7 reasons why your price increases fail (and your bottom line suffers)
This will probably sound familiar:
“When it comes to the prices we pay, we study them, we map them, we work on them. But with the prices we charge, we are too sloppy!”
Jeffrey Immelt, CEO of General Electric, in 2006
Pricing is the most important driver of profit, but unfortunately managers and entrepreneurs seem to neglect the issue. In one of our global pricing studies we asked over 3,900 high-level decision makers from all major service and manufacturing industries around the world, many of them from Europe, how they set their prices. The main findings in a nutshell: many of them don’t get the money for the value they deliver. And weak pricing cuts their profits by 25 percent.
But what are the main hurdles in becoming a pricing champion and how do you get there, nevertheless?
Untapped pricing power = lost profits
Pricing power is the ability of a company to get the prices it deserves for the value it delivers to its customers. Companies who have pricing power can charge a premium even in a commoditized or competitive market.
In other words, pricing power is a key capability and essential to protect profits. In turbulent times like these and given the generally poor price performance, many companies can’t afford to lose even a few percentage points of profit.
But what distinguishes the power pricers from low performers when it comes to pricing? Primary drivers for high pricing power are customer value and brand.
Every company has the ability to achieve high pricing power. If a company can offer its customers real value and communicate that through a top brand, this will translate into money. Unfortunately, in many cases managers deceive themselves and excuse the weak performance of their company by blaming others.
Asked what or who is responsible for their weak pricing, managers often blame “tough competition”. Another favorite is to blame customers, and stating that the customers are very consolidated and have tremendous negotiation power is very common. Often, the problem is felt to originate in the company’s own product assortment is guilty: “We sell a commodity product.”
These are all excuses that avoid getting to the bottom of the problem. Poor pricing performance is not a question of fate; it is largely up to each company to either become a pricing champion or go the road of devastating price wars.
There are no structural reasons for pricing weakness, but three fundamental causes that make the difference:
- insufficient monitoring
- a lack of pricing know-how
- and poor strategies
A few simple steps can help tremendously when it comes to pricing. Our studies show that power pricers do their basic pricing homework and have a different mindset. They simply avoid the biggest mistake, which is to focus strictly on market shares and volume.
You have to ensure you are clearly focused on profit instead of volume or market share. By redirecting the whole organization towards pricing power and making it one of the top KPIs, successful companies achieve higher profits and perform better in many aspects. Those who mainly focus on volume and market share tend to get tied up in price wars.
Here are 8 pitfalls to avoid when thinking about prices and setting or increasing prices:
1. By focusing on market share, you start price wars
Price wars are generally sparked by an unhealthy obsession with market share and volumes. Many decision makers describe their industry as volume oriented. As one study respondent once pointed out:
“If you ask your people to strive for volume, you should not be too surprised when you end up in a price war.”
The effect of price wars on profits is disastrous for all sides. There are no winners— except the customer. That’s why companies should avoid price wars if at all possible and it’s up to their managers and owners to encourage their employees to strive for profit, not for market share.
2. You underestimate inflation threat
Neglecting prices and being weak at pricing will also prove devastating with inflation around the corner. What will happen if you are weak at pricing, you will typically achieve only half of your targeted price increases. That means you only get 53 percent in the end, although you wanted 100 percent of your targeted price.
What typically happens is that managers use the inflation rate as a benchmark for price increase targets. That is is fatal for those who are weak in price implementation: because customers will negotiate this down, you won’t make your target price. And you’ll end up eating the difference: the result is that your profits will suffer. Managers and entrepreneurs need to set higher targets right from the beginning.
And you must know what your execution success rate is and set your price increase targets accordingly. Setting price increase targets sounds easy enough: the boss calculates the cost increases, and that’s what the team has to implement. In many cases it is really done that way.
But what is often forgotten is the price implementation or price execution success rate. As companies achieve on average only half of their planned price increase, managers need to develop specific price increase targets by product, category, segment etc.
3. You give discounts and goodies in return for price increases
Although price increases are essential for survival in inflation periods, managers and entrepreneurs are mostly insecure about how to plan and implement price increases. There are a few steps though that can help them.
First and foremost, you need a consistent and systematic process for pricing. For every single activity companies have detailed processes with descriptions and explanations, but when it comes to price increases many don’t exactly know what to do. Such a process includes starting with the price increase targets, selecting the right instruments, preparing the price increase and, finally, executing it.
