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For too long, most people who run companies have made a variety of unwarranted but detrimental assumptions about pricing. Changing prices, for example, has been looked upon as an easy, quick and reversible process, and new technologies have only reinforced this way of thinking. Similarly, extracting value from a product by pricing it correctly has been seen as relatively uncomplicated; the hard part is creating the valuable product in the first place. But these dismissive attitudes toward pricing miss the mark. As any executive of a company with thousands of products and hundreds of customers will tell you, price changes are not easy: Start tinkering in an ad hoc way and you end up with irrational prices and angry customers. And as any manager of an innovative organization will explain, it’s awfully difficult to set a price for a radically new product in an untested market. Set the wrong price in that case and you squander an opportunity that a competitor is sure to seize.
The problem with typical assumptions is that they reduce pricing decisions to mere tactics, and tactics aren’t enough. If pricing isn’t a strategic capability — a contributor to a company’s ability to devise and implement its strategy — it’s probably a strategic liability. Pricing is complex, and it’s only growing more so as new tools and techniques become available. In order to be able to set the right price at the right time, any time, companies need to invest in resources, infrastructure and processes. These investments allow a company to create a pricing strategy by building the capabilities it needs to routinely set prices for all its goods and services that fit with its positioning, with its customers, with its suppliers and with evolving market conditions.
For many companies, pricing capabilities are increasingly critical to their ability to implement their strategies. We interviewed one CEO in the computer business, in fact, who called pricing the essential capability for survival in that industry and has made investments in his organization that show that his comment isn’t just an idle remark.
In the course of working with dozens of companies in the past couple of years, we have spoken with several other executives who have a similar outlook.1 Their focus is on developing organization-wide capabilities by investing in three areas: human capital, systems capital and social capital.
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1. This article is the outgrowth of the authors’ years of field studies on pricing in consumer-goods and industrial markets. Other papers related to this subject include D. Levy, M. Bergen, S. Dutta and R. Venable, “The Magnitude of Menu Costs: Direct Evidence From Large U.S. Supermarket Chains,” Quarterly Journal of Economics 112 (August 1997): 791–825; D. Levy, S. Dutta, M. Bergen and R. Venable, “Price Adjustment at Multiproduct Retailers,” Managerial and Decision Economics 19 (February 1998): 81–120; S. Dutta, M. Bergen, D. Levy and R. Venable, “Posted Prices, Menu Costs and Multiproduct Retailers,” Journal of Money, Credit and Banking 31 (November 1999): 683–703; S. Dutta, M. Zbaracki and M. Bergen, “Pricing Process as a Capability: A Case Study,” Report No. 01–117 (Cambridge, Massachusetts: Marketing Science Institute, 2000); M. Zbaracki, M. Ritson, D. Levy, S. Dutta and M. Bergen, “Managerial and Customer Dimensions of Cost of Price Adjustment: Direct Evidence From Industrial Markets,” working paper 2000–14, Wharton School, Philadelphia, 2000.
2. For seminal views on the relationship between capabilities and competitive advantage, see B. Wernerfelt, “A Resource-Based View of the Firm,” Strategic Management Journal 5 (April–June 1984): 171–180, and M.A. Peteraf, “The Cornerstones of Competitive Advantage: A Resource-Based View,” Strategic Management Journal 14 (March 1993): 179–191.
3. Examples of recent work on human capital and pricing include K. Ailawadi, D. Lehmann and S. Neslin, “Market Response to a Major Policy Change in the Marketing Mix: Learning From Procter & Gamble’s Value Pricing Strategy,” Journal of Marketing 65 (January 2001): 44–61; D. Bell, T. Ho and C. Tang, “Determining Where To Shop: Fixed and Variable Costs of Shopping,” Journal of Marketing Research 35 (August 1998): 352–369; R. Blattberg and S. Neslin, “Sales Promotion: Concepts, Methods and Strategies” (Englewood Cliffs; New Jersey: Prentice Hall, 1990); R. Dolan and H. Simon, “Power Pricing: How Managing Price Transforms the Bottom Line” (New York: Free Press, 1996); S. Hoch, B. Do-Kim, A. Montgomery and P. Rossi, “Determinants of Store Level Price,” Journal of Marketing Research 32 (February 1995): 17–29; V. Kadiyali, N. Vilcassim and P. Chintagunta, “Empirical Analysis of Competitive Product Line Pricing Decisions: Lead, Follow or Move Together?” Journal of Business 69 (1999): 459–487; R. Lal, “Manufacturer Trade Deals and Retailer Price Promotions,” Journal of Marketing Research 27 (1990): 428–444; T. Nagle and R. Holden, “The Strategy and Tactics of Pricing” (Englewood Cliffs, New Jersey: Prentice Hall, 1997); K. Monroe, “Pricing: Making Profitable Decisions” (McGraw-Hill, 1990).
4. For more on how to think about systems capital and its role in business strategy see G. Heim and K. Sinha, “A Product-Process Matrix for Electronic B2C Operations: Implications for the Delivery of Customer Value,” Journal of Service Research 3 (2001); G. Heim and K. Sinha, “Service Process Configurations in Electronic Retailing: A Taxonomic Analysis of Electronic Food Retailers,” Production and Operations Management 11 (2002); R. Bucklin and S. Gupta, “Commercial Use of UPC Scanner Data: Industry and Academic Perspective,” Marketing Science 18 (1999): 247–273; Indiana University-KPMG, “Retail Technology in the Next Century: What’s ‘In-Store’ for Consumers,” Indiana University Kelley School of Business, Center for Education and Research in Retailing, Bloomington, 1999.
5. For more on social capital see R. Burt, “The Network Structure of Social Capital” in Research in Organizational Behavior, ed. R. Sutton and B. Staw (Greenwich, Connecticut: JAI Press, 2000); R. Burt, “Structural Holes” (Cambridge, Massachusetts: Harvard University Press, 1992); J. Coleman, “Foundations of Social Theory” (Cambridge, Massachusetts: Harvard University Press, 1990); A. Portes, “Social Capital: Its Origins and Applications in Modern Sociology,” Annual Review of Sociology 24 (1998): 1–24.
6. M. Kristofferson and R. Lal, “Value Pricing at Procter & Gamble,” Harvard Business School case no. M-284A and M-284B (Boston: Harvard Business School Publishing Company, 1996).