The Absurd Influence of Pricing on Profits | Hi-Tech Webinar 5

Are you familiair with the disproportional effect of price changes on your profits? In this webinar, Ivo explains how this effect works and how you can use this to your business benefits. Even a small pricing changes can have huge impact on your bottom line profit.

By Ivo Wouters | Hi-Tech Webinar 5

Hello everyone and welcome to another Hi-Tech Webinar! Today we are going to talk about the absurd influence of pricing on your profits, specifically for the self-storage market. I am Ivo Wouters and I am todays webinar host. Let’s start with explaining todays structure, first we will talk about the importance of pricing . Subsequently the impact of price changes and specifically the disproportional influence discounting and price improvements of profits. At last we will discuss the benefits of adaptive price management in self-storage. If there is time at the end of the webinar, we can spend some time on questions. If not, we will ask you to e-mail your questions to us so we can get back to you.

Importance of pricing

The importance of pricing. Essentially, you can do three things with your price: increase, discount for maintain it. But what exactly is your price and what justifies it?

For commercial businesses like self-storage businesses, price is the commercialisation of the value created. Customers are willing to spend a certain amount of money for the space they rent or the products they buy for several reasons, often personal to the customer. If you offer high value for the customer, they are willing to spend more money with you. But it is not only you who decides on the value you create, because this value is oftentimes relative to your competitors. One of the most important drivers in self-storage is location. However, parking availability, opening hours and additional services can also increase your value. For example, if your competitor is for a specific customer located in a more beneficial place than you are, you can be cheaper, other services can be much better but the customer is still renting storage space at you competitor because the location is the most important aspect to him/her.

Essentially everything you do in your business is aimed at creating additional value and justifying the price you ask or want to ask. Price can be seen as the exchange rate of all tangible and intangible aspects of your business.

If you create high value for your customer, you can ask a higher price. However, this also works the other way around, a higher price is an indication of high value products and services. For self-storage, this might be important for people who store high-value goods. These people probably prefer a well secured facility and they expect to pay a bit more for it. So, asking a higher price for your services helps establishing a high-quality positioning.

Occupancy levels are important to maximise profits, one of the levers you can pull to influence this is pricing. Most self-storage facilities use a somewhat adaptive pricing strategy based on rules they set themselves to optimise occupancy levels. Managing occupancy in a way that your facility is filled up to 85% is about optimal, a percentage near 100% could indicate that your prices are too low for the value you offer.

The last topic about the importance of pricing we will cover today is that price often is the aspect consumers ask about the most, therefore most business are afraid of adjusting and especially increasing their price. They are afraid to lose customers because of the higher price, however, this is seldom the case. People ask about price because it mostly is the only thing they can ask a question about, in addition, people are used to ask about price. This does not mean price is the most important driver for them to choose your facility or another one. This is something which you can guide your staff with by providing them with proper sales training on how to deal with those questions.

Why me?

No we established the important of pricing, you might be wondering, who is this guy telling me about pricing? I am Ivo Wouters, the marketing and business development consultant at Hi-Tech. My expertise in pricing is a combination of theoretical knowledge and practical experience. For my masters I researched pricing, in particular gambled price discounts. For about 6 months I read an insane amount of academic literature about pricing and the influence of pricing itself on profits, but also about several discounts types and their positive and negative effects.

My practical knowledge comes partially from running my own business, where I experimented with various pricing tactics. A part of these experiments are conducted online in the webshop I ran for about 5 years and others are conducted together with companies I consulted in or worked for. Testing these theories in practice helped me understand pricing and I would like to share some these insights with you today.

Impact of price changes on profits

Pricing is an interesting phenomena, especially because a very small price change can have huge impact on profits. You can even say the influence of price changes on profits is disproportional. A price increase of a certain percentage leads to a higher percentage of profit increase and the other way around. Whenever you consider changing your prices, knowing about the disproportional influence of profits, price sensitivity should be considered. In self-storage, there is point where increasing your price will eventually result in lower demand because the price does not justify the value you create. Therefore, testing and monitoring the effect of price changes and other tactics to increase or decrease demand is important to find out what is the best price for your offering. This is a constant process which costs some time, but later in this webinar you will find out exactly why this is worth your time!

Discounts

One of the most common ways to increase demand are discounts. Regular discounts like a 10/20/30% off the list price for products and services is something consumers are used to and expect to some extent. There are even product categories where companies discount so often that people wait for products to be discounted before buying, fashion is one of these categories. I shortly introduced the disproportional effect of pricing on profits, but just mentioning this without numerical support says nothing. So, let’s check the table on the next slide and find out how disproportional this effect is.

In this table, you can see how much you need to sell extra to make up for the margin loss for a certain discount. For example, if your average margin in 15% and you lower your price by just 2%, you need to sell 15% more to make up for this loss. Increasing your sales with 15% with a discount this small seems pretty impossible, right?

Now, a more specific example. Assuming your margin is 40% and you discount your prices with just 10%, you will need to increase your sales with a whopping 33%! And this is just for a discount of 10%, which does not sounds like a lot, right? But if you do the maths, you will find out that this discount of 10% lowers your margin with a staggering 25%. This is how a seemingly small discount can make your bottom line profit disappear faster than you would expect.

Just one side note, there might be occasions where you should decide to use a price discount like this. For example, if you have large amounts of stock for a certain product and you just need to clear this out. For example if a certain box size or tape does not sell, you can decide to use this tactic to increase sales.

