Editor’s Note: This article first appeared on the Ibbaka blog here.
It is well known that pricing is the most powerful lever that companies can pull to improve profit. From the classic article, by Michael Marn and Robert Rosiello in Harvard Business Review,
“The right price can boost profit faster than increasing volume will; the wrong price can shrink it just as quickly. Yet many otherwise tough-minded managers shy away from initiatives to improve price for fear that they will alienate or lose customers. The result of not managing price performance, however, is far more damaging.”
Price needs to be part of your strategic planning for 2018.
Before you can develop a coherent pricing strategy, there is some homework you will need to do. Make sure there is alignment on your overall strategy.
- We have a clear understanding of the tradeoffs between market share, revenue and profit and know what our strategy is.
- We have realistic targets for key ratios such as LTV/CAC (Lifetime Value of a Customer over Customer Acquisition Costs)
- We know our brand positioning and where we want to play on price and value.
Broadly speaking, you need alignment on your Winning Aspirations and your Where to Play Choices before you drop down into How to Win Choices. This framing is based on the work of strategy thought leader Roger Martin and is often referred to as Cascading Choices or Strategic Choice Structuring. See his page on this topic.
Pricing strategy connects your Where to Play and How to Win Choices. It does this by helping you define how you create value for your target segments and how you will capture your fair share of that value. To execute on pricing strategy you have to be able to answer the following questions.
- Who gets value from our offer and how? (This is fundamentally a market segmentation question. Pricing begins with market segmentation. If you do not have a meaningful and actionable way to segment your market your pricing strategy will fail.)
- What are the customer acquisition costs for each segment?
- What is the lifetime value of a customer in each segment?
- What is the cost to serve in each segment? (Your cost to serve is the money you will spend supporting the customer once you have sold them.)
- What are the current and future next best competitive alternatives for each segment? (That is to say, what alternatives do your potential customers have to your offer today? What alternatives will they have tomorrow?)
Once you have alignment with overall strategy and understand your target markets, you can begin to define your pricing strategy. We suggest working through the following questions to get to your pricing strategy. We have structured this as a conventional SWOT analysis (Strengths, Weaknesses, Opportunities, Threats).
- Where do we have differentiated value? Who do we have it for?
- What is our pricing power? How can we increase it? (The simplest way to understand pricing power is ‘the ability to raise prices’. Just because you can increase prices does not mean you should. That depends on your strategic goals.)
- What segments combines high Lifetime Customer Value with low Customer Acquisition Costs and low Cost to Serve?
- Where are we losing differentiation? (You can lose differentiation as your competitors catch up with you or as market needs shift and your differentiation becomes less relevant.)
- Where are we undisciplined in our value communication or our discounting?
- What do we not know about our customers, how they get value from our offers, and what alternatives they are considering?
- Are there quick wins we can implement in our solution that will increase differentiated value without driving up our cost to serve?
- Are new segments opening up for us where we have strong differentiated value?
- Are there opportunities to increase prices?
- Can we improve the distribution of revenues across our pricing architecture (this is one of those areas that is hiding in plain sight, one can often get an immediate boost to profit and revenue by adjusting your fencing to get customers into the most appropriate offer.)
- Can we improve our sales process to sell value before price and better manage discounting.
- Are we losing differentiation in critical segments?
- Are business conditions changing for our customers so that our offers are perceived as less valuable?
- Will our competitors take a pricing action? (Lower list prices, discount more, launch a flanking offer?)
Pricing excellence can give you a strategic edge in 2018 but you will have to invest to get this edge. You will need to have a market segmentation that is unique to your offer and that reflects your value propositions and how your customers buy. Your pricing metric needs to track your value. The pricing and packaging model should be designed to deliver on your strategy. The sales model needs to communicate value and support pricing. Discounting needs to be strategic and disciplined (not reactive and random).
Pricing excellence will help you deliver on your strategic goals for 2018 and in years to come.