Pricing is the key to leveraging operating profits

Pricing is not just a number tagged to a product. If businesses set the right price for their products and services, it can boost their profitability as fast as no other lever can. Implementing a price change is more straightforward than increasing the number of units sold, and less challenging than optimising the entire supply chain for lower costs. On the other hand, the wrong price decisions can harm profitability just as much. In short, price decisions are probably the fastest way to influence a business's bottom line. This is why many decision-makers struggle to make confident price decisions. At the same time, the most successful consumer companies can adapt quickly and precisely estimate the impact of their pricing decisions.

Why companies change prices

There are both external factors and internal drivers for price changes. The following are the key influencers of pricing decisions at companies.

Supply and demand in the industry (external drivers)

External effects of supply changes such as factory shutdowns or the entry of new market players, shifts in demand due to demographic transformations or emerging alternative products, and cost variations resulting from technological innovations. These elements collectively play a substantial role in determining the pricing trends within any given industry, not just for consumer businesses but also for software, services and others..

Transaction-based factors (external/internal drivers)

At the transactional price management level, the focus is on setting precise prices for each sale. This involves determining the base price and applying various terms like discounts and incentives. Unlike broader strategies, this approach zooms in on individual transactions, tailoring pricing to specific customers and deals. An example is varying prices for different user groups, such as ticket pricing on flight booking platforms that differ based on the user or device, or varying discount tiers for different levels of membership on digital platforms. This is usually a more automated approach as part of a greater strategy.

Product and go-to-market strategy (internal drivers)

Beyond economic, transaction-based and geopolitical influences, companies can integrate pricing decisions into their product strategy and market entry plans, proactively shaping the market prices. Understanding the elements that consumers value in products and services, gauging the company's and competitors' performance on these aspects, and determining the premium customers are willing to pay for these advantages is key. Techniques like pretotyping with multivariate fake door tests, conjoint analysis, and focus groups are instrumental in gaining this understanding. This insight is crucial for both setting the right price and refining product and service offerings.

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Why pricing is the most effective profitability factor

Utilising data to optimise pricing strategies is critical for consumer operations to achieve the most profitable price point. A study from Harvard Business Review in 1992 by Michael Marn and Robert Rosiello from McKinsey found that even a minor 1% increase in price could lead to a significant 11.1% boost in operating profit, surpassing gains from adjustments in variable costs, volume, and fixed costs. This underscores the disproportionate impact of strategic pricing tweaks on a company's financial performance.

Source: Michael V. Marn and Robert L. Rosiello, HBR, https://hbr.org/1992/09/managing-price-gaining-profit

Taking the right pricing tweaks with behaviour-based market research

With the opportunity to increase operating profits there’s also a threat for price decision makers and their businesses. The concept illustrated by Marn and Rosiella can also be observed when it's reversed: if a company reduces its prices by just 1%, it could result in a substantial decrease of 11.1% in its operating profit. This demonstrates the significant impact even small changes in pricing can have on a company's results. That’s why decreasing the chances of making the wrong decision, or validating your pricing strategy before implementing it, is key.

If you’re going to market with the wrong pricing, damage is likely done already. How do you anticipate the optimal price for your business case before you go to market with your new or existing product, without losing out on demand? The obvious answer is: market research. Building focus groups and surveying market intelligence panels before any price implementation can help to understand the willingness to pay from consumers for your product or service.

In real-life markets though, consumer actions rarely match what they stated previously when they were surveyed - mind our article on the Say-Do Gap - in fact it’s 40% deviation from previously stated behaviour to actual behaviour. For real-life and more reliable insights, companies must show consumers what they could use or buy and measure their behaviour, their actual choices for certain price points of the product or variant they are shown.

One example of such a price test approach is the collaboration with BSH and Horizon. BSH conducted a multivariate price test via Horizon and was able to identify the optimum price point for an existing product, validated by real consumer actions, and was able to increase the price of a current product by 11%. We are linking the case study for you here.

Mastering pricing strategies is a pivotal and dynamic process that requires a deep understanding of various factors influencing consumer decision-making. From assessing industry trends to analysing transaction-specific nuances, and integrating these insights into product strategies, pricing decisions are multifaceted. Companies who leverage consumer action data and engage in behaviour-based market research to determine optimal pricing points can increase their chances of making the right price decisions and increase their operating profits many times over significantly.

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Written by
Daniel Putsche
Daniel is the Founder & CEO of Horizon. He is driving the strategic development of the organization, establishing a thriving company culture with a team on a mission to help teams build products that customers really want. Daniel has a strong record in sales, marketing and building startups from zero to one. Before Horizon, he successfully founded and co-founded multiple companies, i.e. Candylabs, BikeBeat and Venture Advisory Partners.
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