12 price myths you should debunk asap to increase profits
14 Sep 2022 | 9 min read
By Michael Obernberger
CEO of Solia Consulting
Expert for sales and price optimization
Pricing is the single most important driver of profit. And it is the area that most executives overlook when searching for ways to increase earnings and implement improvement initiatives. This is largely because people have developed an inconsiderate mindset when it comes to pricing. Most of the time it is based on fear, outdated beliefs, and popular opinions, rather than facts and rational thinking.
We will examine 12 common myths that executives and business leaders must overcome to achieve a profitable competitive advantage.
The definition of price
But before we look at the most common myths, we first need to better understand what ‘price’ actually means and what it stands for. Let’s deconstruct price in 3 steps:
- Basically, price indicates the number of monetary units at which a transaction of a mutually defined and specified good (e.g., a product, service, etc.) is settled in each unit of measure. It is the amount of money expected, required, or given in payment for something. This agreement between buyers and sellers is usually reached by mutual consent, and since it applies to all parties, the value of the package is, in a sense, objectively determined based on this agreement.
- The price, i.e. the monetary expression of it, has no ‘utility’ or ‘value’ as such, but represents an individual, i.e. subjective, benefit. It conveys a value promise or proposition. The justification for this promise is sometimes based on a real, measurable benefit or intrinsic value offered by the good, but always on a subjectively perceived value attributed to the good by the buyer.
- To reach consensus, the objectively agreed price must be below the customer’s subjectively perceived value (-> maximum willingness to pay) and above the supplier’s subjectively determined price floor (-> very often based on costs).
The 12 myths
1. “Cost is a safe basis for pricing.”
This is not just a myth, but a widespread belief among executives. As a result, the cost-plus approach is widely used in companies and is considered the safest and most effective pricing method.
Instead of understanding customers’ true willingness to pay, which requires studying the value offered, most companies focus on setting the price floor based on cost and adding a margin markup. This seems to be simple and easy. But many are unaware that they are often relying on faulty costing templates.
Among the many deficiencies we have identified the 3 with the biggest impact are: (1) inaccurate or outdated process and machine rates, (2) incorrect and/or misallocated material costs and incorrect consumption assumptions, and (3) a fundamentally flawed calculation setup missing critical process steps.
The truth is that the cost-plus method, while simple, is uncertain because of the common data errors mentioned above. And it is ineffective because it does not consider customers’ willingness to pay. As pricing veteran Jamie Dore states: “It leads to same price/margin for all customers so you will either miss sales to the price buyer or miss revenue opportunity with the value buyer!” Many companies systematically lose money without even realizing it.
2. “The market sets the price!”
This is the most common myth that nearly 50 percent of sales managers and 9 out of 10 salespeople tell me right at our first conversation about pricing. In their view, pricing success is determined by the so-called ‘invisible hand’ – an outside force and the perfect excuse for failure. This myth is also the hardest to overcome because it is based on microeconomic principles that are correct on a bigger scale.
A true market price exists under perfect competition when there is complete comparability of goods, perfect equilibrium of supply and demand, and easy availability or tradability. However, these conditions are relevant only for a few globally traded products and goods.
Truth is that complete and perfect transparency of the interplay of supply and demand and a resulting objective price equilibrium will hardly exist in a locally limited and highly specialized niche market in which most SMEs operate.
Unless you are selling a pure commodity (check also Myth 9) in a fragmented market, you are usually an essential part of the market so be part of it and define it: Accept the fact that there is no general market price and manage each individual transaction price as good as possible!
3. “Increasing volumes can be only achieved by lowering prices.”
Alternative versions of Myth 3 are: “Increasing prices results in lower sales.” and “We will lose business, when we increase prices.”
These similar myths are all based on the loss aversion-bias and are heavily influenced by an economic principle that has been taken out of context: the price elasticity of demand. Price elasticity indicates the percentage change in the quantity demanded for a good when there is a change in the price of that good.
This concept is helpful at the product or customer level to understand how sensitively volumes react to price changes. However, when one generalizes, one often forgets that the objective price communicates a subjective value and that price changes do not necessarily and automatically lead to changes in demand.
