Even though you may have many customers, you’re only addressing three categories they value: image, innovation and time savings. These categories simplify value pricing.
In Part 1, we addressed the concern that value is vague. We did so by recognizing the fact that even though each of us defines value a little differently, there is a commonality to our humanity allowing us to create categories of buyers based on what they value most - image, innovation or time savings. This week we’re going to address two more concerns - the complexity of value pricing and the ability to produce demonstrable results.
Value pricing is complex
As we saw last week, even though you may be dealing with thousands or hundreds of thousands of customers, you’re only dealing with three categories of value. These categories simplify the identification of market segments and value prices for each of those segments.
I’m sure some of you are thinking, “Dale, you have no idea how many products (SKUs) we sell. It isn’t just the customer that adds complexity, it’s the array of offerings we have.”
No doubt what you say is true. Two questions for you:
Why do you have so many SKUs?
Adapting Pareto’s principle, which 20% of them are producing 80% of your profits?
Regardless of your answers, the solution is to establish a process for identifying your 20% most profitable offerings, identify who’s buying them and eliminate the rest. Not only will you simplify your life, you’ll use your marketing dollars a lot more effectively. You’ll very likely free up a considerable amount of cash as well.
If that strategy is a little frightening to you, then eliminate the 20% least profitable SKUs. From experience I can tell you once you see how little impact it has on your sales and what a dramatic improvement is has on your profits, cash flow and employee productivity, you’ll quickly eliminate the next 20% least profitable until you arrive at my initial suggestion.
Which brings us to the next concern many business leaders have, being able to determine which results can be traced to value pricing and which are related to other operating decisions.
Often business leaders point out margin improvements can be achieved from a variety of operational changes including:
- Productivity improvements
- Sales force compensation arrangements
- More effective marketing
- Improved offerings
Or simply from an improving economy. So the question they ask is “How do we know the margin improvement came from value pricing?
The answer is all of these factors are, or should be, part of your value pricing strategy. You can’t establish an effective pricing policy without evaluating all of the factors that influence value creation. Recently I helped a client improve his margin on one line of business from 24.8% to 41% by streamlining the sales process and eliminating back office processing. We accomplished this without raising prices.
While we were evaluating his value creation process, we were also able to justify a 12.5% price increase by calculating the value of his offering. How? By identifying what he was selling was time savings and using demographics to identify the value buyers in his market were placing on their time.
With the 12.5% price increase, his margins more than doubled from 24.8% to 53.5%. If that isn’t a demonstrable result I don’t know what is.
Next time, we’ll discuss the two remaining reasons business leaders avoid value pricing - the perception that value is a moving target and price pressures.