Maximizing Profit Through Strategic Pricing

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Maximizing Profit Through Strategic Pricing

  1. 1. Maximizing Profit Through Strategic Pricing Robert A. McKinney Pricing Strategist with The McKinney Group, LLC Copyright 2009
  2. 2. The McKinney Group, LLC Effect of price on profit What is traditional pricing • Cost-plus pricing • Customer-driven pricing • Competition-driven pricing What is strategic pricing • Keys to strategic pricing • Differentiated-Value Pricing(sm) • Copier example 2
  3. 3. • Growth-oriented startup to $50MM • Competitive Strategy • Strategic Pricing • • Certified Managerial Accountant (CMA) • MBA, Strategic Management, Purdue University • Member: • Experience: 3
  4. 4. The McKinney Group, LLC Effect of price on profit What is traditional pricing • Cost-plus pricing • Customer-driven pricing • Competition-driven pricing What is strategic pricing • Keys to strategic pricing • Differentiated-Value Pricing(sm) • Copier example 4
  5. 5. Pricing affects the bottom line in many ways • Influences perceived value in marketplace • Influences how well a product will sell • Determines profit • Each 1% Δ in price = 8% Δ in profit Original Price Discounted price Price $114 Price $103 10% price cut Costs $100 Costs $100 Net Profit $14 Net Profit $3 80% profit cut! 5
  6. 6. While lower prices sometimes lead to more sales, more sales are required just to break even Total Profit = Profit per piece x Quantity sold $100,000 overhead (fixed) costs / $14 profit per piece 7,143 pieces must be sold to break even $100,000 overhead (fixed) costs / $3 profit per piece 33,333 pieces must be sold to break even Lower price would require >4x the sales just to break even 6
  7. 7. The McKinney Group, LLC Effect of price on profit What is traditional pricing • Cost-plus pricing • Customer-driven pricing • Competition-driven pricing What is strategic pricing • Keys to strategic pricing • Differentiated-Value Pricing(sm) • Copier example 7
  8. 8. What is traditional pricing Reacts to market conditions rather than proactively managing them Focused on: • Closing deals • Growth • Maximizing market share Players: • Finance: • Marketing: • Sales: 8
  9. 9. Cost-plus pricing “Fair” profit after all costs Leads to overpricing and underpricing • Most companies don’t know their total costs • Costs change • Competitor’s costs are different than yours • Customers don’t care about your costs 9
  10. 10. Customer-driven pricing (“Willingness-to-pay” pricing) Goal: Maximum number of happy customers Leads to discounting and underpricing • Teaches customers that you are not serious about getting paid for the value you create • Rewards aggressive behavior by procurement departments • Price disparities can damage relationships with existing customers • Encourages competitors to discount also (“Race to the bottom”) 10
  11. 11. Customer-driven pricing (“Willingness-to-pay” pricing) Price History, Division $400 $350 $300 $250 $/unit $200 5-year CAGR ( 2002-2007) $150 Fredonia bulk -11% $100 Paulding bulk -10% $50 $- 2000 2001 2002 2003 2004 2005 2006 2007 11
  12. 12. Customer-driven pricing (“Willingness-to-pay” pricing) Pricing vs. volume, Division $1,800 $1,600 $1,400 $1,200 $1,000 $/ unit $800 $600 $400 $200 $- - 0 0 0 0 0 0 0 0 0 00 1, 00 2, 00 3, 00 4, 00 5, 00 6, 00 7, 00 8, 00 9, 00 10, 0 Units per year 12
  13. 13. Competition-driven pricing Driven by market share and growth goals Leads to price wars and commoditization • Easiest way to make a sale, cut the price Generic business strategies 1. Low Cost 2. Differentiation 13
  14. 14. The McKinney Group, LLC Effect of price on profit What is traditional pricing • Cost-plus pricing • Customer-driven pricing • Competition-driven pricing What is strategic pricing • Keys to strategic pricing • Differentiated-Value Pricing(sm) • Copier example 14
  15. 15. What is strategic pricing Focused on value creation Proactively manages market conditions Driven to maximize net profit Controlled Players: • Finance • Marketing • Sales • Management 15
  16. 16. Differentiated-Value Pricing(sm) ensures that you profit from the value that you create DVP(sm) is a framework to quantify value • Basis of your value proposition DVP(sm) is the foundation of strategic pricing • Allows you to determine prices that maximize net profits • Minimizes risk of commoditization • Minimizes risk of price wars & “races to the bottom” DVP(sm) helps the marketing team with all aspects of developing a marketing mix DVP(sm) improves the effectiveness of Sales 16
  17. 17. Example: Determining price for new copier from Alpha Copier Company Finance • Manufacturing costs: $1,250 • Alpha’s standard gross margin: 50% • Price should be $1,875 Sales • “Market is very competitive” • Beta company has a $1,200 copier. • Beta has also been very aggressive regarding price, and has been marketing themselves heavily in an attempt to grow market share • Price can be no more than 15% higher than Beta ($1,400) Finance and Sales agree on $1,750 17
  18. 18. The first step is to understand the value created by your company and its competition Attributes Alpha Beta Pages per minute 30 15 Resolution 600 x 600 300 x 300 Paper capacity 500 sheets 1,000 sheets Duplex capacity Yes No USB input Yes No Internet capability Yes No Brand image Reliable Low cost Cost ?? $1,200 18
  19. 19. The next step is to quantify the value Secondary research • Historical company sales data • Scanner data Primary research • Market research panels or focus groups • Surveys • Buy-response surveys • Conjoint (“tradeoff”) analysis • In-store or laboratory purchase experiments • In depth customer interviews 19
  20. 20. The next step is to quantify the value Secondary research • Historical company sales data • Scanner data Primary research • Market research panels or focus groups • Surveys • Buy-response surveys • Conjoint (“tradeoff”) analysis • In-store or laboratory purchase experiments • In depth customer interviews 20
  21. 21. Translating value creation to dollars and cents Attributes Alpha Beta Avg ∆ in value (Alpha vs. Beta) Pages per minute 30 15 $75 Resolution 600 x 600 300 x 300 $200 Paper capacity 500 sheets 1,000 sheets -$50 Duplex capacity Yes No $75 USB input Yes No 25 Internet capability Yes No 50 Brand image Reliable Low cost $300 Cost ?? $1,200 $725 21
  22. 22. Using Differentiated-Value Pricing (sm) to calculate price showed Alpha that their new copier created more value than they thought $1,200 Beta copier $725 Additional value created by Alpha’s new model $1,925 Value of Alpha’s new copier 3% difference in price 38% difference in price 7% difference in net profit 450% Δ in net profit $1,875 Cost-plus price determined by Finance $1,400 Competition-driven price determined by Sales 22
  23. 23. Differentiated-Value Pricing (sm) also allows Alpha to support their value proposition when communicating with internal players, distributors, and customers $1,200 Beta copier Attributes Alpha Beta Pages /minute 30 15 Additional value created by Resolution 600 x 600 300 x 300 $725 Alpha’s new (differentiated) model Duplex Yes No USB input Yes No $1,925 Value of Alpha’s new copier Internet Yes No Brand image Reliable Low cost 23
  24. 24. DVP(sm) is a foundation for strategic pricing Skim pricing Bundling Rebates / Bundling Coupons Bundling Seg mentation Price fences |||||||||||||| Differentiated-Value Pricing(sm) 24
  25. 25. For more information, including many free resources about pricing and business strategy, go to: www.TMG-SMC.com 25

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