In fact, most products and markets are way too complex and untransparent to be limited to price only. There are several companies that are able to drive pricing and volume simultaneously by understanding the value they provide and applying smart customer segmentation and prioritization, as well as multiple price points aligned with it. In the real world demand doesn’t behave like in text books as outlined below but follows different patterns.
For a perfect example of how companies can quickly increase sales while optimizing pricing, watch the video short training I’ve linked for you at the bottom of this article.
4. “Price is best managed by the field. Our sales reps know what to do!”
The view that the unit closest to the customer should have full pricing authority is widespread among B2B executives. It is argued that only salespeople, because of the time they spend with customers, have decisive knowledge that allows only them to set prices. And for the most experienced salespeople, this may indeed be true.
However, the vast majority of salespeople are generally not that experienced. Moreover, this view neglects the impact of applying systemic tactical knowledge provided by central functions. It also does not take into account that salespeople are constantly in a role conflict when acting on behalf of their own company while expressing the needs of their customers.
The truth is that in the absence of centralized pricing structures and tools to capture market intelligence, salespeople in most companies often set prices based on gut instinct or incomplete information, resulting in many deals being unjustifiably underpriced or lost. To avoid role conflict related to pricing, sales should be provided with standardized, value-based markup systems with price corridors that allow prices to be adjusted to local and specific conditions.
When salespeople are able to negotiate within clear boundaries and are ideally incentivized based on profit margin, they are best set up for success and replicate behaviors of pricing veterans.
5. “All customers are highly price sensitive.”
In Myth 3 we have already discussed that the economic principle of price sensitivity is often taken out of context. Moreover, as explained in Myth 1 many sellers in B2B markets completely misunderstand the concept of price and believe that price as such has value or utility, i.e., is a component of the value proposition. They overestimate their customers’ knowledge of price and misjudge the importance their customers place on price. The result is that in less advanced sales organizations, price is almost always the main reason and excuse for lost business.
The truth is that prices are important, and customers will compare quotes. But at the same time prices are less important to most customers than actual or perceived value and total cost of ownership. So if price is the only thing you sell because you are still caught in Myth 9, and you also still believe that the market sets prices (Myth 2), then customers may be in fact sensitive to that.
6. “High unit market share leads to high profitability.”
Executives who focus on increasing per-unit market share usually look at this solely from an efficiency perspective, meaning they expect to reduce overhead costs by increasing purchasing/buying power and by leveraging concepts such as the learning curve-effect and economies of scale. However, there is a problem with this: unit market share does not correlate with profitability and is therefore a poor indicator of a company’s profit.
The truth is that a company’s market power (its ability to raise prices) and its quality performance signaled to the market can lead to an increase in revenue market share and have a more direct effect on profitability than smaller gains due to higher productivity and an increase in sales volume. If you still don’t believe me, you should calculate the net profit resulting from a 1% price increase and a 1% volume increase or directly jump to Myth 10.
How to develop the ability to raise prices and profits is the main topic of a free short video training linked for you at the bottom of this article.
7. “Gaining market share from competition can only be achieved by being cheaper.”
An alternative version of Myth 7 is: “We need to charge less than others to grow.”
Having to be cheaper all the time is the biggest misconception in sales and competing solely on lower prices is a surefire way to sink a company. Yes, price corrections due to competitive shifts or overpricing must always be factored in. And yes, some business models build on the idea of being the cheapest or most cost effective.
However, the truth is that for most established businesses lower price points and levels attract other customer segments with lower benefit and value expectations, while causing them to generate less revenue from existing ideal customers.
Underpricing others and being ‘cheaper’ without understanding the own value is also the easiest strategy to copy and therefore often leads to margin erosion in the short term, significant changes in the customer portfolio in the medium term, and a downward spiral in the long term. Shares should be gained by the instruments laid out in Myth 6.
It is definitely not wise to compete on price when customers perceive different benefits, as the following chart shows.
8. “Tracking prices of competition is not worth the effort.”
Although competition is often cited as the main reason for losses or price reductions, companies rarely track their competitors’ prices as most executives believe that in-depth monitoring of market movements is not worth the effort.
