How the right pricing strategy can transform your business
Wishing your business was more profitable? You’re not alone. Many of the CEOs I speak to are frustrated. Their order book is healthy, staff are run off their feet – it all looks pretty rosy. Until you look at their profits. Something is very obviously wrong.
This was top of my mind last week. I met a number of leaders from Managed Service Providers (MSPs) who were facing exactly this dilemma. Some were curious to hear my ideas on pricing, their faces lighting up. Others dismissed them, telling me I was wrong. I could see they felt threatened by the radical change needed to move forward.
All I can say is I’ve been there. When I joined Rackspace as UK MD, the average lifetime value of our customers was £2000. When I left five years later, this had shot up to £200,000. That’s a pretty stratospheric growth curve. Were we doing anything differently? Not dramatically. Mostly, the building blocks of the business were the same. We’d said to ourselves, given our expertise, what target market could we serve and how could we charge more for it? We wanted to grow our revenue and margin and that’s exactly what we did.
So how do you work out a pricing strategy that increases profitability and drives growth?
Clarify your proposition
Before you even start thinking about pricing, you need to be crystal clear on your proposition. Who is your core customer? What problem do they have? How can your product or service solve this?
Whilst this sounds great in theory, it can be really hard in practice. That’s why last week’s blog focused in on this topic and I suggested a tool called ‘attribution mapping’. This will give you a full picture of your position in the market along with a practical roadmap of activity for the next three years. The aim is to get you to a place where your company isn’t in competition with any other. That way you won’t come under price pressure and customers will buy at maximum profit.
Know your competition
OK – so you’ve worked through the process I outlined last week and have an attribution map for your business. Perfect. You should now have a complete understanding of what your competitors are charging. This is fundamental. How can you set your prices if you don’t know how they compare in the market?
And yet, this is a gap in knowledge that I come across time and again. Often, companies are undercharging for their services. Yes – it’s important that you’re not the most expensive in your market but you can charge as much as your most expensive competitor. I was talking recently to a coaching colleague who’d been working with a modelling agency. They were charging out their models at £75 per day but weren’t making enough margin. After some competitor research, they realised that prices ranged from £70 – £100 per day. They decided to increase their prices to the top of this band – £100. They didn’t go higher, as this would have made them more expensive than their competitors. You know what? It had no impact on their level of bookings. Their fear that they’d lose business was groundless.
Increase your prices (regularly)
Fear is one of the big reasons why companies don’t increase their prices. I met with a client a while back and discussed why they weren’t making enough money. We looked at their cost base but, even after some firm massaging, we still couldn’t get their margin anywhere near where it needed to be. So, I suggested putting their prices up. Their knee-jerk reaction was, ‘We can’t put the price up. Sales will complain! The customers will complain! We’ll lose business.’ Eventually, I persuaded them to try an increase of 1% per month. That was a year ago and they’ve continued with no detrimental effect on their business
A year on and their bottom line profit has dramatically improved. Yes, their cost base has increased as you’d expect with the usual rises in overheads, but not as much as their profit. If they hadn’t put their prices up at all, they would have found themselves going backwards.
On the annual review of this new approach, we discussed whether they should move to a rise of 5% per quarter, but after some debate, they decided this would be too noticeable. The compromise was to continue with small, incremental rises of 1.5% per month with regular reviews. So far, it’s working well.
When I joined IT Lab as their MD, I discovered we were losing £65K per month. Desperate circumstances required desperate measures. We had to get a handle on cost and put our prices up else we’d have gone under. Up until that point, I was nervous about putting prices up. But we did some calculations based on competitor pricing and realised we were totally out of kilter with the market. So up the prices went – by 50%! And we only lost one customer. I kid you not. We said to existing customers, ‘If you know anything about this market, you’ll know we’re too cheap.’ We reassured them that the increase in price would be accompanied by an overhaul of our service, which would drastically improve. And this was borne out by our NPS (Net Promoter Score) rating which went from -7 to +55 in two years.
Until we were forced to do this, I would never have thought we could push the price up this much. But once you’ve done it, you realise that the problem is in your head, not your customers’. You do it to yourself.
