First, a pricing lesson from Pablo Picasso:
An American tourist saw Picasso having a coffee at a Parisian café. She mustered the courage to walk up to Picasso and said, in her high school French:
“Mr. Picasso, what a pleasure to meet you. Can I please ask you to draw a portrait of me?
I’ll pay whatever you ask!”
Picasso picked up his sketch pad, quickly drew a portrait, and handed the drawing to the woman.
“That will be 5,000 francs, madame,” he said. “What!? It only took a couple of minutes.” “No, madame. It took a lifetime.”
What do we learn from Picasso in this short story? Well, we learn that we need to deliver unique value to our clients. It was not the amount of time it took to make that drawing that mattered; it was his experience, his fame, the personal interaction, and the fact that the drawing was a “Picasso” that altogether constituted the value he delivered to the client.
This story also teaches us how the client’s price expectations were different from Picasso’s. She could have gone to any of the other street vendors who were drawing portraits for only a few francs. Maybe her expectation was that Picasso would draw a portrait for the same, or perhaps twice or triple that price. But she did not expect him to charge her the “outrageous” price of 5,000 francs.
Finally, this story tells us that if you do not convincingly communicate the unique value of a product or service—that is, the value that only you can provide to your customers—your price will generate sales friction.
As we can see from this short story, there are only two potential outcomes:
- The client could refuse Picasso’s price and walk away, in which case he would tear up the drawing and throw it away.
- Or she could reluctantly pay the 5,000 francs, becoming a grumpy customer.
The alternative would have been for Picasso to say, “If you’d like an original Picasso drawing—one that will be worth 20,000 francs in 5 or 10 years—I’ll create one for you for only 5,000 francs!”
This approach delivers a value proposition to justify the price and a value over and above the time it takes to draw the portrait. The woman would be happy to pay 5,000 francs now.
Picasso would get his 5,000 francs, and the woman would become a happy, proud customer. What a difference!
And this is what this book is about: how perceptions of value, communication, and the willingness to buy or sell interact. How can you leverage the learning from this interaction to increase the perception of value and, therefore, the price, while making your customers even happier?
Pricing cannot be considered out of context, and sales messages, sales channels, and other attributes that determine how the product or service is sold.
Setting the right price is not a single silver bullet that automatically and alone ensures business success. It is all about context. Pricing correctly must be part of a cohesive go-to-market and marketing strategy. So, while this book discusses price, it also discusses how the process of setting the right price also informs marketing and sales, specifically:
- How pricing must be part of a company’s marketing strategy.
- How the price should influence that strategy.
- What pricing structure and price levels are appropriate for your company and circumstances.
This is because your pricing, pricing strategy, pricing structure, and price levels are a result of everything you do in your company, including:
- Your product or service, its features, functions, and customer benefits.
- How your company goes to market.
- How you market the value and benefits you bring to your customers.
- How your company and its products or services differ from those of the competition:
- Which sales channel(s) you use.
- Which customers and customer profiles you aim for.
- Your company’s overall strategic goal(s).
It is for these reasons that price is part of the Four Ps of Marketing. (The others are Product, Place, and Promotion.) I will discuss the other three Ps too:
- How the product (or service) affects how you set the price.
- How the place (meaning your sales channel[s] and corporate positioning) affects how you set the price.
- How promotion (meaning how the product or service is sold and promoted) affects sales volume and how much customers are willing to pay. This includes factors such as promotional channels, messaging, advertising, and other methods that can be used to find customers.
Because pricing must be considered in context, and because the way the product or service is promoted and sold affects how much customers are willing to pay, it means that when potential buyers say that something is “too expensive” it is because the seller could not convince the customer of the benefits of the product or service. The seller failed to make a convincing argument that the benefits of the product or service justify the price. It’s important to understand is that I’m using the words “make an argument” in the broadest possible sense, which includes the seller’s go-to-market strategy, selected market, marketing their product even though I have zero interest in it. For them, this represents dollars wasted on advertising.
Finally, some people always want to buy the cheapest product despite a lower benefit simply because that is their purchasing style or perhaps because they lack the financial means to buy anything else. Nothing can persuade these types of customers to buy anything other than the cheapest offering.
