Drucker’s Pricing Sins

In his book Managing in a Time of Great Change Peter Drucker writes on the five deadly business sins – avoidable mistakes that will harm the mightiest business.

The first and the most common sin is the worship of high margins and of premium pricing as it always creates a market for competitors. And high profit margins do not equal maximum profits. Total profit is profit margin multiplied by turnover. Maximum profit is thus obtained by the profit margin that yields the largest total profit flow and that is usually the profit margin that produces optimum market standing.

Closely related to this first sin is the second one: mispricing a new product by charging ‘what the market will bear’ as this too creates a risk-free opportunity for competitors.

The third deadly sin is cost-driven pricing as the only thing that works is price-driven costing. Most businesses arrive at their prices by adding up costs and then putting a profit margin on top. Drucker argues that the only sound way to price is to start out with what the market is willing to pay – and thus, it must be assumed, what the competition will charge – and design to that price specification. To start out with price and then whittle down costs is more work initially. But, in the end it is less work than to start out wrong and spend loss making years bringing costs into line – let alone far cheaper than losing a market that you may have created.

The fourth sin is slaughtering tomorrows opportunity on the altar of yesterday as what may have been successful in the past might have no relevance now. This is more important today in our fast changing world than when Drucker penned his thoughts nearly 30 years ago.

The last of the deadly sins is feeding problems and starving opportunities. Generally, resources are applied to problem-solving while opportunities may be left to fend for themselves. All one can get from problem-solving is damage containment. Only opportunities produce results and growth. And, opportunities are actually every bit as difficult and demanding as problems are. First draw up a list of the opportunities facing the business and make sure that each is adequately supported. Only then should you draw up a list of the problems and worry about supporting them.

These sins are temptations that must be resisted.

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