Your pricing strategy has a direct impact on customer loyalty. Reasonable prices increase customer trust and confidence in your entire organization. If your pricing seems unfair or poorly managed, they lose confidence in you. A solid pricing strategy is fundamental retaining customers and profits.
Manufacturers often have thousands of items to price, with more added all the time. It’s tempting to apply a flat profit percentage, only deviating when a complaint is received. Across the board markups run the risk of overpricing a commodity and under-pricing an exclusive product.
Commodities are goods interchangeable with other goods; they are widely available; and the importance of factors other than price and availability (such as brand) are diminished. 1/4-20 hex-head bolts and number 2 wood pencils are commodities. They are easily sourced and pricing is generally known. If you try to apply too high of profit to these items your customer might notice and then assume all of your products are overpriced. Exclusive items are goods only available from you. Devices that are patented, custom, or manufactured using trade secrets are examples of exclusive items. There are also products and services that fall between commodity and exclusivity.
The Pricing Goal
Your primary pricing goal is to maximize company profitability and customer loyalty. Customer loyalty is where your customer buys all they can from you, is impervious to competition, and recommends you to others. A secondary pricing goal is to create a system that allows you to easily manage your pricing system, quickly pricing new items and adjusting prices on existing items.
The Basic Value Pricing Model
Value pricing can get very complex. However, whether you are General Electric or a small fabrication shop the approach can be boiled down to this: group similar items together based on their value to the customer and competition, and apply profit that considers these two factors. You could also argue that a solid grasp on customer needs is also of value. Manufacturers typically have many items to price, and to have a knowledgeable person analyze and price each item is usually unrealistic. Therefore, try to use only 3 or 4 groups and create a set of rules that allow quick categorization and pricing by you or your team.
- Level 1: These are commodities you typically buy and resell. These commodity items are easy to find elsewhere and brand carries almost no value. They buyer considers price, availability, and ease of purchase. Your gross margin percent for this level of products will end up below your company’s average GM percentage. Gross margin is selling price, minus the cost of goods sold, the result is divided by selling price. Use gross margin percentage rather than markup percentage since gross margin translates much more directly to the income statement. Ensure pricing is competitive with the street price (not necessarily the lowest, but competitive). Pricing these products too high might make buyers question all your pricing. Examples are bungee cords, office supplies, common fasteners.
- Level 2: You make, buy, or private label these products. Your offerings have little or no exclusive customer benefits, little or no competitive advantage, no Intellectual Property (IP) protection such as trademarks or patents, and can be sourced elsewhere if the customer is willing to put in the time to research. Target the upper range of competitive pricing for these products or services. Examples are replacement lights for the current model year and uncommon fasteners.
- Level 3: You make or private label these products, or you buy them from a source that is hard to find. These products have some perceived benefits and competitive advantages, and should have a price point slightly higher than competitive pricing. A Level 3 example is an important but not IP protected replacement part that can cause the customer problems if it fails, such as a specific solenoid or gear. You might choose to combine Level 3 with Level 2 if your offerings are fairly straightforward.
- Level 4: You are clearly the vendor of choice for these products either through recommendation or by a directed-buy mandate. You manufacture these items or have them manufactured specifically for you. The products have strong, unique benefits and competitive advantages. They might have patent protection or be manufactured with an exclusive capability that few companies possess. These products might only be available from you. The value is high, so price these products with a higher gross margin percentage. Level 4 examples are items that void the warranty if the system is serviced by non-OEM certified technicians or parts replaced by non-OEM parts. Or, they might be patented items, custom PC boards, or other critical custom components.
Your marketplace might accept gross margin percentages of 15%, 25%, 40%, and 60% for Level 1 through 4, respectively, or it might accept margins far less. The point is, select percentages that ascend logically.
Announce pricing adjustments, not increases, and point out those items where prices have gone down. Create bundles and programs that are of value to your customers.
- If you find you are not winning business on Level 1 and 2 items, consider bundling them with Level 3 or 4 to create attractive packages.
- If you find certain customers are receiving discounts on Level 4 products but never buy anything else regardless of your offers, eliminate the discounts. They have shown you they will only buy products from you they cannot buy elsewhere.
- Create a rewards program that entices customers to buy all four levels of product from you.
- Raise prices on Level 3 and 4 items, while lowering or holding prices on highly visible Level 1 and 2 items.
- Approach customers you have lost with your new pricing programs. Consider special discounts on their next order to encourage them to start buying from you again.
Test For Impact
Adjusting pricing is a scary thing. You can reduce your fear by testing for impact before you launch. Will your efforts increase company profitability? Will they be accepted by the market and increase customer loyalty?
To check for profitability impact, run a cross section of last year’s sales through this year’s pricing model; make sure to compensate for discounts and giveaways. Has your profitability improved? Then, create your messaging and scripts and run them by knowledgeable sales and service people within your company to get their feedback. Will customers think the price adjustments are reasonable? Will the market react positively? If things are looking good, then try it out on a few customers before wide scale launch.
Follow Your Rules
Once you have a value pricing model in place, teach your team to follow your rules. When they are faced with pricing a new item, they should identify which group the item falls, research competitive pricing if the item has a large profit contribution potential, and apply the appropriate gross margin percent. With few exceptions, your rules should help your team quickly and accurately set reasonable pricing.
Creating value-based product groups and creating rules for pricing will help your pricing make sense to your customers, thereby increasing loyalty and profits.