Modern pricing methods determine the sales or profit-optimized sales price taking into account the company’s own costs, the price structure of its competitors, the perceived customer benefit and the willingness to pay available on the market. After all, a successfully implemented price increase has a much more direct effect on EBITDA than, for example, sales increases or cost reductions.
Monopolists have it comparatively easy when it comes to pricing, because they can use a relatively simple price-sales function to determine the prices that give them the maximum profit. This is more difficult for companies in tough competition, because especially with comparable products and services, not only their own costs but also the pricing of the respective competitors is highly relevant.
Current studies show that approximately half of companies say their industry is dominated by the battle for market share the majority of the companies involved in a price war are firmly convinced that this price war was started “by the competitor both customers and competitors are becoming more and more price aggressive
Many companies feel helpless in their respective price wars or at least very limited in the opportunities available to them.
Why it is worthwhile to determine the right price
In addition to the competitors’ own costs and pricing behaviour, the added value offered to customers must also be included in the price calculation. Otherwise, a lot of profit potential is wasted. A study of the annual financial statements of industrial companies such as VW, ThyssenKrupp and MAN has shown that even small price increases are worthwhile. A price increase of only two percent would increase their profits by about one hundred percent.
Instead of price increases, there are many attempts to increase corporate profits with the help of sales increases on the basis of margin renunciation. Cost reductions in the areas of production, personnel and R&D are also very popular. The latter, however, is often accompanied by a loss of quality and innovative strength. Decreasing quality and a lack of innovation output in turn have a price-reducing effect and a company quickly finds itself in a downward spiral.
Customers are very much prepared to pay more for added value. However, this implies that these added values must actually be perceptible. In the case of an absolutely comparable product with a comparable ancillary service, only the price can naturally decide.
How to generate added value for your customers
Buyers or other tactically acting customers try with modern means to make offers as comparable as possible, at best to press them into a scheme. The aim of this approach is to take arguments from the supplier to justify his pricing and to put himself in an advantageous negotiating position. After all, a buyer usually wants to pay the lowest possible price for a product or service. However, the supplier has many possibilities besides the hope that the buyer is not too well trained in purchasing. He can distinguish himself through added value or competitive advantages. These competitive advantages can lie in the product itself (better, faster, more reliable, etc.) or also in the ancillary services such as regional proximity, quality, friendliness, further offers and many others.
For example, a bakery can offer the region’s tastiest rolls, which are always sold warm. The bakery also stands out for its friendly staff, cleanliness and speed of customer service. An inviting interior with pleasant lighting and comfortable dining areas invites you to linger and the coffee machine produces excellent latte macchiato – much better than the stuff that comes out of some vending machines. The snacks and small dishes on offer are fresh and of high quality. This bakery is famous for its bread rolls and for everything else and also sells many other high-margin foods to its customers, who are mainly regular customers.
Although or precisely because the bakery sells around 42 percent more expensive than its direct competitors, it provides its customers with added value, which they like to reimburse.
A further example is offered by the automotive industry with its navigation devices permanently installed in cars. As is well known, navigation devices installed directly by the manufacturer cost a multiple of the mobile GPS devices offered in free trade. The car manufacturers had to decide how to deal with their competitors. In dialogue with car dealers, customers always complained that the manufacturer’s fixed installation was far too expensive compared to the TomTom of free trade. Due to high manufacturing costs, however, car manufacturers were unable to sell their navigation devices at the TomTom price.
Studies commissioned have shown that a certain proportion of customers value a fixed installation more than a mobile solution. The fixed installation requires no external cables, is firmly connected to the vehicle and therefore better protected against theft, often offers greater ease of use and is also more stylish and image-enhancing. Many cars are leased or financed (as company cars), so that the relatively high purchase price of an integrated navigation device is hardly noticeable in the monthly installment.
As a result, many car manufacturers have focused their pricing on those target groups who are willing to appreciate and pay for the added value offered. With these customers they realize less sales, but a high-margin turnover.
It is therefore a matter of adapting to one’s customers and developing value creation configurations which are adequately remunerated by the respective target groups.
A good example of contemporary pricing is also shown by Deutsche Bahn with the Bahncard. This two-dimensional pricing instrument offers customers and Deutsche Bahn many advantages.
Dealing with commodities and other easily exchangeable products
In view of the interchangeability of products, marketing for commodities presents management with particular challenges. Often, quantity and price are the only relevant factors in the business. As a result, it is difficult to stand out from your competitors. Nevertheless, German electricity suppliers, for example, tried to embed their brand in an emotional environment or to lend it fictitious characteristics (“Yello electricity”, “Aquapower”).
Let’s think of the many other products that can be bought almost everywhere. How does the trade deal with this?
If we look at the big chains in food retailing with their discount campaigns or the big IT markets (online and offline), which often sell certain products below the purchase prices of specialist retailers or system houses, then this behaviour seems ruinous at first glance. After all, a low selling price only makes sense if it is based on a (purchasing) cost advantage and not on a renunciation of margins.
However, with the offered underpriced prices, the respective providers usually pursue a cleverly designed tactic as part of an overall pricing strategy. The promotional prices convey an interesting price image in the market, so that a buyer assumes that other products can be found there at similarly low prices. They also ensure a high visitor frequency so that visitors can also buy other (high-margin) products. On average, the prices of the respective provider are calculated in such a way that it maximises its profit situation.
A system house offers some hardware prices only in order to establish or maintain contact with customers and then to conduct more lucrative business. There are products where the customer pays particular attention to the price. A dealer cannot earn money directly with these products. Indirectly, however, they do, because these low-cost products ensure frequency and create customer relationships that one would otherwise not have.
For this reason, discount campaigns must always be created in the context of an overarching strategy. Without this strategy, discount campaigns are simply stupid.
Many companies massively underestimate the topic of pricing
Especially the implication on the company profit is not recognized by many managers. Prices are often set as they see fit, which hardly ever leads to the maximum achievable results. On the contrary. Companies that do not professionally take care of their competitive advantages and prices quickly become driven, which leads to the allocation of high discounts and thus to dramatic profit reductions. In mystery shopping, a tender directed at companies with several locations often leads to different prices, which can vary by up to one hundred percent. The management is regularly horrified.