Pitching your price
Article Date: Oct 01 2004Nothing is more crucial than pricing. Over-price and you will bleed customers. Under-price and you’ll rack up losses. The key to getting it right is knowing the value of your product and your clients.
Winter at the seaside can be bleak, especially if you are running a hotel. Guests are scarce and takings are low. Many owners close down until summer and profitability return.
Nicky Hayward has other ideas. She runs the Seaview Hotel with her husband Nick on the Isle of Wight just across the water from Spithead. Now established as one of Britain’s leading small hotels, the Seaview keeps business ticking over during the winter with some help from the locals.
After one old dear told the head chef that she would like to afford to eat in the brasserie more than once a week, pensioners were given a 50 per cent discount on meals during the winter from Sunday to Friday. ‘As well as being seen to be generous, we keep our revenues up,’ says Hayward. ‘And everyone continues to buy drinks at the bar.’
In the lull before Christmas, the hotel also charges £10 a night for a bed. Because it is just before the holidays, people spend more than usual on what they eat and drink. These ideas usually come from employees, customers and suppliers. ‘We are a bottom-up company,’ says Hayward. ‘Our 45 employees all take part in our business planning and are rewarded for any ideas.’
She tracks the impact of any price offer on the hotel’s booking system. ‘Last winter, we clearly saw that we were busy at lunch in the brasserie, but quieter in the evenings, so we have extended the pensioners’ discount throughout the day.
‘Our profits still mainly come from our busy season in the summer, but we keep morale high in the winter and staff turnover is low. And when pensioners’ families visit in the summer, they all use the hotel.’
Not all customers are equal
Most companies do not have the luxury of customers leaning over the bar at the end of the evening, pointing out what they really like about you. ‘But whatever your business, you have to understand that pricing starts with value to the customer and that not all customers are equal,’ says Stephan Butscher, managing director of Simon Kucher, a leading pricing practice in London.
‘Always look at segments and differentiate your product. Find out what customers value and what they are willing to pay for.’
Mercedes nearly fell into this pricing trap when it launched the A class. It originally wanted to put it on the market for less than £10,000, but realised it had a higher value for customers. ‘We found out that people were willing to pay five per cent more,’ says Butscher. ‘With a capacity of 200,000 units, that meant additional revenues of £100m.’
He adds that the dangers of over-pricing or under-pricing are extremely high. ‘Always look at the market to find your optimum price with analysis based on customer surveys, historic data, employee perceptions and external benchmarking. Then factor in your costs and set your goals. Do you want to maximise profitability? Or do you want full capacity and lower production costs?
‘Pricing strategy is always a work in progress, particularly in an environment which can change quickly and where your competitors can force you to react. In many cases you won’t be able to avoid discounts, but only give them in return for more business.’
Consistently fine tune
Admiral Insurance was launched 12 years ago in Cardiff with a novel attitude to price and risk. It actively sought drivers with higher premiums, offering insurance over the phone to the under 35s, who lived in a city and drove a faster or larger car.
It has just recently floated on the London Stock Exchange with sales of £430 milllion a year. Its multi-branding strategy targets different segments of the market with Admiral as the flagship for younger drivers. Diamond was set up in 1997 for women, followed by Bell for credit card payers and Elephant for internet users. Although these are broad segments, covering 10 million – 12 million drivers in total, Admiral’s experience is that people respond to strong brand propositions, because they feel their interests are being looked after.
The company’s chief executive, Henry Engelhardt, maintains a tight handle on the business with daily, weekly and monthly reports, giving him an instant indicator of each brand’s relative competitiveness. ‘All direct insurers receive details of yesterday's business: you issued 10,000 quotes and sold 1,000 policies. If our conversion rate is 50 per cent, the market is saying that a policy is way too cheap. We might take the opinion that the market is wrong and stick with it. Or we might think we are way out of step and change our rates.’
His goal is to gather a lot of information and look at it in depth. ‘It is all statistically driven. We are always fine tuning. We also look at other data such as credit scoring, which a broker is unlikely to be able to access.’
Cut Out the freebies
Such sophistication is well beyond most companies, according to Martyn Swan, a pricing specialist at Profitbuilder International. ‘Prices are usually all over the place with thousands of pounds a year being given away with unauthorised discounts.
‘Sales people are battered down by customers who insist they are buying on price. That is rarely the case. Your customer has usually already tried cheaper suppliers and prefers dealing with you.’
