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Do your customers know how much your products are worth? At first glance it might seem like a bizarre question, but in reality many companies often fail to convey the actual value of their products. Not surprisingly, these communication issues rarely work in a company’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 lost revenue right from the start, and more than you might think. According to this comprehensive Harvard Business Review study published in 1992 and still widely cited today, a 1% price increase without a change in the volume of products sold equates to an 11.1% increase in operating profits.
Related: 10 Questions to Ask When Pricing Your Product
Where does the value go?
Your products and services inherently create some value for your customers. We’ll call this the “actual value.” In the ideal world, everything you sell would be priced based on actual value. However, we do not live in the ideal world. The actual value is extremely difficult to calculate and may vary by customer.
Not all of your customers will be able to see, or frankly even benefit from, the full potential of a given product. Smartwatches, for example, can track hundreds of unique exercises, but if all you do is run, the value of these additional features would be hard to see. Marketing also has an impact. Following the smartwatch example, if you fail to effectively communicate a useful feature, leaving your potential customers in the dark, this can have a negative impact on this “perceived value”.
Now, your customers might agree that your product produces some value for them, but that doesn’t mean they’re willing to pay for it. Dozens of factors can influence how much a particular customer is willing to pay: urgency, income, brand loyalty, advertising, social impact, etc. Finding this number is complicated, but very rewarding. If you can identify the maximum amount your customers are willing to pay, you can maximize your profits by capturing as much value as possible.
Many companies are unable to determine exactly how much their customers are willing to pay. This means that the price your customers would normally expect to pay is the “target price” instead. This is the value that you and your team have hopefully determined is as close as possible to the actual value of the willingness to pay.
Finally, if you work in a sales-intensive industry, you may find that additional value is lost due to concessions and discounts. In this situation, the final price paid would be known as the “realized price.” How much value has been lost between all these steps? Many think a lot. Bain and Company found, after interviewing dozens of CEOs, CMOs and other executives at more than 1,700 companies, that about 85% of those who responded believe they could do a better job making pricing decisions.
How can I capture more value?
We start 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, gathering focus groups, experimenting with pricing, or even holding an auction.
If we’re not satisfied with what our customers are willing to pay, we may need to take a step back and focus instead on the perceived value of your product or service. When we help our customers see more value through activities like branding, awareness and communication, we directly increase how much they are willing to pay.
Alternatively, we can choose to adopt a completely different pricing structure. More and more service-based companies are looking to metrics-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, such as gym passes and mobile minutes, or user-based pricing, which is a popular choice in the SaaS realm. There are great examples of parameter-based pricing all around us. Mechanics often charge by the hour while bowling alleys often charge by the game. These metrics work because they are reasonable, predictable and fair.
Related: How to Get the Price Your Product or Service Deserves
Don’t miss out on the potential profit
Let’s look at the accounts together. Imagine with me for a moment that you own a coffee shop that sells lattes for $5 each. Preparing these lattes costs you $1, earning you $4 in profit. If you sold 100 lattes, it’s no surprise you’d make $400.
However, unbeknownst to you, your customers are willing to pay $7 for the same milk. That’s a more generous $6 profit, netting you an additional $200 per 100 lattes sold, a 150% increase. In fact, even if you ended up selling fewer lattes, say 90 instead of 100, that would still be a 135% increase in profits.
In short, don’t leave money on the table. If your customers are willing to pay more, now is the time to find out.