Pricing is the single most powerful lever a company has for boosting profitability. Yet, most organizations devote much more time and effort to cost-cutting than to improving pricing.
If the average company captured 1% more in price, without any change in volume and costs, profit would climb by 12.5%, which is a substantial increase.
Pricing is especially valuable to the bottom line during a crisis. Under normal circumstances the value of capturing 1% more in price (which we refer to as the value of 1%) results in a profit increase of between 8-9%. During the 2008 economic crisis, the average profit margin was down to 4%, and the Pricing Solutions team saw that on average, a 1% improvement in pricing resulted in a 25% improvement in the bottom line.
This graph shows that during the 2008 recession, the EBIT (earnings before interest and taxes) or sales ratio for companies in the S&P 500 dropped below 5%. As you can see, at that time, a 1% improvement in pricing would have yielded an almost 25% improvement in EBIT.
A Look at Business Cycles During Times of Crisis
The value of 1% changes depending on the business cycle and historically it increases substantially during a crisis. There are a number of reasons why pricing is more important in a downturn and, perhaps the most crucial one is its direct impact on the bottom line.
The value of 1% applies across all industries and in most cases a pricing improvement flows straight to the bottom line. For example, an improvement of 1% in pricing for a company with a 10% sales ratio or EBIT (earnings before interest and taxes) yields a 10% improvement in EBIT.
In economic downturns most companies and sectors typically experience a decline in EBIT or sales ratios, and for this reason pricing becomes an even more important lever to maintain profitability, especially when there are potential recessionary indicators for several years, as we’re seeing now.
Capturing the value of 1% is critical during times of crisis and is one of many ways to create a more resilient pricing strategy. We recommend establishing a comprehensive pricing framework that is resilient and adaptable.
The Pricing Solutions team has developed 5 Levels of World Class PricingTM Excellence, which is a framework designed to help benchmark the pricing maturity of an organization and ensure offerings are optimally priced. The five levels are a roadmap that help clients build an effective pricing strategy, and the first step to this journey is to identify where your organization is situated within the framework:
- Ad hoc/Firefighting – reactive pricing driven by exceptions and person-driven sales
- Control – reliable and controlled pricing structure, driven by data with clear guidelines and rules for sales concessions
- Value – good understanding and communication of value of products to customers, with pricing decisions based on cross-functional communications
- Optimized – a scientific approach to pricing that incorporates value and data driven understanding of purchasing behaviors, with specialized function revolving around pricing
- Master – well recognized and established pricing approaches and tools with continuous monitoring and development.
The Pricing Solutions team is dedicated to helping brands take advantage of the value of 1%. We have experience assisting clients in a variety of industries improve pricing strategies which has a direct impact on EBIT. Please give us a call to schedule a free consultation to benefit from our team’s customized pricing expertise.
You may also be interested in this article: Pricing During a Pandemic : Solving 3 Common Pricing Solutions
Follow us on LinkedIn!
