Give me higher prices!

Business research shows us that 80-90 per cent of poor pricing decisions feature under-pricing.

Business research shows us that 80-90 per cent of poor pricing decisions feature under-pricing.

I think it is accurate to say that most businesses in Malta have at some time or another used price discounting as a marketing tactic (even the real estate industry innovatively tried it with limited success). In addition, the general wisdom seems to be that the right price tactic (lower your prices, preserve the status-quo or increase your prices) depends on your business objectives such as survival of business, profits, market share and cash-flow.

It all makes sense but perhaps we have all gone too far. In fact, business research shows us that in mature economies the trend is that customers are increasingly treating products and services as commodities and therefore the only thing that seems to matter is price! This obsession with low prices damages brand equity and cuts into profits. I reckon managers and business people need to fight back - stop price discounting and hike their prices back up again.

Are you crazy I hear you say? Hear me out: customers have developed low expectations and are increasingly becoming disengaged. Every buying decision is a price comparison (a search for the lowest price) and no more. In this situation, no marketing communications or branding will persuade the customer of your products' benefits or innovations. It is all about price, price, price and this is not good for those of you wanting to offer something different or better than the run of the mill competition.

Let me give you an example: I chose my internet service provider not because of brand loyalty or because I appreciated the benefits of their value proposition but because of price! Or I know of a premium brand in the photocopy business which recently lost an important account because of price rather than after-sales service, technical support or technological innovation of their machines. Still not convinced? Please allow me to share some facts and figures which should make you sit up and take note.

On the subject of price discounting, business research shows us that price discounts actually hurt the bottom line. McKinsey & Co calculates that on average a one per cent reduction in price typically produces an 11 per cent reduction in profit. Even more worryingly it is calculated that a one per cent price-cut needs a 3.5 per cent increase in volume to maintain profits. Few markets respond so well!

On the subject of price deflation, again, business research shows us that 80-90 per cent of poor pricing decisions feature under-pricing. Put another way, the odds are that at least eight out of 10 prices in your industry are under-priced. The same research actually goes on to say that a one per cent increase in prices improves operating profit by 11.1 per cent. This means that a price increase in your business would actually be more effective than a one per cent reduction in either fixed costs (which on average only has a +2.3 per cent impact on profits) and variable costs (which on average only has a +7.8 per cent impact on profits).

By the way, I am not saying that lower prices are not good for the consumer. What I am saying is that businesses sometimes think that lower prices are the only way to compete in business.

I find McKinsey's research immensely insightful and something that needs to be loudly explained to managers and business people. I think it was Prof. Mark Ritson of London Business School who said: "Pricing is the worst managed of all marketing areas. How prices are decided is often a mixture of voodoo and bingo." He is so right, isn't he? How many of you determine price by either marking-up from your cost base or by looking at what your main competitors do? Or there might be those of you who will claim that they ask the customer by presumably engaging an expensive market research firm.

Sounds better (to ask your customer, doesn't it) but just let me quote from the award winning business article The Price Is Right (Or Is It?) by David Lyon (2002) which claims that when customers were asked how much they would pay for something, it became apparent that upon hearing such a question, many respondents immediately shifted into bargaining mode and produced opening offers that weren't even remotely reflective of what their real world behaviour would be. The truth is that the right price is arrived at by understanding the value of your product / service to the customer and not by asking the customer how much he/she would pay for it.

I recently came across a study on purchasing behaviour which looked at the price elasticity of organic lettuce and free-trade coffee. The results were outstanding - customers were most likely to consider a more expensive product when it was between 50-80 per cent higher than the lowest priced product. This price difference aroused curiosity. It made customers want to investigate why the price was significantly higher? What were the added benefits of this product to justify such a price hike?

Unfortunately, most companies do little or no serious pricing research and do not have a pricing strategy in place. I would say that the bulk of companies (eight out of 10) ignore the benefits of having pricing strategy. What a lost opportunity given that some of you could be charging much more! But to do so you have to break the mental obsession of customers to only focus on price.

Conclusion: How do you know what the right price is? The starting point of this must be the strategic decision to compete on several other competition dimensions rather than just price namely (my list is non-exhaustive): quality, customer fit, branding, customer relationships, bundling, product/service features and availability.

The fact is, however, that some of your prices are too low and some customers would pay more but none of your customers will tell you this. Break the psychological obsession with price by going against the current, hike up your price and arouse interest and be ready to communicate the benefits of your product and service. You could improve your bottom line with such a counterintuitive decision!

Mr Fenech is managing director of Fenci Consulting Ltd.

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