Per Sjofors, aka “The Price Whisperer,” founded Sjofors & Partners and is a thought leader on using price for higher growth and profits.
The CEOs I speak to daily are often scared out of their wits about price increases. I hear comments like, “We have not dared to raise our prices for seven years, and I fear we will lose too much business if we do.” I also hear, “We tried to increase prices a couple of years ago, and it backfired, but now my board tells me we have to. How can we successfully increase prices now?”
As Warren Buffet has said, “The single most important decision in evaluating a business is pricing power.” Pricing power is the ability to increase prices and not lose sales volume. How can that be possible? Do higher prices not always lead to lower sales volume? Not at all. Pricing power comes from differentiation that is meaningful to the buyers in a company’s market.
Take commodities: A commodity is a product or service where potential customers make their purchase decision between identical or near-identical choices based on price alone. The lowest price typically wins the business, and it often becomes a race to the bottom. If the product or service is a total commodity, then it seems like it cannot have pricing power. However, while it can be difficult to gain pricing power for commodity products or services, it is not impossible.
Differentiating What Customers Want
As previously said, pricing power comes from meaningful differentiation. There is a difference between what customers “want” and what they “want to buy.” The latter is related to their ability and willingness to pay, and thus meaningful for a company to know. The former is related to dreams and aspirations. Here are a couple of examples:
• The parent of a couple of young kids might “want” that sports car but will buy a mini-van or SUV, even if the price is the same.
• A restaurant guest might “want” that huge rib-eye steak but will settle for a pedestrian hamburger.
Companies communicate in different ways with their customers, which often gives the company a good view of what their customers “want” and less so of what they “want to buy.” In fact, companies often confuse the two. Consider one of the most spectacular business failures in the last 25 years: the then-called Iridium SSC. This company provided global mobile phone coverage via a set of 75 satellites. It asked its potential customers, “Do you want mobile phone coverage wherever you are on the planet?” and got a resounding, “Yes!”
But they failed to account for some crucial details: The phone was as big as a brick, it cost $3,000, and calls would cost $3 to $8 a minute (in 1999). It could not be used inside or in cars. A great alternative to regular mobile phones—for someone finding themselves in the middle of the Sahara Desert or the ocean. Ten months after launch, the company filed for Chapter 11 bankruptcy, wiping out billions of investors’ money. The company, now under new ownership and with a different customer focus and targeting, and an increased service range, is surviving but is still not profitable.
The bottom line is that the company understood what its prospective customers wanted, but not what they wanted to buy. And they did not buy.
This is where meaningful differentiation comes in. Companies need to understand how they can differentiate themselves so that their customers increase their willingness to buy and willingness to pay, thus gaining pricing power. Some companies will try to do this with A/B testing, but this becomes very involved. Say a company wants to A/B test:
• Six different product or services features.
• Six different marketing messages.
• Six different marketing channels.
• Six different customer segments.
• Three different sales channels.
• Three different sales methods.
• Three different payment models.
• Six different price levels.
The result is 209,952 combinations—quite impossible to test. So companies instead try a couple of different marketing messages and a few different prices, but often done separately, not in combination. If the company sells a true commodity, it is unlikely that this will discover the differentiators that will lead to any substantial pricing power. Instead, testing might just confuse its customers.
Consider conducting or commissioning willingness-to-pay research into your company’s marketplace. (Full disclosure: My company offers this service, as do others.) This research can discover how each of the variables mentioned above, separately and in combination, affect how the company can set prices to match the maximum amounts that customers are willing to pay for your type of product or service.
Another option is to perform a detailed competitive analysis and find what is different between your company’s product, service and marketing messages and those of your competition—something you have probably already done. If you cannot find significant differentiators, consider how to add products to services, services to products, or adjacent services to your existing services to further differentiate yourself.
Next, approach 25 prospective customers who are not current prospects, customers, or friends and family and anonymously ask which of these differentiators they think are most valuable. You will likely find there is consent among the prospects around one or two differentiators they most appreciate.
Then, find another 25 prospective customers and ask them, again anonymously, “What price for the product/service with [main differentiator #1] is so cheap that you think the vendor will overpromise and underdeliver?” Also ask, “What price for the product/service with [main differentiator #1] is so expensive you won’t buy it, however good it is?” Repeat this step for differentiator #2, preferably with a new set of 25 prospects. Take the average of the answers to the two questions for each differentiator, and you will have the price range for each, not below one price and not above another price.
Now, I don’t suggest that a pure commodity product or service provider can double its prices from this information. However, this can allow you to set prices several percentage points higher than your commodity competition—without losing sales volume. With the razor-thin margins of commodity providers, that can have a massive impact on the company!
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