How to Gain Pricing Power

• October 6, 2020

Taste the word “pricing power.” Does it not taste really good? Believe it or not, your pricing gives you power. But what is pricing power? Well, Warren Buffet summarized pricing power very well. He said:

“Pricing power is the most important criterion for investing in a business. Pricing power is the ability to increase prices and not lose sales volume.”

Pretty powerful stuff, don’t you think? When one of the world’s most famous investors and self-made multi-billionaire, says that pricing and, in particular, pricing power is essential, then these are words we need to take on board for our businesses. If Warren Buffet made his money (current net worth of $82 billion) from zero, by finding and investing in companies that did not realize their pricing power, we should take notice, and executives should carefully examine whether their company, in fact, does have pricing power for its products or services. A consequence of having unrealized pricing power is the same as leaving money on the table, and in some cases, a lot of money is left on the table unnecessarily. 

Almost all companies, especially if they have been in business for some time, have products or services that have some kind of uniqueness, have some products or services that are entirely commodities, and some products that are in-between unique and a commodity. Many companies, most of the time, have a pricing strategy that deals with these three categories of products or services in the same way. It can be that they use the same markup from cost, or that they try to find comparable products or services from the competition (hard to do when a product or service is unique!) and set the same price as them. This often leads to a situation where the unique products are underpriced, and the commodity products are overpriced, and the company ends up leaving money on the table for the unique products or services and does not have enough sales volume for the commodity products. This is not a good situation to find yourself in!

But the solution to this problem is often quite simple. The first steps are just to identify what products or services are unique, what products or services are commodities, and what products or services are somewhere in-between. Meaning they may have some aspects that are unique but may also have elements that are more of a commodity. 

Once this categorization is done, the time has come to implement a different pricing strategy for the various categories of products or services that you offer to your customers. 

Products or services that are unique have, by definition, tangible pricing power. Customers have no or few alternatives to the unique products or services in the marketplace. Therefore, discounting on those unique products and services should stop, or at least be reduced to the bare minimum. Discounting to close sales is merely unnecessary – albeit some salespeople want to give discounts because they feel good doing so and because the customer feels good receiving it. But it may not be necessary at all to close a deal for a unique product or service. 

Secondly, prices on those unique products or services should increase. The amount of the increase should preferably come from measurement and model of how price affects sales volume so that the price that yields the higher sales volume and the price that generates the highest revenue can be identified and then set for each unique product or service. It is also very important to determine at what price there are price walls (psychological price points where small changes in price cause substantial changes in sales volume). Armed with this information, companies can set the right price for these unique products or services. The “right” price may differ based on the company’s strategic goals – it may be set for maximum revenue, maximum profits, or maximum sales volume. Or for a combination of all of these. 

A completely different strategy needs to be used when it comes to commodity products or services. Commodities are sold by price alone, (i.e., there is nothing that differentiates those products or services compared with the competition). Commodities are lacking any kind of pricing power, except for price and brand. 

The first thing that needs to happen when commodity products or services have been identified is for the company to ask itself a few measured questions. Such questions that need to be asked for each individual product or service, like the following:

Is this a product or service that generates any kind of contribution margin? If not, is this a product or service that we really need to sell? Does it add value to unique products or services? Do we have to sell this in order to deliver a complete product or service to our clients? Do our clients expect to buy this from us? 

If the answers to any of these questions are “no,” discontinue the product or service. It is a distraction for your company. If the answers to any of these questions are “yes,” there are two possible actions to take. First, work relentlessly taking cost out of the product or service – but be incredibly careful not to reduce the quality or the benefit it provides your customers. Secondly, strengthening the brand as a stronger brand will lead to a higher sales volume of commodity products or services. A strong brand leads to some level of pricing power, even for commodity products and services. Thus, a strong brand allows companies to increase the price even for those, even if it is just by a little. 

So, now we come to the strategy for those products or services that are classed as “in-between.” These are the products or services that are not truly unique but may have some unique aspects to them. You have the options to either make the product or service unique or increase its “uniqueness.” At the same time, the questions mentioned earlier are highly applicable again to be answered. 

In closing – do I say that gaining pricing power is easy? Not at all. But what I’m saying is that executives need to be fully aware that there is something called “pricing power.” The fact that it exists, means that you can, relatively easily, put in place the process I suggest above. If your company has a dozen, or so products or services, this is a quick process. If it has 10,000 SKUs and dozens of services, this, however, is a process that will take a long time, but the earlier you start, the earlier you will reap the benefits of gaining “pricing power” for your products or services. Since the market is in constant change, this is an ongoing process, not a “set and forget.” It is a process that needs to be regularly evaluated and re-evaluated according to the climate in the marketplace, sales volume targets, the competition’s products, and services, etc. 

So, now it is up to you, the reader, to gain pricing power. Be confident; you can do it!

Per Sjöfors
Founder
Sjöfors & Partners
www.sjofors.com