In a chapter on how you can create a culture of profit, Rafi Mohammed lists the many myths that come in the way. Such as, that setting prices involves marking up prices (cost-plus); and that increasing market share involves a trade-off between price and share. Ruing that marking up costs by a certain percentage or using ‘the way that we always have done it’ methods often have become part of a company’s culture, Mohammed advises in ‘The 1% Windfall: How successful companies use price to profit and grow’ (www.landmarkonthenet.com) that a value-based price should be the foundation of every company’s pricing strategy for it captures the product’s value.
To instil a value-based pricing mindset within the company, the author recommends the use of anecdotes, personal experiences, and fact-based case studies. For instance, he urges you to ask staff members how they evaluate prices for their personal purchases. “Do they estimate the cost of a product and have a strict rule of purchasing only if this cost is marked up by 50 per cent (or less)? Most don’t. Instead, consumers evaluate a product by comparing it with its next-best alternatives and selecting the one that offers the best value (in terms of both price and attributes).”
Reversing the inverse relationship
On the trade-off myth, Mohammed avers that it is possible to achieve both the largest market share and highest profits. He traces the common trade-off myth to the elementary economics lesson about the inverse relationship between price and quantity in a demand curve – that a higher price leads to lower quantity sold and vice versa. “As a result, companies seeking a higher market share believe that the only way of doing so is through setting bargain prices. But gaining market share in this manner rarely results in the highest profit for a company.”
The antidote, according to the author, is to consider ‘a pricing blossom strategy’ of offering a variety of prices and plans for a product, rather than one bargain price. By targeting customer segments through pick-a-plan, versioning, and differential pricing tactics, he assures that the maximum number of customers can be serviced. “Additionally, by offering high- and low-price choices, consumers reveal (and are charged) the value that they place on a product. This produces the highest possible profits.”
Waterfall analysis
A key principle highlighted in the book is that you should speak and sell in terms of net prices. Exhorting all B2B companies to undertake a ‘waterfall analysis,’ Mohammed reminds that it is rare for the invoice price listed on a purchase order to be the actual amount that a company collects.
Why so? Because a variety of off-invoice discounts are commonly offered in B2B transactions, including annual volume rebates, financing options (cash, 30-, 60-, or 90-day payment deadlines), freight options (deliver to central warehouse, deliver to individual stores, or the client pick-up), and various other payments (advertising, slotting, stocking), as he explains. “B2B manufacturers often utilise as many as fifty different types of off-invoice discounts in their sales practices. These discounts can add up on an order and significantly reduce the ultimate amount received by companies.”
No wonder, therefore, a waterfall analysis, which examines each account and strips off every discount attached to an invoice price, can result in shock, with invoice prices that appear attractive ending up to be disappointing, observes Mohammed.
Recommended value read for finance professionals.
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