Fine-tuning your pricing strategy: uncovering 'hidden profits'.

At most small and private companies, pricing is an unsettling exercise involving a mixture of compromise, seat-of-the pants analysis, guesswork, marking up costs and more or less simply doing things as they've always been done. Responsibility for what should be recognized as powerful business strategy is often implemented by disparate parts of the organization--with prices set by managers, marketing, sales or a "pricing guy"--when it's the financial executive who should have responsibility for shepherding an integrated strategy throughout the organization.

Indeed, since most companies think about (and implement) pricing in the wrong manner, their products are loaded with hidden profits. Focusing on pricing for profits and growth is a low-risk/high-upside concept that enables you to collect the hidden profits.

Pricing effectively begins with adopting the mantra that "pricing is all about value." Companies tend to base their prices on costs, instead of the value that customers reap from a product or service. The reason why street vendors in Washington, D.C., double their umbrella prices at the first sign of rain has little to do with cost. Indeed, it's all about the increased value that customers place on the rain protection. Similarly, even though it costs the same, are you willing to pay the same price for a steak that you order medium-rare if it is served well done? This simple insight, that price should be based on value and not cost, is the first step to recovering hidden profits.

The epiphany to uncovering hidden profits involves shifting the way one thinks about pricing. Conventional wisdom views pricing as the search for one "perfect price" for your product or service--the nirvana where profits are maximized. However, making pricing decisions on this basis inevitably leads to a catch-22. If you price too high, sales are lost from those not willing to pay (but who would pay less). Conversely, price too low and you'll miss profits from those willing to pay more.

Changing pricing perspective involves embracing lessons from an auction--the notion that different customers have different valuations for a product. Consider the bidding wars at auctions: The opening price is usually low enough to create a fast-paced one-upmanship between bidders, with many people participating. As it heats up, participants drop out. Translated into pricing-speak: "It's not worth it to me anymore." The item finally sells to a lone bidder willing to pay the price.

So, what's going on here? Everyone has the same information and is bidding on the same product. Why do some drop out and others stay? The answer: value is in the eye of the beholder; different people have different valuations for the same product. This common-sense notion is a lesson for a pricing strategist. This simple concept is what transforms pricing from a search for your product's perfect price into a series of strategies that capitalize on different customer valuations. A multi-price mindset is what will fill the gap.

Adopting a multi-price mindset allows you to profit from each customer's unique product valuation. It charges certain customers higher prices, which they willingly pay; and it discretely offers discounts to shoppers who demurred due to your "perfect price," which was too high. There are three categories of multi-price mindset strategies: differential pricing, versioning and segment-based pricing.

Differential pricing allows you to sell at different prices to different customers. For example, movie cinemas are adept at using differential pricing to attract different customers to view the same film by offering discounts to students, children, senior citizens and customers with coupons.

Versioning offers lines of products, based on a core product, designed to attract new customers and implicitly reveal their valuations. For example, some products offer good, better and best versions, with each quality level priced differently. Versioning entices customers with lower valuations to purchase the lower-margined product, and those with higher valuations to buy the premium-priced product. Restaurants often use this strategy by offering chef's table seating, regular prices and discounted early-bird specials.

Segment-based pricing strategies can activate dormant customers. The idea driving this concept is that new pricing strategies will attract new customers.

Sharpening pricing skills can have a powerful impact on your bottom line. A recent study of the Global 1200 found that a net price increase of 1 percent would, on average, result in an 11 percent increase in operating profits. Increasing price does not have to be a draconian, across-the-board hike. As indicated above, multi-price mindset pricing strategies are about offering choices and result in win-win situations for both consumers and businesses.

The multi-price mindset will enable your company to price for profits and growth. Your "chef's table" products will enhance profits, while "early-bird" products will grow your customer base. And, since hidden profits currently exist in your products, many of the pricing for profits and growth ideas outlined here can start working for you today.

Rafi Mohammed is a Director in the Boston office of Simon-Kucher & Partners. His book, The Art of Pricing: Finding the Hidden Profits to Grow Your Business, is available at retail and online outlets.