As the new year opens many of us are reviewing our core assumptions about our business. One thing that often comes up is pricing. We have all been told that ‘pricing power’ is a great way to measure the resilience of our company, “If you can’t increase your prices you have a serious business problem” and at the same time field sales is shouting out that “we have to cut prices to match the competition.”
At the beginning of the year I get an influx of people asking me for help with pricing. Generally they want a quick fix to their price levels or some tweaks to their pricing architecture. Usually I can’t help them.
Many people who think they have a pricing problem actually have some deeper issue. Usually ones they are reluctant to discuss. Some days being a pricing consultant is a bit like being a psychotherapist!
The symptoms of a pricing problem are well known.
- Excessive discounting
- Confused buyers
- Disgruntled salespeople
- Lots of off-invoice services and concessions
- Customers selecting the wrong pricing tier or package (wrong because they won’t get the value they are looking for and because the company will fail to optimize revenues)
- Reacting to competitor price moves rather than responding
- Inability to raise prices
- Price destruction across entire markets
People come to me with some combination of these problems hoping for a simple fix. “If we could just get our price right all our problems would go away.” No, they won’t.
Pricing problems almost always connect to some other problem.
Roger Martin’s classic Cascading Choices model applies as a much to pricing as to other choices an organization makes. Martin begins with Aspirations, what are you trying to achieve, and then works done to Where to Play and How to Win Choices. Specific capabilities will be needed to execute on the How to Win Choices and systems will have to be in place to support the capabilities.
Conventionally, pricing is usually seen as a How to Win Choice, more of a tactical than a strategic issue. This is true if we are talking purely about price setting. But the overall pricing strategy is really a Where to Play choice that needs to support your overall aspirations for your business.
- Aspire to be a premium brand? Don’t offer discount pricing.
- Discounting to invest in a market? How and when will you get a return on that investment?
- Your differentiation is cost reduction? Then plan to reduce the cost of what you offer.
- We want to be the market leader. But we react to competitor price moves.
Almost all pricing challenges come back to two things: a failure to understand the customer and how the customer gets value; a failure to anticipate competitor responses and then reacting to the competitor rather than responding.
Value is always a combination of the emotional and the economic. What does your offer make your customer feel about themselves? How does your offer improve their business model? Pricing begins by asking what value is created for a customer compared to the alternative. A good pricing metric tracks value, like click throughs for search advertising or leads for a CRM. There is always an alternative, and it is often a competitor.
In a conversation with pricing guru Tom Nagle (author of The Strategy and Tactics of Pricing) he mentioned to me that many managers struggle with pricing because it is not a process that can be optimized. It is a game with several different players making moves. At a minimum there is you and your customer, making a series of moves as you commit to each other, there is usually one or more competitors, and you are all making moves with very partial information.
The worse thing you can do in pricing is to react. When a customer pushes back on a price, or sales gets frustrated and asks for discounts, or a competitor lowers a price it is easy to react by giving the discount or making a price cut. This is seldom the right move in the game. At the very least you want to respond rather than react. A response is a move that thinks through a sequence of moves. “If I lower my prices what will the customer do? What expectation am I establishing about future pricing? How will my customer respond?” The secret to good pricing is to think of it as a game that you are playing with your customers. Not a zero sum game, where what one player wins the other loses.
Good pricing is a positive sum game, where by focusing on value and aligning the price with value you can create a win-win situation for you and your customer. It always feels good to win, but there are some customers that are better served by your competitors. Over the long term you win by creating value for a coherent set of customers where you are the dominant supplier.