The Price of the Month. Success or Failure?

08/2010: 1 % Windfall

Posted in Pricing by Jouko Riihimäki on 31.8.2010

The 1% Windfall reveals how modest incremental changes to an everyday business practice – pricing – can yield significant rewards. Illustrating the power of pricing, “a study by McKinsey and Company of the Global 1200 found that if they increased their prices by just 1%, and demand remained constant, on average each company’s operating profits would increase by 11%.”. Using a 1% increase in price, some companies would see even more growth in percentage of profit: Sears, 155%; McKesson, 100%, Tyson, 81%, Land O’Lakes, 58%, Whirlpool, 35%.

This research result made me curious, so I decided to study the subject among the Finnish TOP100 companies. The result of the research is based on the calculated assumption that companies increase their prices by 1 % without changing other variables (= 1 % Windfall). Then the effect of this increase on the development of net sales will be examined. In addition, this message is to highlight the fact that pricing is one of the most important and fastest methods for gaining profit in a company. Below you can see a simplified example of the research results. The table shows that, in case the change percentage remains below 11 %, the company will usually result in higher profits when compared to control companies (Global 1200) and vice versa.

To support the analysis, I searched for the profit information of the Finnish TOP100 companies for 2009 from the Talouselämä 500 report. I edited such companies from the list as did not have information on their operating income available. The list includes a total of 83 companies. The analysis shows that an average increase of 1 % in net price would increase the operating profit of a TOP100 company by 21 %, which is considerably higher than the corresponding growth in the Global 1200 list. We can thus draw a quick conclusion: on average, large Finnish companies are not as profitable as the largest companies in the world. Naturally the time of comparison plays a role in the matter as the results of 2009 are affected by the recession that followed in the wake of the financial crisis.

I wanted to make this analysis more extensive by taking a closer look at the numbers of the biggest company in Finland, Nokia. First, I will examine the matter on Nokia group level. In 2006-2008, the change percentage of profitability of the Nokia group has on average been better than the Global 1200 companies after a 1 % increase in net prices. However, the severe decline in operating income in 2009 has clearly elevated Nokia above average (35 % change).

Furthermore, I wanted to analyze the matter in more detail in terms of the Devices and Services unit (mobile equipment) of Nokia. The picture below presents the numbers of the unit between 2008 and 2010. The information has been obtained from the official interim reports of Nokia.

Mainly the Devices and Services unit of Nokia has gained more profit that the average Global 1200 company, meaning that the lower profitability of the Nokia group originates from other areas of their business operations (e.g. Nokia Siemens Networks). The effects of heavy competition can be seen in the development and the Q2/2010 business unit landed at 11 %. The table below presents the three most essential factors in terms of development of profitability from the perspective of sales: 1. price, 2. volume and 3. mix (geographical and product bases). These factors must be taken into consideration when making and analyzing pricing decisions but they cannot be used as an excuse to hide behind.

It must be admitted that the 1 % jackpot is a simplified method of examining pricing. Regardless, it can be said that correct pricing has a major impact on the profitability of a company. Under no circumstances should personal pricing power be underestimated and markets or other external factors used as an excuse. Internal factors can be used to significantly improve personal pricing skills; increasing operating profit by 11 % is a very realistic objective when these measures are taken, regardless of factors outside the company.

To conclude, I challenge Finnish companies to develop their pricing skills. Without these skills, our competitive edge in the markets is primarily based on cost efficiency, not on customer needs.

Jouko Riihimäki, M.Sc, CPP Certified Pricing Professional

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