Is It Time to Rethink Your Pricing Strategy?

Price setting and price getting require discipline — not luck. Almost any business can improve its pricing performance, provided it approaches pricing in a structured way.

Companies differ substantially in their approach to price setting but most fall into one of three buckets: cost-based pricing, competition-based pricing or customer value-based pricing.

Renowned investor Warren Buffett has said, “The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by 10%, then you’ve got a terrible business.”1

Yet pricing receives scant attention in most companies. Fewer than 5% of Fortune 500 companies have a full-time function dedicated to pricing, according to data from the Professional Pricing Society, the world’s largest organization dedicated to pricing.2 McKinsey & Company has estimated that fewer than 15% of companies do systematic research on this subject.3 And only about 9% of business schools teach pricing, according to the Association to Advance Collegiate Schools of Business.4 This neglect is puzzling, as numerous studies have confirmed that pricing has a substantial and immediate effect on company profitability. Studies have shown that small variations in price can raise or lower profitability by as much as 20% or 50%.5

Pricing Is a Skill

Over the past 18 months, we interviewed 44 managers — from CEOs and CFOs to heads of business units and professionals in marketing, pricing and finance functions — in 15 U.S.-based industrial companies. (See “About the Research.”) These companies varied in size from about 50 to more than 2000 employees and had dramatically different pricing capabilities.6 In the course of this research, we found that pricing power is not destiny, but a learned behavior. While competition, costs and price sensitivity within a market affect the parameters within which companies set prices, superior pricing is almost always based on skill. The companies we found that had achieved better pricing all had top managers who championed the development of skills in price setting (price orientation) and price getting (price realization). Regardless of their industry, the degree to which managers focused on developing these two capabilities correlated to their companies’ success in achieving a better price for their product than their competitors.

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References

1. A. Frye and D. Campbell, “Buffett Says Pricing Power More Important than Good Management,” February 18, 2011, http://bloomberg.com.

2. K. Mitchell, “The Current State of Pricing Practice in U.S. Firms,” (opening speech Professional Pricing Society Annual Spring Conference, Chicago, May 3-6, 2011).

3. A. Hinterhuber, “Towards Value-Based Pricing: An Integrative Framework for Decision Making,” Industrial Marketing Management 33, no. 8 (2004): 765-778.

4. P.H. McCaskey and D.L. Brady, “The Current Status of Course Offerings in Pricing in the Business Curriculum,” Journal of Product and Brand Management 16, no. 5 (2007): 358-361.

5. A. Hinterhuber and M. Bertini, “Profiting When Customers Choose Value Over Price,” Business Strategy Review 22, no. 1 (spring 2011): 46-49.

6. For more on pricing capabilities, see S. Dutta, M. Bergen, D. Levy, M. Ritson and M. Zbaracki, “Pricing as a Strategic Capability,” MIT Sloan Management Review 43, no. 3 (spring 2002): 61-66.

7. J.C. Anderson and J.A. Narus, “Business Marketing: Understand What Customers Value,” Harvard Business Review 76, no. 6 (1998): 53-65; J.C. Anderson, J.A. Narus and W. Van Rossum, “Customer Value Propositions in Business Markets,” Harvard Business Review 84, no. 3 (2006): 91-99; G. Cressman Jr., “Commentary on ‘Industrial Pricing: Theory and Managerial Practice,’” Marketing Science 18, no. 3 (1999): 455-457; and B. Shapiro, “Buy Low, Sell High: Creating and Extracting Customer Value by Enhancing Organizational Performance,” Harvard Business School Note 597-071 (1987).

8. P. Ingenbleek, M. Debruyne, R.T. Frambach and T.M.M. Verhallen, “Successful New Product Pricing Practices: A Contingency Approach,” Marketing Letters 14, no. 4 (2003): 289-305; and P.T.M. Ingenbleek, R.T. Frambach and T.M.M. Verhallen, “The Role of Value-Informed Pricing in Market-Oriented Product Innovation Management,” Journal of Product Innovation Management 27, no. 7 (2010): 1032-1046.

9. See S. Frank, “Applying Six Sigma in Pricing and Revenue Management,” Journal of Revenue and Pricing Management 2 (2003): 245-254; or M.S. Sodhi and N.S. Sodhi, “Six Sigma Pricing,” Harvard Business Review 83, no. 5 (May 2005): 135-42.

10. For more on value-based pricing, see T. Nagle, J. Hogan and J. Zale, “The Strategy and Tactics of Pricing: A Guide to Growing More Profitably,” 5th ed. (Upper Saddle River, New Jersey: Prentice Hall, 2010).

11. As Forbis and Mehta noted as far back as 1981, a new pricing approach is not “just a change of marketing signals” but “a new way of life” See J. Forbis and N. Mehta, “Value-Based Strategies for Industrial Products,” Business Horizons 24, no. 3 (1981): 32-42.

12. Ibid.

13. J. Bohn, “The Design and Validation of an Instrument to Assess Organizational Efficacy” (PhD diss., University of Wisconsin, Milwaukee, 2001).

14. Ibid.

11 Comments On: Is It Time to Rethink Your Pricing Strategy?

  • steven.forth@gmail.com | June 20, 2012

    Compelling. What is the next phase of your research and how can people contribute? Steven Forth

  • beaux62200 | August 2, 2012

    I’m concerned with the analysis methodology. The authors contacted the Professional Pricing Society to conduct research on its membership base. This is a bias in the data collection. Companies that join the society demonstrate an awareness and concern for pricing practices. The results of this study don’t necessarily reflect across-the-board businesses in different industries. It’s not a random sampling of businesses.

  • kate | August 16, 2012

    “Customers must first recognize value in order to be willing to pay for value rather than base their purchase decision solely on price” – yup, that pretty much sums up the online marketing market at the moment. Wildly diverging pricing strategies due to massive disparities in customer education on what “good” looks like!

    Kate Rose
    Director,
    RM social media consultancy

  • Ajit Mathur | August 18, 2013

    I agree with the basics. However, what companies need to think is “what differentiates them from competition.” My experience shows that in service businesses particularly, companies often struggle to define what I call as “core service promise”. And these questions pretty much set the limits of price that a firm can set. Greater the uniqueness of the offering, greater the latitude for pricing. Of course, such a uniqueness must resonate with the potential customers and must be communicated well.

  • moinuddin.adnan | September 13, 2013

    It would be interesting to know more about indirect channel pricing in a B2B setup. A company develops a pricing strategy for its distributors but cannot influence or dictate the distributor’s price to the end customers (due to anti competition governance).

  • Joseph Monush | March 12, 2014

    Complications will naturally arise from extremely granular, value-based pricing models (those that, as one manager basically suggested, include first- and second-degree price discrimination). But that is what makes this conversation compelling in the context of increasingly sophisticated ‘tools’ (imagining “big data analytics” etc.) designed for the purpose of learning about customers, and in this particular case getting closer to understanding customer elasticities on an individual level.

    For example, some grocery stores with troves of customer data are already testing personalized pricing strategies for select products. This is a truer version of a customer value-based pricing strategy than the yogurt strategy discussed here, which was still very much a competition-based approach.

    What is clear is pricing models, often layered with discounting ‘strategies’, are a major source of consternation for companies. Those with visionary management teams will dedicate the proper resources to finding their way from price taker to price maker (and getter).

  • John Vogel | April 7, 2014

    Is anyone able to tell me the difference between Markup pricing and Cost-Plus pricing? Wikipedia claims these are synonyms.
    Furthermore, the article can be found for free via Google.

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