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Do your customers know how much your products are price? This could seem strange at first glance, but in fact, many firms routinely do not provide the true value of their products. Not surprisingly, such miscommunication is rarely to the company’s advantage.
Over 20 years ago, McKinsey & Company experts discovered that between 80% and 90% mispriced products are priced too low – and this is still the case today. That’s potential revenue lost straight away, and greater than you might think. According to estimates, a 1% price increase without a change in the volume of products sold translates into an 11.1% increase in operating profit. is a comprehensive examination by Harvard Business Review published in 1992 and still widely cited.
Where does the value go?
Your products and services inherently create value for your customers. We’ll call this “real value.” In an ideal world, every thing you sell could be priced at its intrinsic value. However, we do not live in an ideal world. The actual value is excruciatingly difficult to calculate and may vary from customer to customer.
Not all of your customers will have the ability to see, or frankly, even profit from, the full potential of a given product. For example, smart watches can track lots of of unique exercises, but if all you do is run, it’s hard to see the value in these extra features. Marketing also has an impact. Sticking with the smartwatch example, if you fail to effectively communicate a useful feature – leaving potential customers unaware – this will have a negative impact on this “perceived value”.
Your customers may agree that your product provides them with some value, but that doesn’t suggest they’re willing to pay for it. Dozens of things can influence how much a given customer is willing to pay: urgency, revenue, brand loyalty, promoting, social influence, etc. Finding this number is difficult, but very rewarding. If you can determine the maximum amount your customers are willing to pay, you can maximize your profits while getting the most value.
Many firms are unable to accurately determine how much their customers are willing to pay. This signifies that the price your customers typically pay is your “target price.” This is a value that you and your team have hopefully agreed upon as being as close to your actual willingness-to-pay value as possible.
Finally, if you work in a high-volume industry, you may find that additional value can be lost through concessions and discounts. In this case, the final price paid can be called the “realized price”. How much value is lost between all these steps? Many think quite a lot. After interviewing dozens of CEOs, CMOs and other executives at greater than 1,700 firms, Bain and Company found that about 85% of those that responded felt they may make higher pricing decisions.
How can I capture more value?
Let’s start by understanding how much our customers are actually willing to pay for our products or services. We can do this by surveying our customers, creating focus groups, experimenting with prices, or even organizing an auction.
If we’re not pleased with what our customers are willing to pay, we might have to take a step back and focus as a substitute on their perceived value of your product or service. When we help our customers see greater value through activities similar to branding, outreach and communication, we directly increase the amount they are willing to pay.
Alternatively, we may resolve to adopt a completely different pricing structure. More and more service firms are looking to metric-based pricing to offer an adaptive structure that higher aligns with the perceived value of each unique customer. Some examples of metric-based pricing are usage-based, similar to gym memberships and mobile minutes, or user-based pricing, which is a popular alternative in the SaaS world. There are great examples of indicator-based pricing throughout us. Mechanics often charge per hour, while bowling alleys often charge per game. These metrics work because they are reasonable, predictable and fair.
Don’t miss out on potential profit
Let’s look at the math together. Imagine for a moment that you own a coffee shop selling lattes for $5 each. This latte costs $1 to make and the profit is $4. If you sell 100 lattes, it’ll not be surprising that you will make $400.
However, unbeknownst to you, your customers are willing to pay $7 for the same latte. That’s a more generous profit of $6, which equates to an additional $200 per 100 lattes sold – a 150% increase. In fact, even if you sell fewer lattes – say 90 as a substitute of 100 – that may still be a 135% increase in profits.
In short, don’t leave any money on the table. If your customers are willing to pay more, now is the time to find out.