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Do your customers know what your products are worth? That may seem like a bizarre question at first, but in reality, many businesses routinely fail to convey the actual value of their products. Unsurprisingly, this miscommunication is seldom in a business’s favor.
More than 20 years ago, experts at McKinsey & Company found that between 80% and 90% of mispriced products are priced too low — and that remains true today. That’s potential revenue lost right out of the gate, and more than you might think. A 1% increase in price without a change in the volume of products sold equates to an 11.1% increase in operating profits, according to this comprehensive study by Harvard Business Review published in 1992 and still widely cited today.
Related: 10 Questions to Ask When Pricing Your Product
Where does value go?
Your products and services inherently create a certain amount of value for your customers. We’ll call this the “actual value.” In the ideal world, everything you sell would be priced based on the actual value. However, we don’t live in the ideal world. Actual value is monstrously difficult to calculate and can fluctuate per customer.
Not all of your customers will be able to see, or frankly even benefit from, the total potential of any given product. Smartwatches, for example, can track hundreds of unique exercises, but if all you do is run, then the value of those additional features would be difficult to see. Marketing has an impact as well. Sticking with the smartwatch example, if you fail to effectively communicate a useful feature — leaving your potential customers unaware — then that can have a negative impact on this “perceived value.”
Now, your customers may agree that your product produces a certain amount of value for them, but that doesn’t mean they’re willing to pay for it. Dozens of factors can impact how much a particular customer is willing to pay: urgency, income, brand loyalty, advertising, social impact, etc. Finding this number is tricky, yet highly rewarding. If you can identify the maximum amount your customers are willing to pay, you can maximize your profits while capturing as much value as possible.
Many companies are unable to determine exactly how much their customers are willing to pay. What that means is that the price your customers typically expect to pay is instead the “target price.” This is the value that you and your team hopefully determined is as close to the actual willingness-to-pay value as possible.
Finally, if you work in a sales-heavy field you may find additional value being lost to concessions and discounts. In this situation, the final price paid would be known as the “realized price.” How much value was lost between all of these steps? Many think quite a bit. Bain and Company found after interviewing dozens of CEOs, CMOs and other executives at more than 1,700 companies that roughly 85% of those who responded believed they could be doing a better job making pricing decisions.
How can I capture more value?
Let’s begin by trying to understand how much our customers are actually willing to pay for our products or services. We can do this by surveying our customers, assembling focus groups, experimenting with pricing or even hosting an auction.
If we’re not happy with how much our customers are willing to pay, we may need to take a step back and instead focus on their perceived value of your product or service. When we help our customers see more value through activities like branding, outreach and communication we directly increase how much they’re willing to pay.
Alternatively, we can choose to adopt a different pricing structure entirely. More and more service-based businesses are looking towards metric-based pricing to offer an adaptive structure that better aligns with the perceived value of each unique customer. Some examples of metric-based pricing are usage-based like gym punch passes and cellular minutes, or user-based pricing, which is a popular choice in the SaaS realm. There are great examples of metric-based pricing all around us. Mechanics often charge per hour while bowling alleys frequently charge per game. These metrics work because they’re reasonable, predictable and fair.
Related: How to Get the Price Your Product or Service Deserves
Don’t miss out on potential profit
Let’s look at the math together. Imagine with me for a moment that you own a coffee shop selling lattes for $5 each. These lattes cost you $1 to make, earning you $4 in profit. If you sold 100 lattes, unsurprisingly you would make $400 in profit.
However, unbeknownst to you, your customers are willing to pay $7 for that same latte. That’s a more generous $6 in profit, netting you an additional $200 per 100 lattes sold — a 150% increase. In fact, even if you wound up selling fewer lattes — let’s say 90 instead of 100, that’s still a 135% increase in profits.
In short, don’t leave any money lying on the table. If your customers are willing to pay more, now is the time to find out.
This story originally appeared on Entrepreneur
