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The Power of Pricing

April 22, 2014

By Jason Green, Managing Director, The Cambridge Group

There's nothing like the power of setting your own prices. It's not something every brand can do, and most brands are actually price takers that accept the prices established by the market. But, when a company offers something that can't be beat, it creates a significant and lucrative business lever — the ability to name your own price.

Just how significant is the opportunity? According to Warren Buffett, it's all important. Buffet says he places more emphasis on a company's ability to raise prices than on anything else. He even goes so far as saying that pricing power is the "single-most important decision in evaluating a business."

Why pricing power? For most companies, managing pricing is the most effective, lowest-risk lever for driving top-line growth and enhancing profitability. Multiple studies have shown that a 1 percent increase in pricing can have a much greater impact on the bottom line than bringing variable costs down by 1 percent or by increasing sales by 1 percent. That said, however, recent Nielsen research across categories has shown wide discrepancies in how successful companies are in their abilities to realize pricing power, making it clear that when it comes to this capability, there are winners and losers both across and within categories. It also highlights an opportunity for those that have not optimized their approach to pricing.

While pricing strategy plays a critical role in the success of any business, managers often report lacking confidence about their approach and ability to optimize pricing, partly because they don't have the necessary insights into consumer demand. As a result, they're often left wondering if their current pricing strategy is leaving money on the table because prices are too low or if a significant amount of business is being lost because prices are too high. Fortunately, three principles can help companies assess their current approaches and harness pricing power's potential.

Three Principles for Increasing Pricing Power

Overcome the commodity perspective. One of the biggest barriers to achieving pricing power is believing that you're stuck in a commodity category or that you only have a commodity offer. The truth is that nothing has to be a commodity. Companies that once felt they were in commodity categories — such as beef, motor oil, socks, paper products, car insurance and others — have successfully gained pricing power with a little help. Bottled water is a great example: if companies can differentiate water, they can differentiate anything.

Price to benefit distinct consumer clusters rather than to the entire market. No two customers — and no two customer needs — are exactly alike. Each customer has a different level of interest in your category, is seeking a different set of benefits and has a certain level of price sensitivity.

Consider a car insurance company that recently shifted its thinking about its primary offering — insurance. In fact, the company stepped away from viewing the entire category as a commodity because two-thirds of its consumers were found to be willing to pay a premium for key benefits. This reality ran completely in the face of long-standing conventional industry wisdom. Comparatively, the remaining one-third of consumers sought minimal coverage at the lowest possible cost. This insight was the key in developing a portfolio of coverage offerings, including those selling for significant price premiums.

Once you understand the consumer segments in the market, examine the value equation for each. The value equation is simply the total benefits gained from the offer divided by the price paid to get them, expressed as "value = benefits/price."

It's important to note that the "benefits" include any and all potential benefits that different customer segments might perceive. This includes obvious rational benefits as well as emotional ("how it makes me feel") and social ("how others will feel about me") benefits. The key is understanding what the most lucrative customers value most and then make adjustments to deliver more of those benefits at a price premium.

A Powerful Pricing Example

For example, an office products company recently determined that its products were becoming commoditized. Without a complete understanding of what benefits consumers were seeking in the category, the company wasn't able to clearly communicate the benefits of its products in a meaningful way. The company also wasn't able to innovate its products to meet consumer needs. The result? Over time, consumers struggled to see the value difference between the company's branded products and the private label counterparts, which led to price declines and steep competition from private-label offerings.

In response, the company's engineering department created several features that made the products easier to use, and marketing focused on this messaging to win customers. However, these efforts had little effect. Why? Consumers were actually looking for a different value proposition. In reality, they were looking to feel more confident about the work they produced, not just faster, easier ways of getting it done — true latent demand.

By helping the company identify this need, The Cambridge Group helped find several features in the product that could deliver on this promise. And by shifting the messaging and point-of-sale materials to clearly highlight the range of applications and benefits, consumers quickly recognized the key trade-offs and were motivated to trade-up to products that more clearly addressed their needs for reliability, speed and confidence. With this strategy, the company was able to reverse the price declines and increase sales, and retailers realized financial benefits as well. It was a win, win, win for consumers, the manufacturer and the retailer.

Ultimately, pricing power is the tangible outcome of an effective strategy — one that differentiates businesses from their competitors and creates something that makes paying more for worth consumers' while. In contrast, undifferentiated commodities will lack pricing power because they simply accept the level of pricing the market will bear.

Source

"The Power of Pricing." Jason Green, Managing Director, The Cambridge Group. Nielsen Newswire, 2014.

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