The price is one of the most effective levers for maximizing profits as it immediately creates income and doesn’t incur costs. This insight is by no means new and has been proven by numerous scientific studies. A recent survey by McKinsey (2015), for instance, which examined more than 1,000 pricing-excellence and performance-improvement initiatives in a range of B2B sectors worldwide found that such efforts typically translate into an increase in return on sales of up to seven percentage points, depending on the sector.
A similar benchmark study conducted by Deloitte in 2011 revealed that, regardless of industry, geography or size, companies with effective pricing capabilities significantly outperformed industry peers across multiple financial metrics, such as net margin, market valuation, return on assets, and return on equity.
Nevertheless, many companies still underestimate the great opportunities associated with an active price management that is aligned with the corporate strategy. Frequently, pricing is merely used as a tactical means for achieving short-term effects. There is lots of potential being wasted here.
Which Pricing Decisions Need to be Taken?
Strategic price management aims to support the achieving of the company’s long-term goals by setting a price/performance position. To do this, according to Hermann Simon, one of the internationally most renowned pricing experts, three key questions need to be addressed:
- Which price positioning does the company strive for?
This is about determining the right combination of price and quality. Companies need to decide whether they want to act as a low, medium, or high price provider in the market.
- What is the price logic behind the pricing strategy?
Regarding price logic, companies have two basic options: they may choose to offer a product/service at a standard price (single pricing strategy) or to charge different prices for the same or similar product/service (price differentiation strategy). Differentiation may be based on geography, time (skimming vs. penetration strategy), or perceived customer value. Price differentiation strategies enable companies to serve customers with different willingness to pay and attract new customer groups. Compared to single pricing strategies, differentiation strategies, therefore, offer much greater opportunities to increase the company’s revenue in a sustainable fashion.
- Which Role Should the Price-Setting Play Within the Marketing Mix?
Pricing setting can be done either actively or passively. While in passive price management prices are rigidly fixed to prevent potential price wars, active price management aims to quickly adjust prices to changing market conditions and, thereby, strengthen, expand, or defend the company’s competitive position. One example of this is "real-time pricing" where electronic prices are changed over very short time intervals. Active price management, therefore, represents a special form of temporal or dynamic pricing strategies.
Challenges and Best Practices
Strategic price management is anything but an easy task. Vast amounts of data on costs, customers, and competitors need to be thoroughly analyzed and integrate into a price which leads to long-term profitability. If the price is too high, the company runs the risk of losing customers. If the price is low, profits will drop. Strategic price management is always associated with risks. With price differentiation strategies complexity increases even more, as different prices for different customer groups need to be determined. Successful strategic price management also presupposes that various functions within the organization, such as sales, marketing, finance, product development and customer service, collaborate closely and act in concert which, depending on the corporate culture, can quickly lead to conflicts.
In corporate practice, three elements have emerged as important success factors for strategic price management:
- Effective information management
Smart, fact-based pricing decisions can be taken only if there is sufficient information on customers’ needs and willingness to pay, competitors, as well as all the work and process steps affecting the profit margin positively or negatively. Each step represents a lever for pricing and, thus, profit maximization. This information needs to be efficiently collected across the organization and centrally stored, quantified, analyzed, and evaluated. The use of appropriate information management systems is essential for this.
- Centralized Organizational Structure
Prices should not be set individually at the discretion of sales people. Otherwise, any strategic focus would be lost. Strategic price setting needs to be a centrally managed, on-going process which clearly defines responsibilities and competencies for price analysis, decision-making, implementation, communication, and monitoring. Internationally, more and more companies are hiring Chief Pricing Officers or Pricing Managers who are in charge of the pricing process and report to the CEO. In Germany, however, this is still the exception. A survey conducted by PwC in 2013 reported that in only 41 percent of German companies the responsibility for pricing and strategy was centralized.
- Value-based Pricing
In academic research and corporate practice there is a wide agreement that value-based pricing generally results in higher profits than traditional cost-based or competition-based pricing (Kuhn & Pfäffli, 2007). Customers do not all "tick" in the same way. They may perceive the value of the same product or service quite differently leading to differences in their willingness to pay. Value-based pricing enables businesses to determine this willingness to pay and take full advantage of it. That is, they can realize the best possible price which a customer is willing to pay for a product or service at a given time. This can lead to a sustainable increase in profits.
While internationally value-based pricing is already widespread, most German companies still stick to cost-based and competition-based pricing, as shown by the PwC study cited earlier. An outdated approach which makes little sense, especially in a high-cost and high- quality country like Germany, as the authors of the study point out. One reason for the low popularity of value-based pricing is certainly its complexity as well as the high costs for determining differentiated customer value. To do so, lots of market research is necessary.
Many companies do not fully exploit their customers’ willingness to pay wasting profits. Strategic price management based on an efficient information management, a centralized, holistic process, and strong focus on customer needs, could help here.
Jubas, J., Kiewell, D., & Winkler, G. (2015). Turning pricing power into profit: Companies often overlook pricing as a driver of earnings growth, instead defaulting to cost cutting and other measures. Here are five steps to growth through pricing. McKinsey. http://www.mckinsey.com/insights/marketing_sales/Turning_pricing_power_into_profit?cid=mckgrowth-eml-alt-mip-mck-oth-1503
Kuhn, R., &, Pfäffli, P. (2007): Wie Unternehmer die Preise erhöhen können. Io New Management: Zeitschrift für Unternehmenswissenschaften und Führungspraxis, 6, S. 78-83.
PwC (2013). Wie gut ist das Pricing deutscher Unternehmen? http://www.pwc.de/de/pressemitteilungen/2013/unternehmen-vergeben-mit-ihrer-preisgestaltung-gewinn-chancen.jhtml
Simon, H. (2013). Preisheiten: Alles, was Sie über Preise wissen müssen. Frankfurt: Campus.