Case Study: Mistakes Companies Make When Losing Profits

 

For the average businessperson, economic conditions have certainly been making it difficult to manage costs, threats from competition, and demand and supply. Oy vey! Not to mention maximizing prices for products and services. That’s certainly true for restaurant chains where discounts and promotions occur frequently.

Starbucks, of course, is known for its higher-priced coffee. So, the McDonald’s-like value meals and related issues at Starbucks provide a prospective classic business-school case study regarding price optimization and maximum profits.

Many businesses can learn from the situation in which the coffee company finds itself.

Thanks to a good store environment and consistent quality, I confess to having enjoyed countless cups of the company’s coffee over business discussions with associates. In my travels, Starbucks has been a home away from home whenever I wanted a good cup of coffee.

Now, questions about the company’s profits abound following a robust 20 years. True, the company and investors are delighted that $175 million in cost-savings helped Starbucks’ Q3 earnings improve to $151.5 million compared a loss of $6.7 million the same period the year before. The company’s profits had declined in significant double-digit percentages, prompting Starbucks to layoff thousands of employees as the company closed nearly 800 stores.

However, cost-savings are only part of the profit-making formula and it appears Starbucks still has more footwork to do. It’s questionable whether Seattle’s proud coffee retailer can return to its its high-profit utopia and sustain it.

Mega Growth

Starbucks seemed to act as if it was invincible by growing to epic proportions – it was everywhere and created a happy-buying environment for coffee lovers. The company became famous for not charging customers when it took a few minutes to brew their customers’ purchases. Cheerful baristas treated customers as if serving them drinks were important daily events and rituals.

But along with the economy, it seemed customer service sagged. My friends and associates have expressed dissatisfaction about the company’s customer service. In my frequent visits, it became rare to hear a barista say thank you to customers or prevent buyers’ remorse. Customers most-often tip jovial Janes and Joes. My sense is that such developments lowered customers’ perceptions of Starbucks’ value. 

Recession or not, consumers who love a company’s services and products, will spend their money. When loyal customers shop elsewhere, my research shows 70 percent of the time it is because the customers feel taken for granted.

Lower-priced value meals are a good idea but they are not the complete solution. At upscale stores or even low-end fast-food restaurants, eventually, it is hard for customers to swallow mediocre service. In a situation where an upscale company slashes costs – without providing noteworthy customer service – it is not conducive to sustainable profits.

Two other profit-complications: Too many company locations will cannibalize sales from each other, and it’s easy to lower prices but it’s difficult to raise them.

In general, how can you manage the sweet spot – between your price-optimization and costs?

Dennis Brown of the consulting firm, Atenga, says many companies make 11 pricing mistakes:

Companies base their prices on their costs, not their customers’ perceptions of value. “In certain circumstances, there are strategic reasons a company may decide to sell a product below its cost for a period of time, or to a certain market segment as a ‘loss leader,’ Brown writes. “However, when a price is set according to the perceived value of the product or service, sales are brisk, and profits are maximized.”

Companies base their prices on the marketplace. “Marketplace pricing is a resting place for companies that have given up, and where profits end up being razor thin,” he says. “Instead of giving up, these management teams must find ways to differentiate their products or services so as to create additional value for specific market segments.”

Companies attempt to achieve the same profit margin across different product lines. “Some financial strategies support a drive for uniformity, and companies try to achieve identical profit margins for disparate product lines,” he believes. “The iron law of pricing is that different customers will assign different values to identical products.”

Companies fail to segment their customers. “The value proposition for any product or service is different in different market segments, and the price strategy must reflect that difference, he asserts. “Your price realization strategy should include options that tailor your product, packaging, delivery options, marketing message and your pricing structure to particular customer segments, in order to capture the additional value created for these segments.”

Companies hold prices at the same level for too long, ignoring changes in costs, competitive environment and in customers’ preferences. “It is important to recognize that the value proposition of your products changes along with changes in the marketplace, and you must adjust your pricing to reflect these changes,” Brown explains.

Companies often incentivize their salespeople on revenue generated, rather than on profits. “Volume-based sales incentives create a drain on profits when salespeople are compensated to push volume at the lowest possible price,” he writes.

Companies change prices without forecasting competitors’ reactions. “Smart companies know enough about their competitors to forecast their reactions, and prepare for them,” he adds.

 Companies spend insufficient resources managing their pricing practices. “In fact pricing is of outmost importance, and a key element of the marketing mix,” he says. “Good pricing strategies use hard data generated by modern methods such as Value Attribute Positioning, Conjoint Analysis or Van Westendorp’s Price Sensitivity Meter, to generate accurate hard data on the perceived value of a product or service, thereby enabling mangers to maximize their profits by optimizing their prices.”

Companies fail to establish internal procedures to optimize prices. “Price optimization data comes from focused research,” he points out.

Companies spend most of their time serving their least profitable customers. “While 80 percent of a company’s profits generally come from 20 percent of its customers, a careful review of the data often will show surprises, since a company’s largest customers are often only marginally profitable,” he says.

Companies rely on salespeople and other customer-facing staff for intelligence about the value perceptions of their customers. “Such people are an uncertain source, because their information gathering methodology is often haphazard, and the information obtained thereby can be purely anecdotal,” he explains.

Here’s a tip of the Biz Coach hat to the consultant’s philosophies. Brown’s points are valid.

My research shows about 18 percent of the population only cares about price. Companies that focus only on the lowest price in the marketplace will generally fail.

To attract the other 82 percent of consumers, you can usually overcome a competitor’s lower price with stronger perceived value:

• Helpful, knowledgeable employees
• Robust company image
• Excellent product or service utility
• Convenience
• Price

You might also consider that many value-conscious customers would appreciate a cash discount in lieu of paying by credit card, which would also save you a credit-card processing fee.

From the Coach’s Corner, if you ask, Atenga will send you a best-practice pricing study and tips on pricing. The company’s Web site: www.atenga.com.