What is “right pricing?” It is pricing not to maximize your margin, but to maximize your profits. Many companies price their products and services to get the highest margin rate. This is great as long as the market will accept your process.

As a pricing leader, you can very often set prices and that is an enviable position to be in. But how many companies are in a position to do this? The answer is very few. The vast majority of the time one must deal with the realities of a competitive environment where you may have some intrinsic advantages but are in no position to dictate prices. You may be able to avoid pure price commodity pricing if you offer basically the same thing as everyone else but provide better payment terms, a sales rep with great connections, really nice people to deal with, a liberal returns policy, etc., but when it come down to it you may only be able to get one or two points in higher prices then your competition.

PREMIUM CONTENT: Gross Margin and Bill Rate Trends: December 2016

So what is your alternative? The answer is right pricing. There are various ways to do this, recognizing that what follows is but the simplest of examples.

Case A is the status quo where one’s revenue is 1,000 units of anything, with a $50/unit price and a 20% margin, generating $10,000 in margin.

Option No. 1 is to fragment the market into regular clients, selling 800 units at the normal $50/unit price and 20% margin which will generate $8,000 in margin, and discount prices from $50/unit to $47/unit, with a corresponding 15% margin. This will add $1,750 in margin. The total margin generated will be $9,750, or 2.5% less margin then we started with which would be counter-productive and not generally a wise strategy, unless there are extenuating circumstances.

Option No. 2 would be the same as above as far the 800 units sold, but is based in greater price-volume flexibility, dropped prices to $46/unit with a 13% margin and selling 400 more units. The total margin would be $10,400, or 4% higher margin then Case A. We assume no increase in fixed cost and not setting pricing precedents that would impact the 800 units sold might be a good strategy.

Option No. 3 gives us the same results as the prior case but at the same overall volume, selling the additional 200 units at $52/units at a 23% margin.

Whatever one does should be based on current conditions as to price and volume sensitivity and setting prices based on the most profitable course of action. Time change and what worked best yesterday might not be the option best today. Test marketing new policies allows one to check out “right pricing” on a small scale first before making global changes.

[…] MORE: Right Pricing […]