The first step is to stop yourself giving away anything for free. ‘Cut out free delivery, repairs and helplines, unless you are being paid a decent price.’
Then figure out where prices can be lifted. ‘You don’t have to look at hikes of ten or 15 per cent. Just squeeze a little bit here and there. Even a percentage point can have a dramatic effect. It goes straight to the bottom line. Pricing is the most difficult, but most effective way of lifting your profits,’ asserts Swan.
Missing value
For Bill Dale, who advises many smaller Scottish companies on growth strategies, the pricing problem is more deep-seated. ‘People rarely understand the value of what they do for customers. They have been brought up on cost plus pricing: calculate your cost and add a margin. This is the worst possible thing to do. You will either be too expensive or too cheap. You’re almost never correct.
‘Worse still, you think about the cost of things rather than their value. So you miss high value applications. You must determine what you actually do for your customer and understand the real benefit of what you are selling. Even in the biggest companies, people know all about the technical features of a product or service without understanding their value.’
He adds that you do not have to know the value down to the final penny, but at least know what the next best alternative is. ‘You cannot just follow the economic text book. There are psychological reasons why people do or do not buy. As an SME, you may have to look at more innovative ways of pricing. You should work out on a case-by-case basis what your value is to the customer and price accordingly.’
Pricing models
Take the IT industry. People are still happy to buy hardware upfront, but are becoming less happy about paying for software until they use it. One answer is to create a model based on demand, where you give customers more control over their use of technology.
‘Pricing used to be straightforward and could safely be left to your accountant,’ says Paul Gostick, international chairman of the Chartered Institute of Marketing. ‘Now is the time for marketing to step up and become more accountable, looking at models to maximise both revenue and volume.’
In the airline industry, for instance, you might initially offer cheap tickets to cover your loading costs, and then raise prices closer to departure. But you do not want to be left with ten £1,000 seats just before take-off. It would be better to fill them for £100, otherwise you will be left with nothing.
Depending on your business, says Gostick, you might factor in other differentials, such as variations in the cost of sales in shops or over the web. ‘You can also change the pricing model by giving people the flexibility to choose what they want. IT manufacturers now allow you to design and build your own configuration, backed up by intelligent software giving you an exclusive price over the web.’
‘For airlines and hotels, there are sophisticated software packages for this sort of analysis, although you can do a lot of things with a spreadsheet. So if you are a small organisation, you can build your own model, based on your cost base, volume curve and distribution channels.’
Winning the net auction
Pricing strategies can be cruelly exposed at internet auctions, argues Colin Coulson Thomas, a serial director and Luton University’s professor of competitiveness. ‘You are invited to huddle around a PC at 3pm and put in a price, usually for the supply of an industrial commodity.
‘Too often companies enter simply wanting to win. If prices run away, it is easy to become dismayed or panic stricken. You do not want to be in a position of not knowing whether to laugh or cry when you win the bid. Without a proper understanding of your cost structure, it is easy to take on business at a loss.’
Coulson Thomas believes anyone with more savvy has a clear bidding strategy. ‘You know the price at which to walk away. If you do have spare capacity, you may bid much lower for the extra volume to reach your optimum point of production.’
He argues that the financial impact of these pricing decisions can be massive. ‘If you can improve your net profit margins by five per cent without significant extra production costs, you could triple the value of your business. Few other areas can have as dramatic an impact.’
Need to know — KEEP your finger on the pricing pulse
Many companies are ad hoc and uncoordinated in how they set their prices, says Professor Colin Coulson Thomas, author of a report on pricing for profit written for The Chartered Institute of Marketing. ‘They rely on trial and error, seeing what margins they can get away with. Relatively few people are involved in the process and they tend to cut prices to win business. They can then easily find themselves locked in a spiral of falling profits and investment, becoming ever more squeezed.
‘By contrast, price leaders do not rush decisions and get input from many more people. Their focus is less on cost and more on value for the customer. It is a very different mentality. They keep their price structures simple and find ways of segmenting the market, as well as locking in key customers with special pricing,’ he states.
Any cuts are made for a good reason, such as building greater volume to reduce unit costs and to become more competitive. Nor do hunches or guesswork have any place in their tactics. ‘In contrast to the laggards, leaders use more analytical techniques and wider sources of price information. They keep their finger on the pulse of customer, user and industry opinion, and review their approaches, strategies and tactics as situations and circumstances change.’
(Further details: www.cim.co.uk)
