August 27, 2010
I’m currently reading the book Smart Pricing by Jagmohan Raju and Z. John Zhang. Anything published by Wharton School Publishing has been thoroughly researched and applied in the real world of work—beyond the ivory tower of theory and abstraction often associated with academia.
In the book’s introduction, the authors present a simple concept: “A manager can pull only four levers to increase a firm’s profitability: sales, variable costs, fixed costs, and price.” If he spends more on advertising to gain market share, then he’s pulling the sales lever. By reducing hours to schedule and lowering payroll costs, he’s pulling the variable cost lever. If he’s able to negotiate better lease terms on space, vehicles, or equipment, then he’s pulling the fixed cost lever. The fourth lever, price, is pulled whenever prices are adjusted.
Though only four levers exist, there are some economic probabilities and consequences to consider that make the manager’s choice of levers more like a chess match. Conventional wisdom suggests that, in a soft economy, the most effective way to preserve profits is to reduce costs. With shrinking demand, increased competition, or both, most companies look to reduce their biggest expense: payroll. This results in the furloughs and layoffs we’ve been reading about (or experiencing personally) for the past several years…
Increasing sales is an attractive option but may be hindered by firms choosing to reduce their sales forces and/or marketing expenditures. And who really wants to tamper with pricing in such an uncertain economic environment?
I was surprised to read that the authors’ analysis found “that if a firm can cut its fixed costs by 1% without affecting its operations, its profitability can increase, on average, by 2.45%. Similarly, if a firm can increase its sales by 1% without changing its cost structure or price, the firm’s profitability can rise by 3.28%. The effect of lowering the variable cost by 1% is larger: Profitability can increase 6.52%. However, the effect of improving a firm’s price by 1% is the largest of all: 10.29%. Remarkably…this effectiveness ranking order holds for each of the eight industry groups using the standard industry classification (SIC) scheme.”
In my last blog post, I referenced a number of studies on the relationship between superior customer service and profitability. The latest study, by American Express and Echo Research, compiled research that revealed American consumers are willing to spend, on average, 9% more with companies that provide excellent customer service.
Do you see where this post is heading?
If companies took steps to improve the customer experience, then customer satisfaction would likely improve. Studies show that customers are willing to spend more with companies that provide superior customer service. And research finds that by adjusting the price lever and improving prices by only 1%, companies can increase profitability by 10.29%.
Companies with subpar customer service: It’s your move.