administrative and shipping costs were greater than the parts prices. Furthermore, the manufacturing company was losing money on the parts for the same reason.

Even more costly, customers were upset at the downtime caused by not having the correct and low value parts in stock. A few customers, with a multitude of similar model instruments, seemed capable of keeping the right mix of parts in stock but others, with limited experience, could not develop good inventory rules. To alleviate the problem, the product manager developed repair kits with an assortment of parts and offered them to customers using a wider variety of instruments. The company’s picking costs went down, average invoice value went up, profits went up, shipping costs went down, and customer satisfaction increased because instrument down time was minimised.

There are 3 common threads in all these examples.

In each, someone has done a careful cost benefit analysis from the CUSTOMER POINT OF VIEW. Even if the customer cannot articulate it well, the salesperson painted a vivid picture of the annoyance and costs of repeatedly digging up pipe, idle production because the right repair part had to be ordered, or down time costs whilst changing drill bits.

Secondly, the penalties were identified first, not the price. Price was introduced after the benefit picture had been painted in stark, primary colours

Thirdly, the price matched the customer specific situation and was MORE than would have been invoiced based upon cost and mark-up formulations.

Contact Andrew for your next meeting:
Andrew D. Gregson B.A., M.A. M.Sc.(Econ)
http://www.pricingstrategies.ca
101-1735 Dolphin Ave.
Kelowna, BC, Canada V1Y 8A6
cell: (250) 859-0752
toll:1-888-959-0752
andrew@pricingstrategies.ca
Andrew Gregson has 15 years of experience as a business consultant to small and mid size businesses in Canada, the United States and the Caribbean. To date, Andrew has analyzed and assisted over 130 businesses in the service, wholesale, distribution, manufacturing and logistics sectors.

7 PRICING MYTHS

Posted on November 30, 2010 by andrew.gregson

Businesses owners recycle old myths about their businesses and their industry in an attempt to simplify and understand their own circumstances. But the myths will not bear much close scrutiny. Here are 7 de-constructed myths.

1. ALL my competitors buy better so they can sell cheaper; and that explains my poor sales.

This is a trifle unlikely. Globalization of supply chains has made it simple for even small store owners to source the best. The suppliers play games, of course, with volume discounts, rebates and other sales devices to push up sales. But, to blame the supply chain for poor sales performance is a red herring that deflects attention from other business problems.

And a final comment – Why is cheap the only measure of value you offer your customer base?

2. Business owners deem that 45% of the time, price is the most important factor influencing a sale. Customers, by their own admission, go to a competitor because prices are too high, only 25% of the time. Quality and customer service rank higher in the customer mind when deciding whether to buy a second time from you.

3. Every customer who says we are too expensive, is RIGHT.

There are customers for whom free would be too expensive. Remember too, that sticker shock can be a buyer’s strategy to get you to lower your price. There are some customers who buy on price alone but they need to be gently pointed in the direction of a competitor.

4. If sales drop, then it is the fault of high prices.

Really? Wouldn’t industry figures indicate a general contraction of the entire industry, particularly during a recession? If market share remains the same, then price is not to blame.

5. Yes, but! If you look only at a few select items, to the exclusion of others, then my prices are bad across the board.

It is unlikely that all prices are poorly positioned. Most regular buyers of a particular product or service can recall 10 prices alone. That appears to be the maximum number of prices we can remember and only through constant reinforcement. So, in a store selling 1000 items, 990 things have no comparable in the mind of the buyer.

6. My costs are the only factor to determine prices.

Prices are determined by a whole host of factors NOT related to costs. Among them are: volume discounts; 30 days to pay; free delivery; free installation; free support; and free add-ons. These factors drive up costs but are not reflected in pricing.

7. Being the cheapest price is the only factor that influences a sale.

This cannot be true. With items of fashion or taste, higher prices are associated with better quality or social standing. There are cheaper sneakers than the ones demanded by teenagers so that they are “cool” in their social circle. And diamond rings would not be the symbol of undying love if they cost $4.95, right?