Maximizing Profit Through Strategic Pricing
- 1. Maximizing Profit ThroughStrategic Pricing Robert A. McKinney Pricing Strategist with The McKinney Group, LLC Copyright 2009
- 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. • Growth-oriented startupto $50MM • Competitive Strategy • Strategic Pricing • • Certified Managerial Accountant (CMA) • MBA, Strategic Management, Purdue University • Member: • Experience: 3
- 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. Pricing affects thebottom 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. While lower pricessometimes 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. 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. What is traditionalpricing Reacts to market conditions rather than proactively managing them Focused on: • Closing deals • Growth • Maximizing market share Players: • Finance: • Marketing: • Sales: 8
- 9. Cost-plus pricing “Fair” profitafter 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. 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. 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. 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. Competition-driven pricing Driven bymarket 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. 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. What is strategicpricing Focused on value creation Proactively manages market conditions Driven to maximize net profit Controlled Players: • Finance • Marketing • Sales • Management 15
- 16. Differentiated-Value Pricing(sm) ensuresthat 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. Example: Determining pricefor 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. The first stepis 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. The next stepis 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. The next stepis 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. Translating value creationto 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. 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. 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. DVP(sm) is afoundation for strategic pricing Skim pricing Bundling Rebates / Bundling Coupons Bundling Seg mentation Price fences |||||||||||||| Differentiated-Value Pricing(sm) 24
- 25. For more information,including many free resources about pricing and business strategy, go to: www.TMG-SMC.com 25