Many companies are seeing their overheads increasing while they daren’t increase their prices, fees or rates. It is therefore hardly surprising if their profitability is declining year-on-year.
Worse still, there are companies that are dropping their prices in an attempt to win business. Dropping your price is often a fool’s game as there is always someone else who will do it cheaper. It is easy to come down in price and much harder to go up. Any price reduction will come straight off your bottom line.
If all your customer is interested in is the cheapest price, then in the near future you will probably lose that customer to a cheaper competitor. If you don’t increase your price by at least inflation each year, you are going backwards.
The effect of inflation
Even though inflation has been relatively low over the past five years, the cumulative effect of five years’ inflation is 18 per cent. That means that if you haven’t increased your prices for five years, effectively you’ve reduced them by 18 per cent.
Work by McKinsey and Harvard shows that pricing is the number one way for a company to optimise its profitability, more so than adjusting fixed overheads and variable costs. And yet Mark Ritson, associate professor of marketing at London Business School and MIT, once described most companies’ strategy on pricing to be a mix of Voodoo and Bingo.
Quite simply most companies don’t spend enough time planning their pricing and budgets for clients. Some clients ask me about payment by results. This is where a supplier or provider receives part of their payment linked to the quality and/or results of the work. Typically the payment increases with increased performance or results. In principle it is an interesting idea. In practice I have heard stories which make me cautious to recommend it.
Clients like it initially but then find it hard to accrue for it. Some companies have had clients renege on a deal, so make sure it is agreed in writing with the client CEO, managing director or financial director. I would caution against putting more that 5-10 per cent of your overall payment at risk with PBR. Some companies use it to hold back payment using it more as a stick than a carrot. So how can we improve the situation?
Strategies to price well
Clients tell me that the practical strategies and techniques have enabled them to increase their prices and profitability. So let’s look at a small selection:
1. Understand what your client really values in what you provide. How well-differentiated is your offering? The more differentiated you are from competitors and in ways the client really values, the more readily you can charge a premium price. Is your value proposition compelling? If they see you as the same as everyone else then you will be commoditised and bought predominantly on price.
2. Are your relationships with your clients and customers “buyer/supplier” or “peer-to-peer” where your expertise and knowledge are really valued? Are you a trusted adviser to decision makers or simply an implementer or doer from the perspective of a “messenger” client? (A messenger client is one that has no authority to say ‘yes’. All they can say is ‘no’).
3. Take a long-term view of your pricing. Don’t just consider today’s price to a client. Think about the longer-term implications if the business with this client were to flourish. If you start off under-pricing, it will have a major influence on how much you can charge this specific client next year, and the year after, and the year after. If you get it wrong at the start you will probably pay repeatedly in the future for this under-pricing mistake.
4. Don’t simply base your prices on ‘cost plus’ or based on hourly or daily rates. Think about value-based pricing. Don’t simply charge the same as your competitors. That simply emphasises the commodity effect.
5. Take time to think through your pricing. In many companies the budget is left until the last minute before presenting to the client. Spend more time on your budgets and you will reap the benefit.