Pricing to profit

The simplest way to price is cost plus pricing.  That is, determine how much it costs you to provide your product and add some factor.  A company that supplies to a department store may do a factor of four to the final consumer.  For example, it costs company X to $25 to make a product.  They may sell it to a department store for twice that, $50, and the department store my price it to the final consumer at $100.  Of course little things get in the way of that like promotional strategy.  Department stores are heavily promotional so they may price the product at $200 so that they can sell it to you at 50% off.  Cost plus pricing requires that you have done your market research on which features and functions the consumer requires.  Otherwise you may double the cost of the product and therefore the final retail by adding features the consumer is unwilling to pay for.

Cost plus is simple and it guarantees your products will make a similar margin percentage but it isn’t the most profitable way of pricing your product.  A better method is pricing to what the customer is willing to pay.  For example, working with Swarovski, I priced a foot tall pure crystal bird sculpture (which would have pricing according to Swarovski’s pricing methodology at $650) at $885.  I knew that the consumer would be willing to pay more for such a majestic piece.  What also helped my pricing decision was that I knew the product was supply constrained.  That is, we were likely to not be able to satisfy all of the consumer demand.  Therefore, Swarovski’s profitability was maximized by raising the price where demand would equal supply.

The goal of pricing is to price to the PROFIT maximizing level.  I stress profit because too many people attempt to maximize sales.  Let’s use a simple example.  Through analysis, you feel that you could sell 1000 units of a product at $10, 500 units at $15 or 250 units at $20.  Sales in these examples would be $10,000 at $10, $7500 at $15 and $5000 at $20.  If the product cost you $9 to make at $10 you would only have made $1000 in profit.  At $15, you would have made $3000 and, at $20, you would have made  $2750.  Therefore, pricing to maximize sales would have you at $10 while pricing to maximize profits would have you at $15.

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Not just the “why” of strategy, the “five whys”

Originally created in the Toyota Corporation by Sakichi Toyoda as part of the Toyota Production System, the five whys is a simple yet effective tool for driving to the root cause of an issue.  In utilizing the five whys, state the issue and then ask “Why?”  Once you have a satisfactory answer, again ask “Why?” to the answer.  Repeat asking “why” until you have discovered the root cause.  Generally speaking asking “why” five times is sufficient to determine the root cause.  For example, 1.) Why was the wrong product shipped to the customer?  Because the sku in the catalog was incorrect.  2.) Why was the sku incorrect?  Because the error wasn’t caught in final proofing.  3.) Why wasn’t the error caught in proofing?  Because too few people are part of the proofing process.  4.) Why are too few people part of the proofing process?  Because the draft was delivered late to the team.  5.) Why was the draft delivered late?  Product marketing was late in providing final information to the catalog team.  This error was really caused by product marketing being late with information.  Of course, “why” could be asked several more times in this example before a satisfactory solution could be found.

The five whys is frequently used in very process oriented systems, such as manufacturing, but it also fits very nicely in marketing and strategy development.  Consider trying to discover why a consumer prefers a competitive product (see below for the first level of questioning).  Use field sales, customer service, management, analysts and insights team to pick the top two or three reasons why the customer prefers the competition.  Then for each answer, do some research.  For example, competitively shop your competition and determine how your organization’s pricing measures up.  Then for each researched answer, ask the most relevant “why” question.  Repeat until you have several paths of root causes for your team to provide solutions.

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The five whys can also be used to build a solid story for marketing or social media campaigns?  Start with why the customer would care about the story.  Several levels and frequently the root of the customer’s motivation will present itself.  Build your campaign to communicate directly to your customer’s root motivation.

Another use would be to determine target customers and best methods for reaching them.  For example, why are Boomers less likely to use our product than Gen X?  Or why are women more likely than men to use our product.