Ten common mistakes companies make in pricing products or services

In the course of our engagements, we have seen examples of good and bad pricing policies. The following is a list of 10 of the most common mistakes companies make when pricing their products and services.

1. Companies base prices on costs, not customers' perceptions of value
Prices based on costs invariably lead to one of the following two scenarios: (1) if the price is higher than the customers' perceived value, the cost of sales goes up, discounting increases, sales cycles are prolonged and profits suffer; or (2) if the price is lower, sales are brisk, but companies are leaving money on the table, and therefore not maximizing their profit.
Result: Higher cost, lower revenue and lower profits.

2. Companies base their prices on the marketplace
The marketplace is often cited as the wisdom of the crowds—the collective judgment of the value of a product. However, by resorting to marketplace pricing, companies accept the commoditization of their product or service. Instead, management teams must find ways to differentiate their products or services so as to create additional value for specific market segments.
Result: Products sold on price alone leads to lower profits.

3. Companies attempt to achieve the same profit with different products
Some financial strategies support a drive for uniformity, and companies try to achieve identical profit margins for disparate product lines. The iron law of pricing is that different customers will assign different values to identical products. For any single product, profit is optimized when the price reflects the customer's willingness to pay.
Result: Companies are unable to optimize its pricing, leading to lower profits.

4. Companies fail to segment their customers
Customer segments are differentiated by the customers' different requirements for your product. The value proposition for any product or service is different in different market segments, and the price strategy must reflect that difference. Your price realization strategy should include options that tailor your product, packaging, delivery options, marketing message and your pricing structure to particular customer segments in order to capture the additional value created for these segments.
Result: Companies fail to maximize its market potential, leading to lower revenue and profits.

5. Companies hold prices at the same level for too long
They ignore changes in costs, the competitive environment and a customer's preference. Most companies fear the uproar of a price change and put it off as long as possible. Savvy companies accustom their customers and their sales forces to frequent price changes. The process of keeping customers informed of price changes can, in reality, be a component of good customer service.
Result: Companies endure ever-reduced profits, and when they make a price change, it is large and they may loose their customers. Each is leading to lower revenues and lower profits.

6. Companies give incentives based on revenue rather than profits
Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price. This mistake is especially costly when salespeople have the authority to negotiate discounts. Companies need to redefine the salesperson's job as maximizing profitability. Companies also need to place incentives based on profitability, while also providing the salespeople the necessary tools to do so.
Result: Higher sales volume on lower cost products and overall lower profits.

7. Companies change prices without forecasting competitors' reactions
Any change in your prices will cause a reaction by your competitors. Smart companies know enough about their competitors to forecast their reactions and prepare for them. This avoids costly price wars that can destroy the profitability of an entire industry.
Result: Danger of costly, non-profitable price wars.

8. Companies spend insufficient resources managing pricing practices
Cost, sales volume and price are the three basic variables that drive profit. Most management teams are comfortable working on cost reduction initiatives, and they have some level of confidence in growing their sales volume. Many companies, however, only utilize simplistic price procedures.
Result: Lower revenue and lower profits.

9. Companies fail to establish internal procedures to optimize prices
In some companies, the hastily-called "price meeting" has become a regular occurrence—a last-minute meeting to set the final price for a new product or service. The attendees are often unprepared, and research is limited to a few salespeople's anecdotes or perhaps a competitor's price list from last year and a financial officer's careful calculation of the product's cost structure across a variety of assumptions.
Result: Lower revenue and lower profits.

10. Companies spend more time serving their least profitable customers
Most companies do not even know who their most profitable customers are. While 80 percent of a company's profits generally come from 20 percent of its customers, failure to identify and focus on this 20 percent leaves companies undefended against wilier competitors. Such failure also deprives the company of the loyalty that more attention and better service would provide.
Result: Lower revenue and lower profits.

The optimization of a pricing strategy is as important as the management of costs and the growth of sales volume. Since most companies have never done it, rigorous price optimization has emerged as an important source of competitive advantage and increased profitability.

Per Sojofors is a managing partner of Atenga Inc. He may be reached through his companys Web site, www.atenga.com.