Mention innovative pricing to gain more profit, and most people think of charging more for "extras." I got a new set of glasses this week. The lenses only cost $59, but they tried hard to sell me an "anti-glare" coating for another $50. Based on what I know about coatings, this probably costs $0.10 to apply. I'm on to that kind of so-called innovative pricing. No, thank you!

Lower prices instinctively feel to most people like a way to shave their profit margins, and drown in the resulting profit squeeze. While you certainly need to be careful whenever you lower prices, help can come in the form of price adjustments that reduce your costs at the same time. Let's explore how to find these cost-reducing price adjustments.

You can also use prices as a carrot or a stick to influence which offerings your customers and end consumers will choose. Whether you use the carrot or the stick in a particular circumstance depends, in part, on your fully analyzed current and potential costs.

Adding volume has widely differing impacts on average and marginal costs across a variety of offerings. This is true in the short term and in the long term. You should consider both time perspectives and dimensions of costs.

Consider Southwest Airlines. That carrier uses both dimensions of pricing to reduce costs.

First, the airline specializes in lean operations that have lower costs than all other major air carriers. This enables the company to offer lower prices for vacation travelers and others who can book flights well in advance. Such discounted prices are usually about 10 to 20 percent less than competing airlines for the same routes.

You can often fly on the airline coast-to-coast for the same price paid for a similar, discounted flight more than years earlier. Those low prices attract lots of customers, and the airline often has a higher percentage of seats filled than its competitors. That popularity drives down costs because the extra expense to add another passenger is very small. As Southwest spokespeople might say, it's just peanuts. Most of the increased revenue becomes profit contribution.

Second, like other airlines Southwest also charges more for people who buy tickets at the last minute. However, Southwest's prices differ from those of other airlines by being based on a much smaller percentage increase from the discounted fare. Thus, a business traveler may be able to buy a last minute ticket as little as 25 percent of the price of a competing airline. This strategy drives a lot of last minute travelers to Southwest at premium prices, further lowering costs while fattening margins.

How can you use lower prices to cut your costs faster than your prices drop?

Copyright 2008 Donald W. Mitchell, All Rights Reserved