The entire process must be supported by systems tools and data; as always, you have to monitor the result. That may sound like a no-brainer. But many companies have no clue about the real net effect of a price increase. Why? Because price increases are often accompanied by “goodies”, discounts, give-aways, customer-friendly payment terms, etc. Many fail to factor in the effect of these customer-friendly measures.
The pricing process involves several detailed steps and activities. Selected aspects – strategy and leadership, price instruments, and surcharges – are described below.
4. You don’t fight hard enough for the necessary price increases
Companies often think they are extremely smart to pursue the following strategy: they make smaller price increases than needed or than the competition is applying, then combine that with higher advertising spending, and hope for higher profits through high volume in shares.
This strategy does not work in reality. Companies should not settle for lower prices, but fight for the necessary increases instead. At the end of the day, volume and market share will not save you.
5. You don’t think creatively enough about prices
Also, it helps to think creatively about prices. Besides a classical list price increase, there are tens or perhaps even hundreds of price instruments available. The key is to go through the list of possible instruments, analyze which one fits your specific situation the best and then make a conscious decision as to which instruments to take – be it discounts, shorter payment terms, smaller package sizes and so on.
Take this example: the price of a one-liter bottle is known by most consumers. Almost nobody overestimates the price of a one liter bottle of water. But customers have a much lower price awareness of the small pack. More importantly, 50 percent overestimate the price.
If you want to increase the price of your water bottles, the solution seems clear: don’t touch the price of the one liter pack, but apply a disproportionally high increase for the small pack. This is a general message that applies to B2B as well as B2C companies: set different price increases by product/customer groups based on the level of price elasticity.
Introducing a surcharge is another alternative. Many airlines have already gone too far with that instrument, but in other industries there is still a lot of potential.
Why do surcharges make sense? Because the surcharge elasticity was and continues to be significantly lower than the elasticity of the base price. We don’t suggest introducing surcharges across the board and blindly. The idea is to think broader, to be creative, and find price elements with high acceptance and low elasticity.
6. You weren’t the first to set an ‘anchor’ price
Companies often ask us whether they should be the first ones to make a price move. If a company is or wants to be the leader of an industry, then it must make the first move and set the anchor price.
Studies, scientists and Nobel Prize winners have revealed that nothing is more influential in determining the outcome as setting the initial price or, if you will, the anchor price. As you can’t be sure that your competition is doing the right thing, make sure that you are the first one to set and communicate the anchor.
Many but still too few companies are doing that. When you knock at your client’s door and ask for higher prices, the clients are already informed, they already know about the price change, and the bad news has already been communicated.
7. You don’t reward your sales team right
Implementing the new price is the job of the sales department, but very often sales is struggling with this task. Either they only manage to implement a small part of the planned price increase or they give away goodies and discounts in exchange for the price increase; the bottom line being that nothing is achieved.
What can be done to improve the price implementation? Simple on-top incentives are the solution— on top money that is only granted if certain price implementation targets have been achieved or overachieved. Let’s take a concrete example.
A sales rep had a revenue base of one million. He managed to raise the price by five percent, which was two percent points more than the minimum price increase target, in this case three percent. Two percent points means 20,000. Out of this 20,000 he got 25%, which is 5,000. The remaining part went to the company. The pay-out was on a quarterly basis, and only after the clients had paid their bills with the increased price levels. There was no negative cash effect for the company, no need for budgeting anything. That’s a real win-win situation.
After having gone through the different steps of the process, it has become clear that this systematic approach not only pays off, but also is a must to achieve good results. This fact is also underlined by the two real case examples below. Both of them are in B2B business, the same industry, one followed the systematic process, the other announced the price increase and just scraped by. Both companies were striving for a similar price increase: around seven percent. At the end of the day one achieved 1.2 percent, the other one 6.3. That is a plus of 425 percent. That clearly proves the success of a systematic approach.
The formula for success is: The better the pricing know-how, the higher the pricing power, and the higher the profits. The five key recommendations are:
- Redirect your price strategy to achieve higher profits, rather than volume or market share. Introduce pricing power as a new KPI.
- Pay particular attention to the pricing of new products and services.
- Improve pricing expertise in sales, marketing and management.
- Consider pricing implications already when developing new products
- Make your company inflation-safe by improving your price implementation and setting high price increase targets.
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