Strategic pricing sets the price of a given sale based on the value of a product or service to the specific customer that’s buying it, with the competitive position in mind. In the absence of strategic pricing, many companies build pricing standards as a function of the cost of the product.
Strategic pricing is particularly important in business-to-business (B2B) situations where a company sells many different products or services to a wide range of customers. Simplified pricing standards are common in these situations, applying similar markups to many products and customers. This over-simplified pricing approach (we call this “peanut butter pricing”) results in companies not capturing the margin and profitability available to them on specific products and types of customers.
Strategic pricing delivers significant profit improvement to companies that operate on lower profit margins in general. In industries where competitive pressure and commoditized product lines create this environment, small increases in selling prices in key areas can drastically improve bottom-line profitability.
For example, a typical wholesale distributor generates around four percent operating profit as a percentage of total revenue. Adding an average of just two percent to the gross margin of a sale moves a company’s four percent operating profit to six percent, which is an overall 50 percent increase in profitability.
A company sells its products at an average 25 percent markup (gross margin), earning a four percent profit. If a company adds two points to its sale prices (27 percent on average) the entire increase goes to improving bottom-line profit to six percent. When a company goes from four percent and add two percent, it improves by 50 percent of what you had.
But companies can’t increase all prices in this way. Across-the-board price increases carry the risk of losing your competitive edge on core products or with key customers. That’s why differentiating standards in strategic pricing is so critical.
Companies that employ a strategic pricing strategy commonly create different pricing standards by product and customer. Basic strategic pricing sets different standards by the type of product and by the revenue potential of the customer. Companies that have graduated to a more advanced strategic pricing model use more sophisticated analytics to differentiate standards for each specific product and approach customer pricing segmentation more granularly.
For companies with many products and a wide array of customers, analytics provide a scalable, accurate way to apply the right pricing model to each sale they make. This data-driven guidance enables the sales team to achieve optimal price points and higher margins.
We are surrounded by businesses that sell different types of products at extremely different margins. As consumers, we buy everyday items from grocery stores, big-box retail, and everywhere else that are sold at very different gross margins. When you fuel your car at a gas station, the store is making limited margins on the fuel itself, but significant margins on the coffee, candy bar, and sunglasses that you purchase in the convenience store after filling up. To maximize profitability, every business must apply a similar philosophy to its own product lines.
A common misconception about strategic pricing is that the margin improvement comes at the expense of lost customers. This misconception may also result from the perception that wide-spanning price increases define strategic pricing. The truth is, strategic pricing rarely results in a measurable loss in revenue potential, when planned and executed well. This is true because products and customers that are priced at a higher margin are less sensitive to price changes, and in less competitive parts of a business.
In some businesses, particularly those in a retail environment, most customers buy at the same price points. However, in B2B situations, it’s common and expected that different customers have access to different pricing based on who they are and how much they may buy.
There are several factors that determine how price sensitive a given product is to a customer. How likely the customer is to cross-shop the purchase, how often the product is purchased, whether it’s purchased repeatedly, and what it is commonly sold with are just a few. Many companies start by simply evaluating how much they sell a given item.
While sales volume is a piece of the price sensitivity puzzle, it is not the only one. In fact, there is a relatively weak correlation between sales volume and true price sensitivity. It’s advantageous for companies to analyze a number of factors when determining an item’s price sensitivity. As an example, SPARXiQ utilizes as many as twelve different factors when it analyzes its customers’ data sets.
You can segment products in various ways, depending on your business. If you are selling products sourced from a variety of manufacturers, you would likely benefit from segmenting by manufacturer. Products from well-known manufacturers that are sold by a large number of other suppliers will logically be more sensitive to price premiums than those from specialized, niche companies.
Similarly, if your products include a combination of original equipment, add-on parts, and replacement parts, all three types of products should be reflected in your product segmentation as they have different price sensitivity to buyers. The bottom line is that products should be segmented to account for differences in the way the buyer buys them. And, when you apply a more granular analysis of buying patterns for products, you’ll find more areas where there are opportunities for additional premiums.
Customers can be more or less sensitive to paying slightly higher prices based on a number of factors. The most obvious is determining why a given customer might buy from your company. Customers who buy because of convenience, buying experience, service level, ease of doing business, or lack of alternatives will likely pay a little more. Similarly, customers who don’t purchase as often, or in high volumes, will likely not be as sensitive to paying slightly higher prices.
The inverse of each of these factors is also true. Customers who have more options, actively cross-shop your competitors, and buy repeatedly in high volumes will generally be more sensitive to price changes.
Different types of customers buy your products for different reasons, or for different users. And larger customers who purchase more expect better pricing and terms in exchange for their business. When building a strategic pricing framework, be sure to account for these distinctions in both customer type and size, at a minimum. Beyond that, you may opt to segment more specifically, accounting for things like customers’ geography, loyalty, and cost to serve. Whenever there is a variance in each of these factors, you may be able to capture a bit more margin by strategically pricing.
If your business sells products to very different types of customers, some of those customers are likely buying the same products, but for different uses or reasons. A contractor may buy certain parts that they stock in their service van and use daily. Likewise, some of those same parts might be something that a maintenance department of a building buys and uses on a rare occasion.
Logically, because of these distinctions, your pricing model may benefit by rating product sensitivity differently for different types of customers. While this is a valuable enhancement to a pricing strategy, it often is not necessary in the early stages of a strategic pricing journey.
Contracts and customer-specific pricing are essential tools in a pricing strategy used to offer appropriate pricing for key sales opportunities. Contract pricing generally offers lower-margin, highly competitive price points that logically should not be focus areas for additional margin. However, these competitive pricing standards should only be reserved for the most important items on the contract. It’s a best practice to limit preferred contract pricing for a given sales opportunity to the product lines where it is necessary, allowing room for additional margin on long-tail, lower-sensitivity items where additional margin can be captured through strategic pricing.
In a number of industries, key business is sold through a bid process, or as large project opportunities. These cases are often extremely competitive, with other suppliers offering the lowest price points they can in order to win the business. When considering bid and project situations in your pricing strategy, be sure to account for how bids are evaluated. If you considered the total price of all items, then there isn’t much room for adding additional margin in lower-sensitivity product lines. However, if the winner is determined based on the pricing for fewer, higher-volume items on the bid sheet, there may be an opportunity to add margin on the long-tail items that are sold around the project.
Strategic pricing involves price sensitivity and product segmentation based on the market and your customer accounts.
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