Subtract Psychology from the Pricing Equation

Posted on September 8th, 2009 Adam Honig Comments 0

Where discounting ends. Photograph by Lordcolus.

“Is That Your Recession Pricing?”

How will you price your goods or services during the recession? Of course, times are tough. Every customer is probably expecting—and pursuing—a better price from you than before. In fact, many customers probably think their vendors are desperate for sales, full stop.

How do you deal with this pricing challenge? Because during the downturn, how companies approach pricing and pricing discipline will be a major factor in their long-term success or failure.

For starters, you could cut the sales price of your goods or services. But is that wise? Probably not. For example, let’s look at a typical medical device manufacturer, which has an average gross profit margin of 40 percent. If the company increases its discounting by 10 percent, then—because it has probably already streamlined operations and can’t produce its products for much less—its gross profit margin drops to 30 percent. So the medical device manufacturer would be taking a pretty big haircut, and might have trouble paying for sales salaries and business overhead.

Then again, it might never recover from its price cuts. Because once you create a new expectation for low pricing, it is very, very difficult to raise prices later. In other words, if you’re trading down now to get deals, then you’re eroding the long-term health of your company.

To Stay in Business, Lose Deals

But in these tough times, don’t prices have to fall? Isn’t everyone thinking that lower prices are a must for survival?

Correct me if I’m wrong, but I don’t see any law of economics that backs that up. If demand is down, the price-elasticity curve should adjust downwards, provided you keep supply at a static level. But since everyone is busy adjusting supply, shouldn’t prices stay the same, or even rise? After all, inflation in many countries is still growing. Here in the United States, oil just hit $70 per barrel.

What does need adjustment is not necessarily the price of your goods and services, but the psychology of how they get priced. Too often, salespeople psych themselves into discounting something that they don’t need to discount. Sometimes they must even do the opposite: walk away. That’s right: Companies and salespeople need to accept the (perhaps counterintuitive) fact that they must lose a certain percentage of deals on price. Otherwise, you won’t know if your pricing is right, or if you’re maximizing the price per unit.

Thus, my golden rule for pricing: If you’re not losing deals, then you are leaving money on the table. And you can’t do that, especially in a down economy.

So, what percentage of deals must fail, so that you know your prices are right? In some industries, maybe five percent. For Boeing, maybe it’s one percent. For commodities buyers, it’s probably more like 40 percent. But the percentage is almost irrelevant. The point is that as you use CRM to master the art of pricing discipline, you will be constantly optimizing your prices based on a number of internal and external factors.

The Psychology of Everyday Pricing

Exactly what can you do from within a CRM framework to help make the discounting process more objective? As a number of organizations—including Dice and Monster— have shown, quite a lot.

For starters, create a structured process in the CRM system for discounting, quote generation, and approving deals. This removes the emotional “what do I have to do to win the deal?” component from sales interactions, replacing it with a logical set of rules that everyone must follow. Because as noted before, salespeople’s impulse will be to offer discounts; it’s human nature.

Now, the CRM system doesn’t function as a black box. Rather, the CRM software facilitates the approval process with management. For example, say a salesperson is in Detroit, and his sales manager is in Washington, D.C. How do they coordinate pricing? Via CRM. The sales manager sees all salespeople’s pending deals in the CRM system, and has the ability to discount a certain number of deals every quarter by 10 percent. If he wants to discount any more, he has to kick it up to his manager in New York City, who can discount a certain number of deals by 10 percent, and so on.

This approach is elegant because it allows managers to use their judgment, and for salespeople to negotiate, but within prescribed boundaries. Even better, because you’re using a CRM system, you can dynamically change those boundaries based on inventory levels, your position (if in the commodities business), or any other salient business factors.

As a bonus, using CRM to automate these processes—price lists, quote generation, pricing approvals—will also make your sales teams more efficient and effective, as well as prevent them from changing a price or quote. And if you already have price controls in your CRM software but salespeople are somehow routing around them, consider rewriting the existing CRM rules on pricing to block workarounds, while still giving salespeople some pricing flexibility. (We have helped numerous companies do this.) And as the result of either approach, I’d be extremely surprised if you don’t see a 5-percent improvement in revenues simply thanks to the increased automation and oversight.

One caution, however, is that as you become more disciplined with pricing, don’t forget to still arm your salespeople with the reasons why prices should remain where they are, if not go up.

Don’t Leave Money on the Table

A final and quite substantial benefit of handling pricing from within the CRM system is that every time you go through an RFP process and generate a quote, you’re capturing quite a lot of relevant data in your CRM system. By analyzing this information, you’ll find an optimal price point, and also know which deals to decline.

For example, if you approve three deals with a 10-percent discount, and customers accept two of those deals, and then you approve two deals with a 5-percent discount, and both of them get accepted, then you probably shouldn’t have approved the three deals at a 10-percent discount. You left money on the table. And in today’s economy, who can afford to do that?

Learn More

For details on the practice of collecting market intelligence on competitors and using CRM to create a scorecard of products and pricing, see our Q&A with Aspect Medical, a medical device manufacturer.

Our white paper about how high-technology companies can battle product name, option and SKU proliferation also contains numerous price-related best practices.