But I know what my market will bear….

This blog is supposed to comment on pricing stories and pricing news. I follow the media closely, but have not seen anything really interesting lately. Maybe most journalists are following the financial meltdown and the few who are not have been assigned to the election. So, in their absence, I hope you’ll bear (sic!) with me as your source for another true story…..

One of the most common objections we hear about value based pricing is individuals (typically founders, CEOs or CMOs) saying “I have 10 – 20 - 30 years of experience in this market and I know what the market will bear”. Are they right? I don’t think so. First off, in my experience, individuals making these kinds of comments are rarely working at the market leader, rarely at a market innovator, or even at a fast-growing company. No, a response like this almost always comes from an executive from the lagging company, the runner-up. They think they know but they don’t. Sure, they have all the “right” answers, but can’t seem to find success in their chosen industry.

So are they right? Of course not. If you are in a stable market and you have lots of experience in the market, your prices are typically within 15% of the optimum market price. Not a big deal, you may say. But think about it? 15%. What could getting that additional 15% of optimization do for your company? Will it really make a substantial difference?

Let’s look at a real world example to find out. One of Atenga’s recent clients wished to determine the optimum price for their consumer electronics product. Before retaining us, they had been selling the product at $200 because it felt like a nice round number, and it drove a retail price of $399.95 They were considering dropping their price to $170 (for a retail price of $339,95) to try and improve sales volumes and profitably. We examined the market preferences and buying behavior, and concluded that this company’s marketplace (with in +/- 15% of the current price) had a price elasticity of 1. This means that a 1% change in price will result in a 1% sales volume. So with that information it becomes easy to plot a number of different price points and conclude the results. Here is what our research concluded, both for their lower price point, as well as for the optimum price we discovered.

Example A: Lowering Price to Gain Market Share:

Cost of your product: $100
Price of your product: $200
Gross margin per product: $100
Price elasticity: 1
Sales volume: 10,000
Revenues: $2,000,000
Overall gross margin: $1,000,000
New lower price: $170
Gross margin per product: $70
Sales volume: 11,500
Revenues: $1,955,500
Overall gross margin: $805,000

-or-

Example B: Raising Price to Optimum (based on independent market research)

Cost of your product: $100
Price of your product $200
Gross margin per product: $100
Price elasticity: 1
Sales volume: 10,000
Revenues: $2,000,000
Overall gross margin: $1,000,000
New optimum price: $230
New gross margin per product: $130
Sales volume 8,500
Revenues: $1,955,500
Overall gross margin: $1,105,500

So in the first case, lowering the prices by 15% -- a typical quick-fix solution at struggling companies – and where the company planned to move the price - the sales volume will go up, but the result will be an almost 20% decline in margin. In the second case, market research shows that raising the price 15% to the optimum will instead result in a 10% improvement from the original margins. (For this company, the per-unit cost did not change much depending on volume). And just as important, a nearly 40% rise in margins from the company’s “we know that the market will bear” strategy to lower the price. Not bad! Just a little bit of market research, and now everyone at this electronics firm can see that huge holiday bonus coming right around the corner.

Consider the huge difference this will make, compounded over multiple years. Where do you want to be? Using your experience, your gut feel, your “I know my market” strategy. Or, do you really want to find out with hard, independent, unbiased data where the optimum price is? In looking at the data above, the answer’s pretty clear.

With warm late September regards,

Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com