Donald Mitchell

Offer Price Incentives for Customers to Help You Lower Costs

Prices can raise profits by helping encourage customers to ask for things that are very expensive to deliver. This article looks at two examples of creating lower costs and higher profits by using this technique.

With increased global competition, the customer is more in charge than ever. That doesn't mean that you need to offer services that cost you a fortune: Better designed pricing can be a great help.

Let's consider an industrial example. A building materials manufacturer studied its customers in terms of how the mix of products they ordered affected profits.

The company had a unique manufacturing process that made it cheaper than competitors to produce higher volumes of identical items, but more expensive to produce smaller volumes of those same items. This was true due to every item being made to order.

The ideal solution for this company would be to have customers split their orders, buying the small unit quantities from competitors and the larger quantities from this firm. The manufacturer had prided itself on being the low-price supplier across the board and wasn't sure how well this focus on getting profitable volumes could be accomplished.

Through market research, the company was able to determine that a high percentage of current and potential customers would be willing to split their orders in this way if a price disincentive were provided for lower volume orders. The manufacturer provided that disincentive through higher prices on small volumes of individual items, and keeping low prices on the higher volumes.

Quickly, its business mix shifted towards its highest margin manufacturing configuration, and its profit margins soared. This positive result occurred despite having just lost much of its low order-volume business.

A Hewlett-Packard unit investigated how its customers used its various service capabilities in the mid 1990s. Products were priced as though every customer used each service offering equally. In fact, some customers did use most of these services while others did not.

The profitability of an account that did not use the services was much larger than that of a customer who used most of these services. The services also presented another problem in that providing the services often tied up the best people at Hewlett-Packard.

Based on this analysis, the Hewlett-Packard unit started charging for most of the services that were not used by the bulk of its customers. At the same time, it could lower the price for those who used few services and gained market share with those customers.

Services that were hard to supply or were too intrusive on the time of key people were priced at a substantial premium to their cost, to discourage anyone using the services who didn't really need them. As a result, Hewlett-Packard saw its costs decline as the required service levels declined while revenues rose due to more competitive prices for those who didn't need much service. The increased volume also helped drive costs down.

How can you adjust your prices to encourage low-cost behavior by your customers?

Copyright 2008 Donald W. Mitchell, All Rights Reserved

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