The 1% Windfall

1. Pricing is a powerful yet underutilized profit lever

A small change in price can have a big effect on a company's financial bottom line.

The 1% windfall. Many companies overlook the direct link between prices and profits. A modest 1% increase in price, assuming demand remains constant, can lead to significant profit gains. For example:

• A company with 5% operating profits would see a 20% increase in profits from a 1% price increase
• Major corporations like Sears, Tyson, and Wal-Mart could see operating profit increases of 155%, 81%, and 18% respectively from a 1% price hike

Underutilized strategy. Pricing is often neglected compared to other business initiatives:

• Most companies use arbitrary or outdated pricing methods
• Pricing changes can yield immediate results, unlike other strategies that require significant investment and time
• Few companies have a cohesive, strategic approach to pricing

2. Set value-based prices to capture customer willingness to pay

Value-based pricing uses the next-best alternative's price as a starting point and then adds or subtracts based on product attributes.

Customer perspective. Value-based pricing involves thinking like a customer when setting prices. This approach considers:

• The next-best alternative product
• How your product differs in quality, features, brand, etc.
• What premium or discount customers would pay for those differences

Moving beyond costs. Many companies mistakenly base prices solely on production costs. However:

• Customers' willingness to pay depends on perceived value, not costs
• Value can change rapidly based on circumstances (e.g., umbrellas during rain)
• Disassociating prices from costs allows companies to capture more value

Implementation methods:

• One-on-one pricing for single unit/customer sales
• Multi-customer pricing for broader markets, using demand curves and profit maximization analysis

3. Implement pick-a-plan strategies to attract new customers

Growing a business can be as straightforward as offering a new pricing plan that attracts new customers.

Activating dormant customers. Pick-a-plan strategies target potential customers interested in a product but hesitant due to the current pricing structure. Key approaches include:

• Ownership alternatives: Interval ownership, leasing, rentals
• Reducing uncertainty: Success fees, auctions, future purchase options
• Price assurance: Flat rates, all-you-can-eat plans, peace-of-mind guarantees
• Overcoming constraints: Financing, layaway, prepaid options

Real-world success. Companies have seen significant growth through new pricing plans:

• Terminix increased renewable termite plan sales by 12% with a new inspection and protection plan
• XOJET grew revenues by 80% using dynamic allocation and targeting high-volume customers

4. Use versioning to serve different customer segments

A slight tweak to a product's characteristics can attract new customers.

Good, better, best. Versioning involves creating multiple product variations based on a core offering:

• Allows companies to serve customers with different willingness to pay
• Captures more value from high-end customers while still attracting price-sensitive buyers

Meeting unique needs. Versions can also target specific customer segments:

• Different package sizes (e.g., bulk vs. individual servings)
• Usage-based variations (e.g., professional vs. consumer software)
• Platform-specific versions (e.g., digital, print, and audio books)

Implementation examples:

• Restaurants offering bar, à la carte, and tasting menu options
• Software companies providing basic, professional, and enterprise editions
• Airlines selling economy, business, and first-class tickets

5. Apply differential pricing to maximize profits

Since some customers are willing to pay more than others, companies that offer just one price per product end up in a trap that I call a pricing catch-22.

Overcoming the single-price trap. Differential pricing allows companies to:

• Charge higher prices to less price-sensitive customers
• Offer discounts to price-sensitive customers without reducing prices for everyone
• Maximize total profits by serving more customer segments

Key tactics:

• Hurdles: Rebates, coupons, and sales require customer effort for discounts
• Customer characteristics: Pricing based on geography, age, or affiliation
• Selling characteristics: Quantity discounts, bundling, dynamic pricing
• Distribution channels: Different prices for online vs. in-store purchases

Real-world application: Hotels often use multiple differential pricing tactics:

• Rates vary by booking channel, season, and customer type
• Discounts for advance bookings, loyalty program members, and package deals
• Premium prices for guaranteed rooms or special views

6. Create a comprehensive pricing blossom strategy

The pricing blossom visually describes how to think about and create a comprehensive pricing strategy: the value-based price serves as the foundation from which three strategy "stems" bud out.

Integrating multiple approaches. A pricing blossom strategy combines:

1. Value-based foundation price
2. Pick-a-plan options
3. Product versions
4. Differential pricing tactics

Implementation steps:

1. Set the value-based "starting" price
2. Offer pick-a-plan alternatives
3. Create good, better, and best versions
4. Modify products to meet specific customer needs
5. Implement differential pricing tactics
6. Set prices for each tactic
7. Conduct cannibalization checks

Customization. The specific mix of tactics will vary by product and industry, but the framework provides a systematic approach to maximizing profits and growth.

7. Develop a culture of profit to support better pricing

A culture of profit is a business environment that supports and encourages employees of a company to price for profits and growth.

Breaking pricing myths. Key principles to instill:

• Set prices based on value, not just costs
• High-volume customers don't always deserve the lowest prices
• Discounts today don't guarantee premium prices tomorrow
• Higher margins aren't always a sign of pricing success

Building confidence. Create a value statement for products:

• Articulate unique selling points vs. competitors
• Empower employees to confidently discuss and defend prices

Ongoing initiatives:

• Speak in terms of net prices (after discounts)
• Monitor competitors and changing product value
• Incorporate profitability into sales compensation
• Host regular pricing strategy discussions

8. Adapt pricing strategies for recessions and inflation

There are many situations (new competitor, recession, and inflation) when demand for a product decreases. In these cases, a pricing blossom strategy can be implemented that maintains price and implements a series of discount tactics.

Recession strategies:

• For products "traded away from": Maintain prices, implement targeted discounts
• For products "traded down to": Consider modest price increases, add value

Inflation responses:

• Demand-pull inflation: Raise prices cautiously, reduce discounting
• Cost-push inflation: Adjust prices based on whether product is traded up or down

Key tactics:

• Offer financing options or payment plans
• Create "fighter brands" (lower-priced alternatives)
• Emphasize value proposition to justify prices
• Use versioning to capture different willingness to pay
• Implement targeted discounts rather than across-the-board cuts

9. Respond strategically to new competitors

When a new competitor enters the market, it's natural to consider offering discounts to keep customers from defecting. Resist this temptation.

Maintain price integrity. Avoid knee-jerk price cuts:

• Many customers will remain loyal
• Across-the-board discounts reduce profits unnecessarily

Emphasize differentiation. Focus on communicating your product's unique value:

• Clearly articulate advantages over the new entrant
• Train frontline staff to confidently discuss value propositions

Targeted tactics:

• Implement selective discounting for at-risk segments
• Create "fighter brands" to compete on price without devaluing core offerings
• Offer bundles or value-added services competitors can't match
• Use pick-a-plan strategies to lock in customer loyalty

10. Monitor and adjust prices as value changes over time

To keep prices consistent with value, companies need to build a value-and-cost-monitoring system, or at least institute periodic "right price" evaluations.

Continuous evaluation. Regularly assess factors affecting product value:

• Economic conditions and consumer budgets
• Competitive landscape changes
• Shifts in consumer preferences
• New product introductions (yours and competitors')
• Input cost fluctuations

Adjustment strategies:

• Update value-based pricing analyses
• Fine-tune differential pricing tactics
• Introduce or modify product versions
• Adapt pick-a-plan offerings to changing needs

Organizational support:

• Create systems to gather competitive intelligence
• Conduct periodic pricing strategy reviews
• Empower frontline staff to provide market insights
• Foster a culture of pricing awareness across departments

Last updated: October 12, 2024