Sunday, December 7, 2008

The Power of 'Pricing'

"Pricing" is the biggest of 4Ps of the Marketing Mix (Product, PRICE, Place and Promotion). Yet so often businesses are reactive in their pricing strategy - largely founded on competitive pricing pressures. It is no secret then that market-share in mature markets is often won by waging price-wars with your competition.

By reducing prices, businesses would probably win market-share. But such a pricing strategy would dimish value of premium products, commoditize brands and, ultimately, hurt the bottom line. It is the latter that most companies haven't understood quite well - how much a pricing strategy could affect the bottom-line.

We all understand that increasing pricing improves Revenues. What most marketers do not understand is that "pricing" is a profit lever - directly impacting company's bottom line.

Consider this: By increasing Price by 1%, the "operating profit" rises by more than 11%. (based on Compustat survey of 2463 companies).

No other profit lever matches Pricing's impact on Operating profits:
1) a 1% reduction in variable costs, improves profits by 7.8%.
2) a 1% increase in sales volume (units), improves profits by 3.3% only.

Reducing "price" for premium product should not be a strategy - not even your last resort. Companies like General Motors (GM) have been market leader in the US but unprofitable. The sole purpose of business is to ensure profitable returns for its shareholders- GM was bleeding cash even when it was a market leader and now it is at the brink of bankruptcy. How did that happen? Well! put it simply, regardless of the top-line, if companies dont make enough profits and under pressures from analysts, they will trim marketing budgets and cut operational expenses to achieve targeted profits (EPS).
Classic example of "downward spiral": blind cost-cutting results in inferior product quality and limited marketing resources - which in turn results in drop in sales/revenues. In order to maintain their top-line, companies would cut their price again falling into the trap of "shrinking" profitability.

But then you might ask, and rightly so, how can businesses maintain current price-levels and leave alone raising prices for products/services in these times of economic downturn.

Follow my next post on "Pursuit of premium pricing" for answers to these questions.

RECOMMENDED READING: For those interested in further reading on pricing strategies, I'd recommend two books:


3) Basic Marketing (Kenneth Wong)*

[* Ken Wong is professor in marketing at Queen's University. He is one of the best marketing minds and thought leaders in Canada. I had the fortune to be taught Advanced Marketing courses by Ken during my MBA class at Queen's in 2005. I majored in Marketing and I still use lessons from Ken's classes to date - at work.]

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