The truth is that understanding competitors’ price movements and tracking the status of all bids, whether won or lost, always provides important insights for optimizing any pricing strategy – whether it is a cost-plus, a competition-based, or a value-based approach – and it helps to understand one’s position in specific markets and value chains.
9. “Products are difficult to differentiate.”
Unfortunately, many executives we encounter have a commodity mentality that they actively embrace within their companies. The result is that entire businesses no longer recognize, see, or appreciate the uniqueness of their company, employees, or products, leading to a purely transactional mindset that is disconnected from their customers.
The truth is that almost any good can be differentiated in customers’ perceptions through value, importance, specialness, quality, emotion, uniqueness, etc., as well as through all the associated tangible, intangible and ancillary offerings as indicated in the chart below. Ultimately, the beliefs and messages continuously and collectively sent out to the marketplace determine how customers perceive an offering – and even if it may have little impact, it still counts. This brings us directly to Myth 10.
Again: How to differentiate your products to increase profits will be shown in the currently free short video training linked for you at the bottom of this article.
10. “Small price changes have little impact on profits.”
While addressing the big, strategic issues and topics that have a big impact on the business and determine the way forward, less importance is usually given to small transactions and small customers and the associated small requests. In addition, small discounts and minor price concessions are given lightly and price and margin leaks are neglected because of their seemingly little impact.
The truth is that executives too often forget the direct impact of pricing on the bottom line and that sales – due to the role conflict discussed in Myth 4 – is usually too generous when confronted with customer requests. They both overlook the fact that every single transaction has a significant impact on the company’s profitability.
Just to give an example: A price reduction of just 1% across the board has a devastating effect of minus 20% on profits for a company that previously generated a 5% return on sales.
11. “Managing price means changing or increasing prices.”
Many executives have a very limited understanding of the pricing profession and believe pricing is limited to a few tactical measures like quoting, managing tenders, and implementing price increases.
The truth is that not only price, but all commercial terms should be touched by pricing (payment, warehousing, delivery, and deal language terms, etc.). In addition, effective price management requires to strategize, to communicate value, to develop skills, and to establish systems, procedures, and controls. Without touching or changing a single specific price point, professional price management can influence the composition of the entire customer and product portfolio to increase profitability.
12. “Price management is much too complicated!”
Yes, it can take time to think about pricing in detail. However, implementing basic pricing strategies and processes can be done quickly and easily after analyzing sales data and after just a few customer meetings. Systematic price management with precisely defined upper and lower bounds doesn’t require sophisticated analysis and already provides considerable benefits for sales. And: Over the last 10+ years we have NEVER seen a company that has tracked and optimized their pricing in the same way they did with costs.
The truth is that, like any other initiative in business and life, the most important thing is to just start! Pricing, like costs, is not a one-time optimization effort, but an ongoing process.
And if you get stuck, hire a professional or get advice here.
Although no other lever has the same impact as price – neither cost optimization, nor volume increase, nor anything else – price is not strategically set in most companies, and pricing is too often not on the management agenda. While pricing is still a black box for many, there are already some highly successful companies that have debunked the 12 myths and are winning it!
It’s time to ask yourself: Are you winning it or still trapped in a black box?
>>> Learn how to win at pricing to quickly increase profits in the following – still free – short video training:
Free Online Course: In 5 simple steps to 2x business profits
This currently free training shows in 5 short videos step by step how CEOs of industrial SMEs can achieve a highly profitable company.
Focused on key drivers and insights from 10+ years the training will guide how to increase earnings through price optimization fast and easy.
You can watch the 5 short videos of the training here for a short time for free (click here)!
ABOUT
Michael Obernberger
Michael Obernberger is the founder of Solia Consulting and helps SMEs to become more successful and more profitable.
Over the past 10+ years, he has refined the Profit Mining Method and the program built on it, leading companies to significant profitability improvements.
In this short training, which is currently still free of charge, he provides insights into the profit mining program and shows for the first time step by step how CEOs of industrial SMEs can quickly and effectively increase the profit of their companies.
