How to Think About Pricing Strategies in a Downturn - Your Best Downturn Strategy? Think Twice About Price Cuts4/15/2002
Before you think about slashing prices, think again, says Nick Wreden, author of a forthcoming book on strategic branding. As he explains in this article from Harvard Management Update, a knee-jerk reaction to the recession is never good for business in the long run, and could even erode your brand image. Instead, make your pricing decisions based on clear strategic goals. Here, he shows how.
When times are good, pricing sins can be easily forgiven. But when the economy sours, a misguided pricing strategy can shrink profitability, warp customer relationships, and destroy a brand. When sales and profits are plummeting and customers are demanding better deals, the instinctive response is to cut prices. This silences customer complaints, helps cover fixed costs, and buys time until the economy rebounds. A price cut can also boost sales quickly, especially when there is no money for advertising or other promotions. But such a knee-jerk reaction may not be the best strategy, say the experts. Price cuts now may affect your company's profitability when the upturn occurs. It may signal to customers that you're an easy prey for additional discounting. And it may cloud your brand's hard-won image. Pricing decisions should not be viewed as Band-Aid solutions for bleeding income statements, says Reed K. Holden, president and CEO of Strategic Pricing Group in Waltham, Mass., and co-author (with Thomas T. Nagle) of The Strategy and Tactics of Pricing. Rather, they should be part of a long-term strategy for fiscal fitness. When economic storm clouds gather, trim your production levels, postpone expansion plans that aren't absolutely vital to your future growth, and slash nonessential costs wherever you can. This prepares you to pursue low-value business opportunities that help you maintain your cash flow without drastically reducing your production capacity.
Crafting the right strategies will not only strengthen your business now, it will also prime it for growth later. To bolster sales while avoiding a price cut's dampening effect on long-term profitability, keep the following advice in mind: Remember the big picture
Adjust your sales goals Instead of sales goals, set dollar contribution goals for products, market segments, and individual customers. To do this you may have to invest in financial systems that can track process costs as well as direct costs. Moreover, setting profitability goals may mean abandoning market-share goals. After all, a large market share doesn't necessarily mean increased profitability—as the recent performances of Sears and GM show. But switching to profitability benchmarks can help you pursue other low-price business. It may also make sense to change the basis for your pricing. Most expert believe that pricing based on value—the economic or psychological benefits delivered by your product or service—is much more effective than competitor-, cost-, or customer-driven pricing strategies. Remember, too, that the basis for customer value can shift when the economic climate changes. When times are good, customers often place a premium on your maintaining production capacity to ensure timely delivery of their orders; otherwise, their sales suffer. But in a recession, logistical services may be more valuable. Understand your competitive advantage Leverage your segmentation strategy Offerings can be segmented not only by value added but also by time (for example, peak-load purchasing), location, or purchase quantity. "The more you can slice and dice your prices and offerings without affecting your brand, the more you can sustain profitability," says Mitchell. Dynamic pricing represents an extension of such a segmented pricing strategy; here, prices shift instantaneously in response to changes in supply and demand. Although the practice doesn't suit every company, early testers of dynamic pricing software have been pleasantly surprised to discover how much more they can charge without affecting sales volume. The consulting firm Accenture reports that a price increase of just 1% can improve operating profits by 11% if sales volume remains constant. Pamper loyal customers But don't make the same mistake the wireless industry did. When carriers offered attractive deals to new customers but didn't make those same offerings available to existing customers, high churn rates resulted. Plug revenue leaks In a recession, revenue leaks also occur because sales forces become less resistant to customer pressures. They knock down the price until the sale is won, despite the impact on profitability. Ideally, prices should be negotiated based on business rules—volume, delivery, financing—and not according to the negotiating skills of purchasing agents. They should also be based on the value to the customer. But sales forces often oppose value pricing because it usually means higher prices and a greater willingness to walk away from price-sensitive deals. To encourage the desired behavior, compensate your sales force based on its contribution to profitability and/or customer equity, not just on sales volume. Shift the battleground
Protect your brands Despite the risks associated with poor decisions, only 11% of the respondents to the PPS survey of 124 of its members said that senior management is primarily responsible for pricing. "Successful companies," says Holden, "have CEOs who are very involved with a well-developed pricing strategy at the beginning of the strategic process, and who empower pricing managers to be tyrants about the execution of that strategy."
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