Per Sjofors, also known as “The Price Whisperer”, founded Sjöfors & Partners and is a thought leader on the use of price for higher growth and profit.
The CEOs I speak to daily are often terrified of price increases. I hear comments like, “We haven’t dared to raise our prices in seven years, and I’m afraid we’ll lose too much business if we do.” I also hear, “We tried to raise prices a few years ago but failed, but now my board is saying we have to. Now how can we successfully raise prices?”
Like Warren Buffett said, “The single most important decision when evaluating a company is pricing power.” Pricing power is the ability to raise prices without losing sales volume. How is that possible? Don’t higher prices always lead to a lower sales volume? Not at all. Pricing power comes from differentiation that is meaningful to the buyers in a company’s market.
Take commodities: a commodity is a product or service where potential customers make their purchasing decision between identical or nearly identical choices based on price alone. The lowest price usually wins the company and it often becomes a race to the bottom. If the product or service is a total product, it seems like it can’t have any pricing power. While it can be difficult to acquire pricing power for basic products or services, it is not impossible.
Discerning what customers want
As mentioned earlier, pricing power comes from meaningful differentiation. There is a difference between what customers ‘want’ and what they ‘want to buy’. The latter is related to their ability and willingness to pay, and therefore useful for a company to know. The first is related to dreams and aspirations. Here are a few examples:
• The parent of a few young children may “want” that sports car, but will buy a minivan or SUV even if the price is the same.
• A restaurant guest may “want” that huge rib-eye steak, but settle for a pedestrian burger.
Companies communicate with their customers in different ways, often giving the company a good sense of what their customers ‘want’ and less of what they ‘want to buy’. In fact, companies often confuse the two. Take a look at one of the most spectacular bankruptcies of the past 25 years: the former Iridium SSC. This company provided worldwide mobile phone coverage via a set of 75 satellites. It asked its potential customers, “Do you want cell phone coverage wherever you are in the world?” and received a resounding “Yes!”
But they ignored some crucial details: the phone was the size of a brick, it cost $3,000, and calls cost $3 to $8 a minute (in 1999). It could not be used indoors or in cars. A great alternative to regular mobile phones – for someone who is in the middle of the Sahara desert or the ocean. Ten months after its launch, the company filed for bankruptcy under Chapter 11, wiping out billions of money from investors. The company, now under new ownership and with a different customer focus and targeting, and a wider range of services, is surviving but still not profitable.
The bottom line is that the company understood what its potential customers wanted, but not what they wanted to buy. And they didn’t buy.
This is where meaningful differentiation comes into play. Companies need to understand how to differentiate themselves so that their customers increase their willingness to buy and their willingness to pay, thereby increasing their pricing power. Some companies will try to do this with A/B testing, but this gets very complicated. Suppose a company wants to do an A/B test:
• Six different product or service features.
• Six different marketing messages.
• Six different marketing channels.
• Six different customer segments.
• Three different sales channels.
• Three different sales methods.
• Three different payment models.
• Six different price levels.
The result is 209,952 combinations – virtually impossible to test. So companies instead try a few different marketing messages and a few different prices, but often done separately, not in combination. If the company sells a genuine product, it is unlikely to discover the differentiators that will lead to significant pricing power. Instead, testing can only confuse its customers.
Consider conducting or commissioning a survey of your company’s willingness to pay. (Full disclosure: My company offers this service as well as others.) This research can discover how each of the variables listed above, individually and in combination, affects how the company can determine prices that match the maximum amounts that customers are willing to pay for your type of product or service.
Another option is to conduct a detailed competitive analysis and identify the difference between your company’s product, service and marketing messages and those of your competition – something you’ve probably already done. If you can’t find significant differentiators, consider how you can add products to services, services to products, or adjacent services to your existing services to further differentiate yourself.
Then approach 25 prospects who aren’t current prospects, customers, or friends and family and ask anonymously which of these differentiators they think are the most valuable. You will probably find that the prospects agree on one or two differentiators that they value the most.
Then find another 25 potential customers and ask them, again anonymously, “What price for the product/service [main differentiator #1] is so cheap that you think the supplier will overpromise and underdeliver?” Also ask: “What price for the product/service with [main differentiator #1] is so expensive you won’t buy it, no matter how good it is?” Repeat this step for differentiator #2, preferably with a new set of 25 prospects. Average the answers to the two questions for each differentiator and you will have the price range for each, not below one price and not above another price.
Now I’m not suggesting that a pure commodity product or service provider can double its prices based on this information. However, this can allow you to set prices several percentage points above your commodity competition, without losing sales volume. With the razor-thin margins of raw material suppliers, that can have a huge impact on the business!