Discounts - the theory

Be prepared, this part is going to be a bit more theoretical. So pay attention, otherwise it will be hard to understand! Besides the negative effect of discounts on profits, fixed price discounts have another negative side effect which can hurt your profits on the long term even more. People have a certain price in their minds about what something should costs, this price is based on what prices they faced before, prices of substitute products or services and a few other factors. If you decide to discount your units rental price with 25% from €100,- to €75,- a month, your consumer perceives €75,- as a reasonable price for a unit of that size. If this discount is only for a fixed period of time and the price will go up to €100,- again, the customer will feel like he or she is overpaying for the unit. This is because their internal reference price for the unit is lowered by experiencing the discounted price of €75,-. Chances are that the customer will re-consider renting storage space and you thereby give him/her a reason to leave your facility. Again, there could be situations where your occupancy is really low and you just need more people that a discount could be beneficial, but knowing that discounts have a disproportional negative effect on profits and harms consumers internal reference price in the long term, think twice before you use discounts to increase demand.

There are opportunities to overcome this effect, for example using an extreme discount instead of a discount of 25%. If you have a promotion to stimulate rental periods of 4 months or longer, you could decide to not charge anything or €1,- instead of discounting the rental price for four months with 25%. Bottom line your revenue is the same but the internal reference price will stay te same because the discount is extreme and therefore the price is not considered as a normal price.

Overcoming negative effects of discounts

Discounting is one tactic of stimulating demand. However, there are several other tactics which you can use that are less focussed on price, overcoming some of the negative side effects. One opportunity is bundling products and/or services to make your offer more valuable. For example, when people rent a relatively large unit, they probably need to move more stuff which they could use accessories for. You can offer these for a reduced price together with renting storage space to increase your total revenue and profit.

Going one step further then bundeling is giving away free things. If you decide to do this, make sure the gift adds value for the customer and you create an offer the customer can’t refuse. Preferable by giving away a high margin product, because these hurt your bottom line profit the least. An example of a free gift construction beneficial to your profit could be an x amount of free boxes if people sign a renting contract for 3 months. This could be especially interesting if the average renting period is shorter than 3 months, because this way you can increase the customer lifetime value and improve your profit.

The last discount opportunity discussed today has more to do with steering your customers interest by forcing them to compare options. People roughly know how many m2 they are looking for. If they select a certain size, let them face three options with the one which you would like to sell as the most attractive one. For example offer a 1.5m2 unit for 45 a month, a 2m2 unit for 50 a month and a 3m2 unit for 80 a month. This way, the 2m2 option is by far the most interesting option, while the 3 m2 unit is relatively a bit cheaper than the 1.5m2 room but feels way more expensive than the 2m2 room. It is most likely that people will go for the 2m2 in this example.

Price improvements

Optimising your prices can also mean a price increase is required to improve your profits and most of the time this is a really interesting opportunity. Just like discounts, price increases have a disproportional influence on you profits. However, the influence of a price increase is disproportionally positive!

In this table you can see how much less you can sell while maintaining your profit. So, if you increase your prices with 2% and your profit margin is 20%, you can sell 9% less and still have the same profit, assuming your costs will stay identical. This is primarily because a price increase represents 100% extra profit. Even if you customers would decide to leave your facility because of the price increase, that is not necessarily a bad thing. The price conscious customers are mostly the customer who demand the most of your staffs time, so chances are you will gain some operational efficiency too!

Let’s take a more extreme example, assume you will raise your prices with 10% and your margin is 40%. If this would result is a 20% decline in sales, your profit will still be the same!

Now you understand the disproportional influence of price on profits, let’s compare this too other opportunities your business has to increase it’s profits. On the slide you can see the influence of an 1% improvement for price, variable costs, volume and fixed costs. Price has by far the most influence on profits. In this study a 1% price increase resulted in 11.1% more operational profit. Comparing this to a 1% improvement in fixed costs which only generates 2.3% more profit.

Based on these results, we could even say the tables presented before are a bit cautious in their predictions about the disproportional effect of price!

Adaptive price management in Self-Storage

Pricing in self-storage is relatively conservative if we compare it to similar industries. One example are airlines, airlines are selling seats in an airplane whereas self-storage sells storage sells space for a certain amount of time. The only difference is that the time of consumption is longer for self-storage customers than for airline customers. Pricing in aviation is very adaptive, as we all have experience, ticket prices change all the time and some even say that it even depends on your online search behaviour! In self-storage it happens that prices are adapted but it mostly is a person changing these prices by hand. Seldom price management in self-storage is automated, while there is a huge opportunity. But why should we use airline style pricing in self-storage?

First, because you can better manage occupancy and profits. We would like to have our storage facilities as full as possible for the highest rental price as possible. However, a very low occupancy rate is bad for the bottom line profit and a very high occupancy rate indicates our prices are too low. Therefore adaptive pricing can help you optimise both occupancy and pricing at ones.

Since each self-storage company has it’s own KPI’s and works in it’s own particular market, it is important to base your adaptive pricing on rules you decide. These can be on site or company level.

So, why do we talk about adaptive pricing in this way? That is because we developed a system which can help you with this! The system is called rate administrator and it helps you optimise your pricing so occupancy and profits are maximised while not losing control. You have the opportunity to set up the system in a way you need to approve when pricing rules come into action.

We would not talk about automated pricing if you would need to maintain everything in two systems, therefore we built rate administrator in a way you can hook it up to your management software package and truly automate your pricing!

Since we talk about pricing in this webinar, we of course communicate Rate Administrators pricing with you. You can start using rate administrator for only €89,- per store per month if you want to use it for 1 to 10 stores. Do you want to use it for more than 10 stores? Please send us an e-mail with your enquiry so we can provide you with a custom quote.

With that, the only thing remaining is for me to thank you all for joining us!

If you have questions relating to anything in this webinar, then feel free to get in touch with us anytime, and we’ll be happy to answer your questions.

Thank you.