The sentence above about being unable to convince the customer of the benefit of the seller’s product or service is of the utmost importance to understanding how to price correctly. It also underscores the basics of these Four Ps of Marketing and shows that pricing is part of the entire business operation. Pricing correctly is a result of everything the company does: its product or service, its go-to-market strategy, its selected vertical market, its marketing and sales messages, its sales channels, and its ability to close a sale.
If marketing and sales fail with that message, the customer may choose to buy a cheaper product or service from that vendor or select a product or service from a competitor whose marketing and sales messages are more appealing. Or the customer may choose to buy nothing at all.
When looking at companies with a pricing problem—such as too much discounting or too much downward pricing pressure—we usually discover that the pricing is incorrect; but this issue is overshadowed by the company’s lack of good marketing and sales processes and messages. I often say, “The disease is in marketing and sales, but the symptoms show up in pricing.” The solution then is to fix marketing and sales, as well as to focus on pricing.
The disease is in marketing and sales, but the symptoms show up in pricing.
Because pricing is a result of everything you do in your company, and because every company and every company’s circumstances are different, the right price for your company is not necessarily the right price for another company. There may not be a simple formula for pricing and price levels in your industry. People say, “I run a corporate health service company. Tell me what price I should charge.” Or, they may say, “My company provides the watering infrastructure for cannabis growing plants. What price should I charge?” or
“Since we are on the topic of cannabis, what’s the right price for this bottle of CBD oil I sell?” Unfortunately, questions like these do not have simple answers. There is no pricing formula or price that works for every company every time. Correct pricing is about process and the need to focus on many, often relatively small, aspects of your business that, when taken all together, will have a profound impact on the bottom line. We are back to the Four Ps of Marketing again.
Correct pricing is about process and the need to focus on many, often relatively small, aspects of your business that, when taken all together, will have a profound impact on the bottom line.
A Bit About Me
Because of my frustration with what I did not learn about pricing in business school and from various books on the topic, in this book, you will find few references to academic research.
Many people think there is some magic associated with getting pricing right. Many people say that pricing is an art that cannot be mastered. This is all wrong. Good pricing is about science, details, and process.
Now, if I have managed to make a few readers curious about me, and for those who might be interested in me personally, I had added some more details of my pricing journey in the Appendix.
Oh, and one more thing… Writing this book has been a labor of love for several years, and that means that some of the examples and stories are a couple of years old, but they are still as relevant as examples.
Chapter 2—A Sense of Urgency
If you look at it from the highest level, a company’s resulting profit comes from only three variables: the total cost of its entire operation, the volume of sales, and the price of the product or services it sells. The equation below summarizes profit:
(Price x Sales) – Cost = Profit Of these three variables, price has the highest impact on profit.
Only three variables affect a company’s profits: the total sales, the total cost, and the price of the product or service it sells.
The reasons are simple:
- Increasing sales volume increases revenue, but also increases the cost.
- Increasing price or reducing discounting means that all money flows to the top line.
- Reducing cost and is, a lower number affects a lower number than the company’s top-line revenue and is, therefore, a lower number.
Let me give an example. Say a company sells an item for $100, and it cost the company $50 to make the item. If you change the price by 10% or change the cost by 10%, the dollar change is different. If you increase price by 10% to $110, you make an additional $10 in profit. If you lower the cost by 10%, the cost will be $45, and the dollar change is $5. So, because the price of the item is higher than the cost, it has a higher leverage effect on profits. So, in the first case, profit increases from $50 to $60 and, in the second case, profit increases from $50 to $55. The quickest and most effective way to increase profits is by adjusting prices.
But there is more to this than meets the eye. Companies already invest a tremendous amount of resources and money in marketing and selling their products and services; thus, it is highly unlikely that suddenly becoming more effective in marketing and promotion would instantly increase sales. It would require a greater investment in marketing, training of salespeople, and maybe adding more salespeople or expanding sales channels.
Likewise, companies are typically very good at controlling costs, so it is doubtful that they could suddenly find ways to improve their cost control materially. If they did, it may include reorganizing the company, adding new processes, and maybe adding new infrastructure software or reducing staff. These activities take a tremendous amount of resources and effort, and the results cannot always be clearly measured.
