The Price is Right! Or is it?

Pricing may be the sharpest double-edged sword that senior management can wield in their bid to create value for the enterprise. A tale of two companies illustrates the point.

Within his first 100 days on the job, the new chief executive of a Swiss-based international engineering firm made the rather bold move of raising prices for all clients by around 10 percent.

The pushback was significant – internally, at least. But the firm had a good reputation for product quality, service, reliability and the integrity of its business dealings. That put it in a good position in terms of the value exchange between the company and its customers. Coming up through the business, the new CEO knew this and had taken a calculated gamble that his customers would accept the new pricing. He’d also, wisely, left himself room to retreat should these customers reject the increases or should competitors seek to gain market share at his expense. The company’s reputation – its "brand" if you like -  made the price increases perceived as merited - in fact the move drew very few client objections. The end result - the firm has a much-improved bottom line and with it, significantly more money to invest to further solidify its market leadership position.

Then, there was the startup European mobile operator that had invested enormous sums to acquire licenses and build out the latest generation mobile network. The challenge: to gain market share as rapidly as possible to offset its large sunk and fixed costs. It wasn’t easy in this business - there was little at this stage to differentiate the company from well established operators in a crowded market. On top of that, its leading-edge technology wasn’t working as well as planned, making its marketing messages less clear-cut than originally thought.

The executive team reached for the biggest lever they could pull to get short-term gains - pricing. Without testing "in market", they moved quickly to reduce prices dramatically, simplifying an otherwise complex tariff system and allowing them to price well under market norms. But this bold move failed to affect short-term volume significantly, largely because the move was perceived as a signal that its product didn’t quite measure up.

Of course, the move severely damaged operating profit margins, forcing the company to sell at a net loss even while much more substantial investment was necessary for product improvement and customer acquisition. The brand has never really recovered and, a decade later, the company still hasn’t broken even.

The Pricing Conundrum

Pricing is often the single, most powerful lever of improved performance that can be used by an executive team.

Consider: The commonly accepted rule of thumb across many sectors is that a 1 percent reduction in operating costs will create a 3 percent improvement on the bottom line. A 1 percent improvement in realised price, however, is likely to create a 10 percent or better increase on the bottom line. Despite this, short-term trading pressures often create a temptation to compete on price to get needed performance bumps. But the cumulative effects of discounting can be severe: Pricing is a very clear signal around the value of the exchange and the value that the company wishes to place on the brand.

As the first example showed, if you actually understand your pricing power, you also understand the fair exchange point with your targeted market segments. You can also use that knowledge to align closely with and support your brand goals. But, as the second example showed, pricing can also be used in the pursuit of fairly short-term goals and can, in the most dramatic instances, erode the brand value to irrecoverable levels.

The problem is that, too often, business considerations behind the wielding of that doubled-edged sword tend to neglect two truisms. First, what isn’t measured isn’t managed. Second, important decisions aren’t made in isolation.

Pricing practices today

There is a maturity curve to how organisations think about and manage their pricing practices. At the least sophisticated end is cost-based pricing: "It costs us $XX to make this product, so $XX plus 30% is our price." A surprising number of businesses still use variations of this approach, which doesn’t reflect the nature of demand or value of the product. It just reflects the input cost and a notional "rent" factor.

Further along on the maturity curve is competitive-based pricing. "If all my competitors are charging $XX, so will I."

New market entrants might charge $XX minus a few percentage points. Those that believe their product or service is somewhat stronger than competitors will add a slight premium to their pricing. Probably the majority of organisations across industries follow this path, with price-matching widespread.

At the pinnacle of the curve are those businesses which are sophisticated in their pricing practices because of two particular areas of focus. First, they develop a high level of understanding of their market segments, not just in terms of their demographics, but, more importantly, in terms of their behaviours. That, in turn, informs their ongoing measurement of customers’ responses to pricing moves, and how they’re influenced by any number of factors – competitor moves, advertising  or promotional campaigns and the state of the overall economy among them.

Supermarkets have well-honed capabilities in pricing and promotions strategies. A rich supply of data from point to sale and loyalty card programs enables a deep understanding of the implications of their pricing moves up and down. Supermarkets have become adept at understanding tradeoffs: If I promote a particular product, am I cannibalising sales of my house brands of similar products? Am I creating more demand for another, potentially higher margin product? If I discount eggs, am I creating demand for bacon?

Supermarkets, retailers in general and many others in business-to-consumer sectors (where pricing moves are very visible and public) have also made the connection between pricing decisions and their impact on the overall shopping experience and brand perceptions.

For example, the "everyday low pricing" strategy that has worked so well for Walmart (and been imitated widely) is a clear signal of brand positioning: "We’re going to have a fair exchange with you; we’re not going to mislead you through pricing that’s up 10 percent one day, then the next day announcing a 15 percent discount that, in the end, only poses a 5 percent savings."

Business-to-Business: Rigour Can Pay Off

On the other side are practices in the business-to-business realm, where pricing is  often still considered something of a dark art and built around more qualitative elements, such as a deep understanding of competitive dynamics.

Considerable light can be thrown on the darkness, however, through use of data analysis techniques to support fact-based decision-making.

Often, more thorough analysis can result in counterintuitive findings that will go against ingrained management expectations. In one instance, we performed the analysis of a commodity type business with a very few, large customers. We found about 30 different "leakage points" before we got to pocket price, or what the firm was getting from customers. These were things like exchange rate variations or bonuses for early payment.

The counterintuitive finding in this case was that several of the largest customers were actually losing the company money. Because of their size, they had achieved more bargaining power; they were sophisticated enough to over the years extract more and more value. And the smaller customers, which were viewed as less profitable – they "cost too much to get" – were relatively far more profitable even after cost of sales was taken into account.

The pricing management discipline

The reality is that accumulating the kind of intelligence that should guide pricing decisions over time requires the kind of expertise that typically falls within the marketing realm.

The four Ps of marketing? Yes, pricing has always been one of them. Yet responsibility over the pricing has generally transitioned to other senior management – the chief executive, in particular – making it a difficult barrier for many CMO’s. Indeed, marketing tends to defer to other parts of the organisation, like finance or operations, when it comes to these decisions, even though it "owns" the analytics and insights into the areas most affected – customer relationships and brand.

Taking the reins back – or at least getting a seat at the table – requires marketing leadership to make the case, pushing back to demonstrate the impact of pricing decisions on perceived value, and potentially on the health of the product, the whole category or the brand.

In fact, pricing decisions should not be undertaken in isolation. The organisation that optimises pricing against long-term brand value will experience a far more positive impact on overall performance over time. That’s where your profitability will come – in very strong hues and in the ability to better engage with customers, long term.