One of the things that absolutely baffles me is watching high-growth-aspiring companies who act like profit harvesting companies when you look at their pricing strategy. Is your company a high-growth-aspiring company? How do you know? And what does that mean for your pricing strategy?
In the famous BCG company classification model, they describe four different types of companies, as follows:
Stars: Market leaders in high-growth markets
Cash Cows: Market leaders in low-growth markets
Question Marks: Non-market-leaders in high-growth markets
Dogs: Non-market-leaders in low-growth markets
And the implication of this classification is that Stars are great investments, Question marks need work, Cash cows can yield profits but are not good investments, and Dogs should be avoided at all costs.
From a growth strategy perspective, Stars and Question marks should theoretically focus on growth, as there is clear opportunity to either overtake Stars or protect the leadership of Stars. Not focusing on growth could lead to a massive, missed opportunity to become a Star or stay a Star. In high-growth markets, winners are typically determined by who wins the market share battles. For this reason, you would expect both Stars and Question Marks to be highly focused on growth and growth strategies.
Conversely, Cash Cows and Dogs have little opportunity for growth as they are in low growth markets, and so they are more likely focused on harvesting profits. Cash cows, as market leaders, have a larger opportunity to milk profits. And even Dogs, despite their lack of leadership, have their best opportunity to milk as much profitability as possible. However, there are cases where Dogs have the opportunity to disrupt a mature, non-growing market and steal share to try to gain a leadership position. So, it is possible that Dogs may have a short-term focus on growth.
Where is your company? Are you a Star? Are you a Question Mark? If so, you probably should be focused on growth strategies. And even if you are a Dog, you may want to focus on growing into a cash cow position. In fact, the only type of company that should be focused on profit harvesting strategies is the Cash Cow—a market leader in a low-growth market.
Growth Pricing Strategies vs. Profit-Harvesting Pricing Strategies
There is a significant difference between Growth Pricing Strategies and Profit-Harvesting Pricing Strategies. The primary difference is the objective metric. In profit harvesting, the objective metric is profit margin % or profit margin dollars. Growth pricing strategies focus on the objective metrics of revenues, customers, and sales per customer. Growth pricing strategies tend to focus on incentivizing the acceleration of customer acquisition, the expansion of revenues per customer, and strategies to reduce customer churn. And in fact, growth strategies can often be harmed by attempting to increase profit margins—a core profit-profit harvesting strategy.
If your company is a growth focused company, is your company appropriately pursuing growth focused pricing strategies? Or does the focus seem to be mostly on expanding margins.
Unfortunately, I have seen many growth-focused companies erroneously focusing their pricing efforts on expanding margins, while their competitors encroach on their market share.
Growth companies need growth-focused pricing strategies!
Chasing profits, when you are fighting a market share battle, is a fool’s errand. You can pocket dividends, but at what cost? The cost can be very high. The cost may be a long-term leadership position that could last decades. Most companies that focus on profit expansion too soon miss the point that growth and market leadership lead to sustainably lower costs, which can ensure more significant profits over the long term vs. short-term profit gains from price increases. And so by focusing on profit too soon, companies sacrifice the ability to have extraordinary profits in the future.
Caution: Beware of CFO-CEO Frankenstein strategies that claim to combine both growth and profit into some sort of super strategy. This is a fallacy. While it is possible to both grow revenues and profits, there is no strategy that simultaneously maximizes profit margins and maximizes growth. This is not a super-strategy. It is a tug-o-war strategy. If you are growing margins, you are most likely not maximizing your growth opportunities. The only exception would be if you are growing so fast that you are actually able to decrease costs due to economies of scale. But that is not the output of a profit-expanding price strategy. That is a bonus outcome of a growth strategy.
So how do you know whether or not your company should be fighting for growth or fighting for profits?
The reality is that most companies have aspirations of growth, and therefore, they should be using growth-focused pricing strategies, not profit-expansion pricing strategies. But here is a quick litmus test you can use to make a quick determination. If you can answer yes to most of the following questions, you probably should be implementing growth-focused pricing strategies:
Does your company desire to grow annually at a rate of 20% or higher?
Is your company’s market growing by more than 10% per year?
Does your company believe it is possible for there to be a change in the overall market share leader in the market?
Are there credible competitors attempting to take market share away from your company?
If you can answer yes to most of those questions, it is pretty clear that your company should be focused on growth-focused pricing strategies. That means pricing strategies should be focused on things like new customer acquisition, existing customer revenue expansion, and minimization of churn.
On the other hand, if you have people in your company that believe your pricing should be more focused on margin-expansion strategies, it is likely that you would also be answering yes to most of the following questions:
Is your company’s market growing at less than 5% per year?
Is your company’s market already saturated with solutions?
Is there little market share shift (less than 5%) year to year in your company’s market?
Is it very unlikely that customers will switch to different providers due to moderate price increases?
If you answered yes to most of these questions, then it is likely your company is either a Cash Cow or a Dog, and a margin expansion strategy is probably the right way to go. Margin expansion strategies are strategies to raise prices, and thereby expand margins, even at the expense of losing a few customers—as long as overall profit dollars increase. But the unfortunate reality is that these companies are at the beginning of the end. Some of these companies can live on for decades, continuing to harvest profits from their customer base, while other companies may be a going concern for only a few more years. The key reality is that their markets aren’t growing, and competitors are fighting each other for a share of what’s left in the market.
The good news is that most companies are clearly in the growth category. That means chances are high that your company is also a growth-focused company. And so, to help your company achieve success in its growth objectives, you should ensure that your company’s pricing strategies are growth-focused rather than profit focused. That means margin percentage should NOT be your primary objective metric in optimizing your pricing decisions. Instead, your primary objective metric should be overall revenue growth rate and overall company market value.
It can be very eye-opening to see how changing your metric focus can change both your strategies and your ultimate outcomes. As an example, one company increased their new customer growth rate by 2% and reduced their churn rate by 4%, leading to an improvement of 6% to their net revenue growth rate, and by doing so, they doubled the market valuation of their company. When you consider the leverage that growth rates can have on company valuation, you soon see why chasing profits when you should be focused on growth can be so costly.
Learn about Growth Pricing Strategies by checking out my new book to be released January 2021: Price for Growth
About the Author: Jeff Robinson brings the perspective of two-decades working with companies across industries to help them improve their pricing practices and results. He has designed, marketed, and implemented pricing solutions used by hundreds of companies, whose combined revenues total more than one trillion dollars. Having earned a bachelor’s degree in economics, combined with an MBA in marketing and finance, he has brought new perspectives to the world of pricing, often challenging prevailing notions or widely accepted strategies. Combining his formal education with over 20 years’ experience, he has recently authored the up-coming book, Price for Growth, A Step-by-Step Approach to Massively Impact the Value of Your Company by Leveraging Focused Pricing Strategies, expected to be release in 2021. Today, he is leading the development of a new company, Revolution Pricing, focused on helping companies create and select appropriate pricing strategies for maximizing the value of their own companies.
About Revolution Pricing: Revolution Pricing is a company founded to help companies create and select appropriate pricing strategies for maximizing the value of their company value by focusing on the right metrics, building goodwill with their customers, and reducing the risk of future profits. Unlike most companies that offer pricing solutions, Revolution Pricing focuses on longer term benefits largely driven by metric other than near-term profit dollars. We believe the path to success requires education and understanding prior to implementing “optimization” tools to insure any such tools accomplish the right desired objectives. For more information, visit RevolutionPricing.com