Thursday, September 17, 2009

Pricing: Discounting v. Unbundling

With times being so tough, most companies feel that the only way to attract new customers is to lower their pricing. While doing so in some cases will generate a short burst of activity and increased revenues, as a standard, long term course of action, it is not a wise thing to do .

The first reason why it is not a good idea to lower your prices is that your associated costs have not been lowered, and in order to make the same amount of profit, you have to sell a higher percentage of product just to stay even. A case in point, if you lower your prices by 20%, you need to increase your sales volume by 25%. If you reduce your prices by 30%, then you need a correspondent increase in sales VOLUME of 42%; a 40% discount needs a 67% increase in sales. I think you see where this is going. Unless there is a huge amount of elasticity in your pricing (where volume increases appreciably more with a price reduction), that without corresponding lowering of your costs, a reduction in price is at best a stop gap measure and at worst can lead to your eventual demise.

There are also some secondary problems that arise when you just arbitrary lower prices without taking something away in the sale. While market conditions might warrant some course of drastic action, an arbitrary price reduction can accidentally convey two things to your present and future customers. The first is an ongoing expectation that you will always lower your prices when things are tough. This essentially conditions your customers to "wait it out" until you decide to lower prices. The second is an impression that you have been lying to them all along if all of a sudden you can lower you price without giving up anything in exchange. This second situation is disastrous to the long term health of your company.

So what are you to do to increase sales AND profits? If you have to lower your prices, there are some strategies you can use to add more customers, reduce your costs, stay above the fray, and in the process keep from loosing the farm.

First and foremost, you need to look at how much PROFIT you make pre product and which products produce the most profits, not necessarily the most revenues. If you can make $10 selling a $20 item, or $20 selling a $100 item, sell the hell out of the $20 item. Plus the margin on the $20 item is 50% (versus 20%), and it will be a hell of a lot easier to sell five $20 items, than one $100 item (usually). Next, look at your portfolio of products and get rid (i.e. stop selling) those products that do NOT generate significant PROFITS. That is right! You may have to shelve high volume revenue products that are NOT producing profits. THIS IS THE MOST IMPORTANT CONCEPT I CAN CONVEY TO YOU, and it will be a hard pill to swallow in some case, but in the long run the you will see the benefits of actually having MORE money and will have to exert LESS effort in obtaining it by following this strategy.

OK, say all your products make about the same profits, and they are all priced comparably, what then? The next strategy is called unbundling. Say you have a product you sell for $100, and it has 3 or 4 components to it. Well, you can now remove sell each component separately for say $40 (versus $25 in a bundle), OK, say you cannot physically separate the product what then? Well you can ask the customer to give up (or pay extra for) the warranty, or customer service, or something if you are going to sell it for anything close to $25. This does two things: First is to increase your profits (or reduce your costs) and secondly instill some value for the “freebies” you used to give away while giving your customers the power to choose what “features” they want to pay (or save on) for.

A good example unbundling comes from Proctor & Gamble's attempt to sell shampoo into India. Initially, P&G wanted to sell a 12 oz container of its shampoo into the Indian market (similar to how they sell in Europe and the USA. There initial foray was disastrous for two reasons. First, this container cost the equivalent of a day's salary and secondly since Indians do not wash their hair as often as in the West, the quantity was equivalent to a year's worth of shampoo. P&G was able to penetrate this market (and still holds an 80% market share) when repacked their product for a single use size (about 20 rupees or 40 cents). This move was actually MORE profitable for P&G than selling in volume and allowed them to services a market that was previously untapped.

Too often I just see people leave money on the table when price negotiations begin and end. With these strategies and focusing on your profits (instead of just revenues), you will be in a better position to weather this economic storm of uncertainty.

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