Aug. 30, 2010
By Rafi Mohammed
Pricing is one of the most powerful – yet underutilized – strategies available to businesses of any kind. A McKinsey & Company study of the Global 1200 found that if companies increased prices by just 1 percent, and demand remained constant, on average operating profits would increase by 11 percent. Using a 1 percent increase in price, some companies would see even more growth in percentage of profit: Sears, 155 percent; McKesson, 100 percent, Tyson, 81 percent, Land O’Lakes, 58 percent, Whirlpool, 35 percent.
It’s logical, then, that the pizza industry – one of the most notorious for offering perpetual discounts, and one which is currently stuck in a $10 price war at the top – is undervaluing their product and short-changing their profit margins. Implementing the following six strategies will help turn the industry around.
Offer good, better best versions. All pizza concepts should have a “pizza plus” option. They can offer a lower price version, but not of their signature items. That’s a huge mistake. If you look at QSRs -- Wendy’s McDonald’s, Burger King -- they all have dollar menus. And they all have signature items. And now they’re adding higher items – McDonald’s has the Angus Burger. Burger King has the ribs that are $10-plus and sell out. So it’s all about offering different versions.
People are scared of not discounting in this economy. But I often tell people that if a business says they’ve lost 25 percent of customers, that sounds dire. But the good news is, 75 percent are still paying full price. So if you do an across board price cut you’re losing a lot of margin.
Stop marking up without reason. The most common mistake in pricing involves setting prices by arbitrarily marking up costs (“I need a 30 percent margin”). While easy to implement, these “cost-plus” prices bear absolutely no relation to the amount that consumers are willing to pay. As a result, profits are left on the table daily.
Realize that a discount today doesn’t guarantee a premium tomorrow. Many people believe that offering a discount as an incentive to trial a product will lead to future full price purchases. In my experience, this rarely works out. Offering periodic discounts serves price sensitive customers (which is a great strategy) but often devalues a product in customers’ minds. This devaluation can impede future full price purchases.
Set prices that capture value. Manhattan street vendors understand the principle of value-based pricing. The moment that it looks like it will rain, they raise their umbrella prices. This hike has nothing to do with costs; instead it’s all about capturing the increased value that customers place on a safe haven from rain. The right way to set prices involves capturing the value that customers place on a product by “thinking like a customer.” Customers evaluate a product and its next best alternative(s) and then ask themselves, “Are the extra bells and whistles worth the price premium (i.e., organic vs. regular items) or does the discount stripped down model make sense (private label vs. brand name frozen pizza, for example). They choose the product that provides the best deal (price vs. attributes).
Create a value statement. Every company – whether a mom-and-pop or a Boston’s, for example -- should have a value statement that clearly articulates why customers should purchase their product over competitors’ offerings. Be specific in listing reasons: this is not a time to be modest. This statement will boost the confidence of your frontline so they can look customers squarely in the eye and say, “I know that you have options, but here are the reasons why you should buy our product.”
It works. Regina’s pizzeria in Boston never discounts, and that chain has been around since 1926.
Reinforce to employees that it is okay to earn high profits. I’ve found that many employees are uncomfortable setting prices above what they consider to be “fair” and are quick to offer unnecessary discounts. It is fair to charge “what the market will bear” prices to compensate for the hard work and financial risk necessary to bring products to market. It is also important to reinforce the truism that most customers are not loyal – if a new product offers a better value (more attributes and/or cheaper price), many will defect.
Rafi Mohammed, Ph.D is the author of "The 1% Windfall: How Successful Companies Use Price to Profit and Grow" (HarperBusiness). He has been working on pricing issues for the last 20 years. Mohammed is the founder of Culture of Profit LLC, a Cambridge, Massachusetts-based company that consults with businesses to help develop and improve their pricing strategy.