Of course, it’s important to approach any price increases with fairness. There are some companies that are underhand, annoying and losing customers. BT Broadband springs to mind. I recently got to the end of my contract and they didn’t tell me they’d just doubled my monthly bill. I left them swiftly. In contrast, T Mobile had a brilliant product called Flex. It guaranteed immediate notification if there was a cheaper product, giving you the option to switch. Hardly anyone did, but the perception was they were honest and trustworthy. That trust is worth so much.
The thing is, most of the time customers will stay put. They expect prices to go up and, as long as they perceive it to be fair, they won’t switch suppliers. Look at energy providers. The Government has been disappointed that more people don’t switch. Even when they have the information, the vast majority won’t move as they can’t be bothered. This is also the case with IT Services. Customers are more likely to change banks or get divorced than change MSP.
So my advice is, get your customers used to price increases. Make small changes often. It’s like compound interest – you’re much more likely to get to where you need to go. This is far better than increasing prices in big step changes.
Band prices in ‘threes’
Have you ever noticed that restaurants tend to band their wine list into three – cheaper, medium-priced, expensive? The majority of their sales will be in the middle. It’s all about perception. Customers perceive the best value to be had in the middle of the price range. This can be manipulated to increase profits – with higher mark-up wines deliberately placed in the mid-price bracket to increase margin on wine sales.
It’s common practice – you see it when you look at airline tickets. For every Flybe route, customers are given three prices. Again, the volume will be in the middle of the price banding and you’ll find even if the prices either side increase, the gravitational pull of the centre will continue. These tricks of the trade could have a major strategic impact on your profits.
A recent article in The Hustle looked at the pricing of cinema tickets and popcorn in the US between 1929 and 2019. Inflation on popcorn has massively outstripped that of tickets. That’s where cinemas make their money. They have a captive audience and realised there’s less price sensitivity on the cost of popcorn and drinks.
The same goes for low-cost airlines. They keep the price of the flight low as this is the price customers use to select a purchase. But they add on food, baggage, seat allocation etc as extras.
The MSPs that I work with might have a headline price of £100 per seat for managed support. This needs to continue to be transparent. But, if it’s difficult to raise this price, look at what’s the least you can include? Could you take out some professional services and charge extra for them?
Other creative pricing strategies that spring to mind are Amazon. Introducing Prime Membership at £75 per year had a massive impact on their profitability. Again, they keep the headline prices competitive but make their money on the peripherals. CostCo do a similar thing. Because it’s cheap to run, their membership fee drives a large part of their profit.
Don’t confuse price with quality
Quite often I see people using price as a proxy for quality. Don’t confuse revenue and profit. If you’re going to drop the price of your products, you have to increase your volume to recover the margin you’ve lost.
When I worked at ServerBeach, we realised that we were three or four times cheaper than Amazon. But our sales were static. Amazon was growing massively. So, it couldn’t be price that was the problem, even though our salespeople were pushing for reductions. We were actually competing on APIs and automation. Price didn’t come into it.
There’s this thing about price elasticity – companies think that if they’re cheaper they’ll drive more volume but often they don’t. When I arrived as MD at Peer 1, our salespeople were saying to potential customers, ‘We’re just like Rackspace but 30% cheaper.’ I could see this wasn’t working. We changed this narrative and increased our price to $1 more expensive. Then, rather than making our pitch all about price, we made it about quality. Customers would ask us why we were more expensive than Rackspace and that gave us the opportunity to talk about the difference in our service. We could say that on average, our level 3 technicians had five years’ service whereas, at Rackspace, they had less than two. Experience mattered to customers – no one wants to deal with the new guys who don’t know enough to fix the problems quickly.
If we’d continued to be cheaper than Rackspace, customers would have perceived that the service we provided was less. This matters for business-critical systems – a drop in price is just not worth the hassle when systems fail. I took a punt that our customers would go for a better service and it paid off. When I first arrived, Peer 1 was advertising a server on the front page of its website for $249 a month, with two months free on an annual contract. By the time I left, our largest customer was spending $1m per month!
With a bit of creative thinking, it’s possible to make a massive difference to your profitability. Recognise what’s holding you back. Overcome the fear and increase the price of something. Something with enough volume to make an impact. And keep at it. You’ll be amazed how this builds over time, slowly and steadily, enabling you to take your business where you want it to go.
Written by business growth coach Dominic Monkhouse. Find out more about his work here.