This column is adapted from The 1% Windfall: How Successful Companies Use Price to Profit and Grow by Rafi Mohammed (HarperBusiness, March 2010).
Pricing is one of the most powerful, yet underutilized strategies available to businesses. A McKinsey & Company study of the Global 1200 found that if companies increased prices by just 1% and demand remained constant, operating profits would increase on average by 11%. Some companies can profit even more; A 1% increase at Sears (SHLD), for instance, would raise profits by 155%. Just as important, price is a key attribute that consumers consider before making a purchase.
Many times customers are intrigued with a product or service but refrain from purchasing simply because the pricing plan does not work for them. Instead of making an outright purchase, for instance, some may prefer to rent, lease, or interval own. Offering a new pricing plan opens the door for new customers to purchase, generating blockbuster growth. Pick-a-plan pricing tactics can be categorized as providing ownership alternatives, mitigating uncertain value, offering price assurance, and overcoming financial and other constraints.
Some customers are interested in a product but can't afford it or don't need to own it. Alternatives include interval ownership, leasing, rental, and the Netflix (NFLX) model. The interval ownership concept has broadened the market for private jets and vacation condominiums. Many automobile customers prefer the convenience and upgrade benefits of leasing. The co-owner of Frank Kent Cadillac in Ft. Worth, Tex., told The Wall Street Journal that leases used to account for 65% of its business, according to a 2009 article. Companies such as Zipcar are innovating on the rental concept by offering hourly rentals to serve new customer segments: urbanites and college students.
Uncertainty about a product's true value is often a roadblock to purchases. Is the seller going to deliver? Will the technology really be embraced by consumers? Pricing plans that reduce uncertainties about products and services include success fees, licensing, and future purchase options. Success fees are only awarded if sellers deliver on their pledges. Similarly, licensing agreements such as franchise fees and author royalties pay sellers according to commercial success. Auctions can quickly establish the market value of uncertain products. Auctions are sealing deals in weak housing markets whose consumers have been conditioned to wait for lower prices. Future-purchase plans allow customers to pay a fee to guarantee the right to buy in the future at a set price.
price to overcome buyer constraints
Many customers value the certainty of knowing the final price. Pricing plans that serve this fundamental customer desire include flat-rate, peace-of-mind guarantee, two-part high/low pricing, and all-you-can-eat. Instead of open-ended "we'll see how long it takes" pricing, flat-rates offer fixed fees for services such as resolving legal issues. Peace-of-mind guarantees provide certainty of future prices for volatile commodities, including oil and food products. Warehouse clubs charge an up front annual fee in return for low prices. (Costco (COST) pledges not to mark up its wholesale costs by more than 14%.) All-you-can-eat pricing plans ("all inclusive") are popular with vacationers who prefer to pay a set price so as not to have to worry about the prices of food, drink, and activities they enjoy on their holidays.
Finally, customers may refrain from making a purchase due to constraints. Pricing plans to overcome constraints including financing, job-loss protection, prepaid, and layaway. Financing can draw in customers who cannot afford to pay the entire price up front. Job-loss protection, which allows products to be returned in the event of a layoff, has been popular, stimulating customers wary of purchasing in an uncertain economic environment. Prepaid plans impose discipline and serve customers whose usage does not conform with monthly plans (cell phones, for example). Layaway allows customers to pay over time—the product leaves the store only after the full price has been paid. Kmart featured its layaway policy in a 2008 national advertising campaign. In a 2008 Wall Street Journal article, Mark Snyder, Kmart's chief marketing officer, was quoted as saying, "While not sexy, layaway became the big idea at Kmart these holidays."
Since pricing is an underutilized strategy at most companies, it offers a lot of prospects for new profits. The power of offering new pricing plans comes from the ability to sell products to new segments by better meeting their needs.
What pricing plans can activate your dormant customers?