However, increasing price or reducing discounts can be done in a flash! This does not take much effort at all. Further, pricing is often the business area that companies invest in the least. So, for that reason alone, increasing prices or reducing discounts can often yield rapid and substantial payback. But pricing is an area that needs to be managed very carefully, as pricing and the pricing process are all about focusing on details. But as you will see as you continue to read this book, there is the potential to gain significant financial rewards. So, please take pricing strategy seriously, embrace it, and make it part of your company’s culture and infrastructure. And do it today!
But it’s not only me. Several years ago, McKinsey examined the relationship between cost, sales volume, and price among the Global 1200 companies1; sometime later, another of the
1 https://www.forbes.com/2010/03/25/profit-gain-value-mckinsey-sears-whirlpool-cmo-network-rafi- mohammed.html?sh=48ebfe605059
large consulting firms did a similar research project. The method they used was to make an assumption: what if we changed one of these three variables by just one percent? What would the result be on pre-tax profits? Both McKinsey and the other consulting firm came up with similar results.
As you can see in Figure 1, increasing sales by one percent added about 3.3 percent in profits, while reducing the cost by one percent yielded about a 5.5 percent increase in profits. However, increasing the price or reducing the discount by one percent generated an 11.3 percent increase in pre-tax profits for these S&P 500 and Global 1,200 companies.
Figure 1. Profit Increase
How this works for your company depends on your particular circumstances. I encourage you to calculate your company’s profit using the chart in Figure 2.
Figure 2. Profit Calculation
But there is more to this. My company performed a study among a statistically significant number of American CEOs (see the results in Figure 3 below). To our amazement, we found very few truly understood how pricing affects profitability. Among those CEOs, the vast majority—a staggering 82 percent—said that increasing sales is the best way to increase profitability.
Figure 3. The Best Way to Increase Profits
Looking at the chart in Figure 1 and Figure 3, you can see those 82% of CEOs who said sales volume increase is the best way to increase profits were obviously wrong. This is because when you increase sales, you also increase the cost. Only 12 percent of these CEOs indicated that better pricing (an increase in price or a reduction of the amount of discounting) is the most efficient way to increase profits. These 12 percent are right—with the right pricing strategy, any company can defend higher prices (or less discounting) without losing sales volume, which means that every dollar captured from the market shows up on the bottom line as an increase in profit. For that reason alone, pricing should be at the core of a company’s operation.
In this context, I was wondering why so few CEOs believe pricing is the best way to improve profitability. In conversation, a colleague mentioned an adage I had not heard before. He said, “Boards care little about whether a company is profitable or not, but if market share drops by one percent, heads will roll.” Many companies now embrace the “sharing economy” buzzword: Uber and Lyft (ride share services), DoorDash (food delivery services), WeWork (office space), Bird (electric scooter sharing) and LimeBike (electric scooter services). Many others are hemorrhaging money like there is no tomorrow—all to capture market share (and to alter customer behavior to some extent) with no obvious route to profitability. At least none is obvious to me.
Just to prove the point, I randomly checked four public companies just to see how much difference, if any, a one-percent increase in price (or decrease in discounting) would do for a company’s resulting profit. (I don’t know any of these companies, nor do I have any affiliation with them. I’m just using public data. But in the interest of confidentiality, I decided not to disclose company names. I encourage you to look up the financials for some public companies and make the calculation in Figure 2 above.)
Company A (see Table 1) is a global manufacturer and distributor of chemical products and a leading U.S. manufacturer of ammunition. A one percent increase in pricing would increase profits by over 21 percent.
Table 1. Company A—Annual Revenue
Company B (see Table 2) is a provider of financing services to owners of commercial real estate. A one percent increase in pricing would increase profits by almost five percent.
Table 2. Company B—Annual Revenue
Company C (see Table 3) operates in the forest products industry in the United States, Canada, Mexico, and internationally. A one percent increase in pricing would increase profits by 16 percent.
Table 3. Company C—Annual Revenue
Company D (see Table 4) is a leading provider of pawn loans in the United States and Latin America. A one percent increase in pricing would increase profits some twenty percent.
Table 4. Company D—Annual Revenue
You might ask, if prices increase or discounting decreases, will this not lead to a loss in sales volume? The answer is: well, rarely. This becomes the segue to the rest of this book: how to use pricing strategy to drive sales and profits.
Not only does pricing have the highest leverage on a company’s profitability, but it is also the easiest and quickest variable to change among the variables that affect profits. Thus, there is no need to wait.