When Customers Help Set Prices
To many managers, the idea of involving customers in pricing decisions seems counterproductive. But it may be time to reexamine that assumption.
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For most companies, pricing has long been a sensitive, private affair. Management has a fundamental obligation to recoup costs and earn an adequate return. But it’s worth asking: Is your pricing model one of your core competencies? And does it provide you with a competitive advantage? If your answer to these questions is “no,” then it may be time to rethink the way you look at pricing.
This article is directed at managers who seek to profit from differentiation. If you sense that your company is leaving good money on the table and struggling to convert product differentiation into revenue and profits, then you should consider enlisting the help of unlikely partners: your customers. To be sure, the thought of working with customers on a critical business activity such as pricing can be unnerving for managers. However, in the same spirit that companies today are recruiting customers to improve product design and marketing communications, managers need to recognize that it’s those who purchase a company’s products or services who ultimately determine what they are worth. While customers need not have sole discretion over these activities, they can certainly provide important input. It’s critical to recognize that outsourcing pricing to customers isn’t an all-or-nothing proposition: Managers can select pricing models ranging from complete oversight to complete delegation. The trick is to choose an approach that is suited to the characteristics of the market you’re in and that limits the costs, real and potential, that may arise.
In this article, we integrate classic views on pricing with the latest research and practice to develop a simple framework to help managers decide how much pricing control they should retain and how much they should relinquish to customers. (See “About the Research.”) To be clear, we do not recommend that companies go out and fire their pricing teams and invite customers to pay whatever they wish. However, we do recommend that companies take a fresh look at their approach to pricing — a part of the business that may be ripe for revamping.
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1. To be fair, the literature already contains several classifications of pricing models. Probably the most popular are those that describe different levels or types of price discrimination — for instance, the distinction between first-, second- and third-degree discrimination. However, in our mind these alternatives tend to have a strong academic slant and consequently are less useful from a practical standpoint. For an excellent early example that has inspired much research, including our own, see M. Harris and A. Raviv, “A Theory of Monopoly Pricing Schemes with Demand Uncertainty,” American Economic Review 71, no. 3 (June 1981): 347-365.
2. For a thoughtful discussion on the economic inefficiency of single fixed prices, see L. Phlips, “The Economics of Price Discrimination” (Cambridge, United Kingdom: Cambridge University Press, 1983).
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