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