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Do your customers know what you have? products are they worth This may seem like a strange question at first, but in reality, many businesses routinely fail to convey the actual value of their products. Surprisingly, this miscommunication is rarely in favor of a business.
More than 20 years ago, experts at McKinsey & Company discovered that between 80% and 90% of mispriced products are priced too low – and this remains true today. That's potential lost revenue right out of the gate, and more than you might think. According to this comprehensive study from the Harvard Business Review published in 1992 and still widely cited today.
Connected: 10 Questions to Ask When Pricing Your Product
Where does the value go?
Your products and services inherently create a certain amount of value for your customers. We'll call this “current value.” In the ideal world, everything you sell would be valued based on present value. However, we don't live in the ideal world. Present value is extremely difficult to calculate and can fluctuate per customer.
Not all of your customers will be able to see, or frankly even benefit from, the full 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 these extra features would be hard to see. Marketing also has an impact. Sticking to the smartwatch example, if you fail to effectively communicate a useful feature – leaving your potential customers unaware – then this 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 affect how much a particular customer is willing to pay: urgency, revenue, brand loyalty, advertising, social influence, etc. Finding this number is tricky, 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 many customers they have willing to pay. What this means is that the price your customers usually expect to pay is the “target price”. This is the value that you and your team hope you have determined is as close as possible to your actual willingness to pay value.
Finally, if you work in a sales-heavy field, you may find that additional value is lost from concessions and discounts. In this situation, the final price paid would be known as the “realized price”. How much value was lost between all these steps? Many think little. Bain and Company found after interviewing dozens of CEOs, CMOs and other executives at more than 1,700 companies that approximately 85% of those who responded believed they could do a better job making pricing decisions.
How can I capture more value?
Let's start by trying to understand how much our customers are willing to pay for our products or services. We can do this by our customer surveyby gathering focus groups, experimenting with prices or even organizing an auction.
If we're not comfortable 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, outreach and communication, we directly increase what they are willing to pay.
Alternatively, we may choose to adopt a different pricing structure entirely. More and more service-based businesses are looking toward metric-based pricing to provide an adaptive structure that better matches 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 field. There are great examples of metric-based pricing all around us. Mechanics often charge by the hour, while bowling alleys often charge per game. These metrics work because they are reasonable, predictable and fair.
Connected: How to get the price your product or service deserves
Don't miss the potential profit
Let's look at the math together. Imagine with me for a moment that you have a cafe that sells lattes for $5 each. These lattes cost you $1 to make, earning you $4 in profit. If you sold 100 lattes, surprisingly you would make $400 in profit.
However, unbeknownst to you, your customers are willing to pay $7 for the same latte. That's a more generous profit of $6, netting you an extra $200 per 100 lattes sold – a 150% increase. In fact, even if you end up selling fewer lattes – say 90 instead of 100, that's still 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.