Top 3 Reasons Companies Leave Money on the Table
Almost all companies leave money on the table. Some leave a lot; some leave a little. Some on all their product or services; some on only a few of their products or services. In this article, I will examine why that is, and suggest a remedy.
Reason Number 1
One of the most common ways to set prices is to use the competition as a reference. Look at their prices and say, "our product or service is a bit better so we should be a little higher priced." Or, "we want higher sales volume so we should be a little lower priced." However, there is a legion of problems with this type of strategy:
1. Nothing actually says the competition has the right price. It is just a price. This means that the competition is likely to leave money on the table, and those who follow them, will too.
2. A little higher or a little lower – is just pure guesswork. It may work. It may not work. This type of guesswork is very unlikely to have the desired effect.
3. Unless the competition has its prices published, and only a few of them do, how can a company know their prices? It is really hard to get price information unless it is published. Joint customers are highly unlikely to divulge prices, price lists are a closely guarded secret. And even if a current price list could be obtained, it will not say what discounts, deals, and bundles the competition offers to close sales on its products and services.
Prices of the competition are important if they can be obtained, but what is more important is to understand what customers are actually willing to pay for the product or service. If the competition's price can be obtained, it is then possible to compare their price with the willingness to pay and therefore predict sales volume and revenue in comparison – taking the guesswork out of the process and greatly helps to stop leaving money on the table, as a more realistic and optimum price can be attached to each product or service that will, in turn, increase sales volume and revenue.
Reason Number 2
Another popular way to set prices is cost-plus, (i.e., the cost of goods or services multiplied by some variable). Cost-plus goes by some other names: margin goals or margin corridor. Cost-plus pricing means the company ensures its products or services are not sold below cost. This is good, but it also leads companies to leave money on the table and suffer from a lower sales volume than they could have. There are several problems with this type of strategy:
1. Different industries often have a diverse standard for the variable that is used to calculate the price of a product or service from the cost; it can be as low as 15% on top of the cost in some industries, while others take the cost times 7 or even as much as 10 to arrive at the price. In most industries and among the competing companies, the actual cost of manufacturing, or delivering a service, is about the same, and with companies that are using the same variable for their cost-plus calculation, it means they come to the very same price, leading to commoditization; buyers end up seeing products as equal because they are priced virtually on a similar level and it becomes a bit of a hit or miss process to what product or service they end up buying. This leads to lower-than-possible sales volume for a particular vendor, which is the worst possible position to be in.
2. Almost all companies have products or services that have some level of uniqueness and some products or services that are pure commodities. By using a fixed variable or fixed margin for all the products or services, the products or services that are unique inevitably will be priced wrong and thus, money is left on the table. Maybe they are unique in such a way that they appeal only to those potential customers that are extra price sensitive. If that is the case, then the cost-plus pricing will make them too expensive for the price-sensitive customers, and sales volume will suffer because of this. On the flip side, the product or service may have a uniqueness that appeals to those customers with a higher willingness to pay, then the cost-plus pricing simply means that the company is leaving money on the table.
3. The cost of a product or service has no relevance to the buyer as these type of customers only makes a purchase for the benefits the product or service provides them. So, with cost-plus pricing, if the company is able to lower the cost, then the price is lowered too. Why? It just means that (more) money is left on the table. That is an even worse position to be in!
Reason Number 3
The most common way to set pricing is to "estimate our customers' willingness to pay and set a price that feels right." Another way to say this is "we guess," or "we pick a price out of thin air," etc., and so forth.
Yet, in a study by S4P conducted in June 2018, two-thirds of companies say that knowing their customers' willingness to pay is of utmost importance. The key word here is knowing, not guessing. There is a big difference between the two.
Companies typically don't want guesses to drive their business. Aircraft engineers don't guess the strength of the planes' structural components. Food companies don't haphazardly toss together a bunch of ingredients, hoping it will become a palatable dish. Accountants don't guess the income and expenses a company has had. Logistics companies don't guess when trucks will show up at a distribution center or where they are going, etc.
So why then is "estimate our customers' willingness to pay and set a price that feels right" acceptable when it comes to the price of the product or service they sell? A few plausible reasons:
1. Companies simply don't know that it is possible to accurately measure willingness to pay for their product or service and then set the price accordingly. Yet, the few who do enjoy superior business results.
2. If they know the customers' willingness to pay can be measured, some companies don't think it would be appropriate for them to do that, or they would not trust the results. Yet, historical data shows setting prices based on customers' willingness to pay always works for the benefit of the companies who employ this method for their pricing strategy. Sometimes leading to spectacular business improvement results, sometimes less spectacular, but still positive, with always an improvement.
3. Individuals in companies may simply be too scared to find out that their guesses have been totally wrong. That there is a better way and they elected not to use it.
The end result of guessing customers' willingness to pay is that the company leaves money on the table, sometimes by a lot, sometimes by a little.
So, in closing, in this short review, we examined the top 3 reasons companies leave money on the table: to price like the competition, to use cost-plus pricing, and to guess customers' willingness to pay for a product or service. The benefits of all these methods are that they are quick and require virtually no company resources. The downside is that they are very costly in terms of lost sales volume and revenue. Companies, therefore, have a choice, the quick, easy, and inaccurate way of pricing or a slightly more involved and much better way to optimize the prices for their products or services. Which way do you prefer? The way that leaves money on the table or the way that brings money to the table?
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