The One Percent Windfall

the-1-percent-windfall

The 1% Windfall: How Successful Companies Use Price to Profit and Grow

by Rafi Mohammed

Rafi Mohammed is an economist who consults on pricing strategy. The 1% windfall refers to the large impact on operating profits resulting from small adjustments to price. “A study by McKinsey & Company of the Global 1200 found that if they increased their prices by just 1%, and demand remained constant, on average each company’s operating profits would increase by 11%.” The book is about creating a portfolio of pricing options to appeal to as many customers as possible, thus maximizing profit.

“The foundation of better pricing involves setting prices that capture the value that customers place on a product or service…  Value-based pricing uses the next-best alternative’s price as a starting point and then adds or subtracts based on product attributes.” Mohammed explains his profit maximizer analysis to find the most profitable price.

Prices can be structured to overcome various obstacles. “Pick-a-plan pricing tactics are classified into four core groups: (1) ownership alternatives, (2) uncertain value, (3) price assurance, and (4) financial and other constraints.” The author discusses 16 alternative pricing approaches to address these concerns. For example, flat rate pricing can make it easier to customers to budget rather hourly billing.

Adding premium and entry-level versions of a product can broaden the customer base. “Companies also benefit from current customers who choose to upgrade to more profitable products (as Southwest Airlines discovered with its Business Select ticket versions).”

The author suggests holding a pricing summit with sales and customer service staff. “I’ve moderated many pricing strategy brainstorming sessions at companies and found that the people on the [front lines] have an excellent understanding of customers’ pricing needs… They watch customers balk at a price that is too high and smile at prices that are lower than what they would have paid, see what attributes customers prefer, and listen to customers discuss what they need from a product and pricing plan.”

The book includes a section on pricing in a recession. “A company’s pricing response to a recession depends on whether its product is traded away from or traded down to… Once a price is lowered it is difficult to persuade customers to psychologically reset their product valuation if prices are raised shortly thereafter. A price cut often devalues a product… One option is to offer a ‘fighter brand’—a lower-priced version. If customers are going to defect from a company’s flagship products, it is best to sell them discounted versions instead of completely losing their patronage…  It’s important to emphasize that a decrease in demand, as brought on by a recession, doesn’t mean that everyone will stop purchasing at the current price.”

The book also addresses six pricing myths:

  • Myth #1. Setting prices involves marking up prices (cost-plus).
  • Myth #2. Increasing market share involves a trade-off between price and share.
  • Myth #3. The highest-volume customers should receive the lowest prices.
  • Myth #4. Discounting to get in the door will lead to premiums once a product proves its value to customers.
  • Myth #5. Higher operating margins signify pricing excellence.
  • Myth #6. Lower prices to regain lost volume.

“Many executives view increased operating margins as a metric of success for pricing initiatives… From my perspective, higher margins can indicate that opportunities to sell to price-sensitive customers are being missed. When discount tactics to serve these customers are implemented, additional profits are earned. However, since prices are lower, the overall operating margin may decline. The best metric to evaluate the success of a pricing initiative is straightforward: is the company earning more profit than it was before?”

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Mohammed, Rafi. The 1% Windfall: How Successful Companies Use Price to Profit and Grow. New York: Harper Collins, 2010. Buy from Amazon.com

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