«Why executives should make pricing their personal mission I magine a world in which over 80% of companies have come under increased pricing pressure, ...»
Once you have deﬁned your pricing strategies and made your teams accountable for them, you need to make sure you have the right organization so that your company can act on it conﬁdently and effectively.
Having executives devote more of their time and energy to pricing makes a difference. But the impact grows when the executives equip their companies to do the same. That means creating a dedicated pricing organization. The Global Pricing Study 2012 showed that such organizations also have a clear impact on a company’s ability to translate pricing power into higher proﬁts.
Support the development of a pricing organization with well-deﬁned pricing processes Y our employees may talk about pricing a lot, but they probably do not always talk about it in a structured or efﬁcient way. That is an unfortunate truth in most companies, large and small. It not only hampers a company’s ability to deliver an explicit pricing strategy. It makes it harder to generate and harness pricing power.
That fact has something to do with the nature of pricing itself. Pricing complexity is a fact of life. It almost always involves too many people, too many opinions, too many interactions, too much data, and too little time. Pricing is also complex because making pricing decisions – both strategically and tactically – involves taking internal and external information into account. You have to look at customers and competitors as best you can, even if the data are sketchy and you need to make your best assumptions.
Finally, the pricing “process” itself is also a unique animal. Unlike other processes such as manufacturing, a pricing process needs to generate an optimal outcome as its output each time, not an identical outcome.
It is naïve to think that transparency and accountability in such a process can arise without the guidance and catalyzing involvement of senior management. Likewise, it is naïve to think that a pricing organization can emerge organically from the general chaos and complexity of day-to-day pricing without senior management support and inspiration, never mind emerge with a credible mandate and the resources to execute it. Pricing is too complicated a process in most organizations to untangle cleanly without authoritative guidance, if not objective voices.
In this area as well, C-level executives need to become active in pricing and make pricing their own personal matter.
The Key to Higher Proﬁts: Pricing Power - Page 12 Companies with dedicated pricing organizations are 15% more likely to increase prices than companies which lack one. They also pass on 11% more of their planned price increases than companies without a pricing organization.
Pricing organizations make a clear difference Companies with dedicated pricing organizations
When that phrase “pricing organization” comes up in a discussion with anyone familiar with
a company’s pricing decisions, it inevitably leads to two questions:
• What functional area should “own” the pricing organization?
• How centralized should the pricing organization be?
There is no single correct answer to either question. The best way to approach these questions is to align the pricing organization with your company’s market position, brand strength, and need for regional differentiation. At one extreme you have a company such as Apple, with a well-deﬁned market position, a strong and ubiquitous brand name, and little need for regional customization. Such companies lend themselves much better to a centralized pricing organization. They face a high risk of arbitrage, but the risk of damaging the brand outweighs the arbitrage risks and leads them to exercise ﬁrm centralized control.
The Key to Higher Proﬁts: Pricing Power - Page 13 At the other extreme you have companies such as 3M, which have a large number of heterogeneous business units, from health care to ofﬁce products. Furthermore, regulations often create not only a need, but also an obligation to make local adjustments properly and quickly. These companies tend to have a decentralized structure, with a division or region serving as the highest level of aggregation.
In between you have companies whose approaches combine central control with some regional autonomy and input. Porsche ﬁts this model. The headquarters issues speciﬁc process guidance that applies to all regions (such as not allowing “cash back” incentives), but the regions have some leeway to set the prices locally. In turn, the regions must provide that pricing information and its rationale back to the central organization.
Regardless of the type of organization – and whether it sits in sales or marketing – some elements hold true universally. First, you need to write down who does what, when, and with what kind of data. You need to ensure that all relevant stakeholders from different divisions are included to the right degree and at the right time.
Like many of the recommendations in this eBook, that sounds deceptively simple. But it is very difﬁcult for a company to establish a clean RACI chart (Responsible, Accountable, Consulted, Informed) combined with information ﬂows without direct intervention of senior management.
The study showed clearly that having some form of centralization – in best case, a dedicated pricing organization – also has a correspondingly high impact on a company’s pricing power, its ability to implement bigger price increases successfully, and its optimism about future proﬁts. This does not mean that a centralized structure is the answer for all companies who establish pricing organizations. We see this instead as the result of CEOs who put pricing on their agenda and who want to get the pricing authority closer to themselves (e.g., more centralized) in the interim. But over time, the best organizational form still depends on a company’s market position, brand strength, and need for regional differentiation.
So it is now time for another simple question: does your company have a process for raising prices? Process here does not mean the anecdotal “process in people’s heads”, passed along haphazardly from generation to generation like tribal oral history. It means a process that aligns and deﬁnes the task that several functions – primarily marketing, ﬁnance, and sales – have to perform. It means a process that has a system behind it, designed to allow the organization to make decisions as efﬁciently as possible. It means a process that is written down, teachable, and not entirely dependent on the knowledge any individual keeps in his or her head.
The Key to Higher Proﬁts: Pricing Power - Page 14 The process for exercising pricing power should have as much standardization as possible.
The rule of thumb is to start the planning with universal standards, then place the burden of proof for an exception clearly on the business unit, region, or division which feels it requires one. Common sense and experience dictate that you will need to tolerate some exceptions, but they must always have a justiﬁable basis.
Finally, you need to help your organization get in the habit of ending debates. One global company whose C-level executives play key roles in pricing refers to this as “creating knowns”. Revisiting assumptions is necessary for any organization, lest it lapse into a comfort zone. But the revisiting assumptions cannot become a paralyzing, perpetual state of mind.
Even in the extremely dynamic context of e-commerce, some companies have made the choice to deﬁne strategic “guardrails” for pricing, supported and vetted by their C-level executives. These guardrails describe their relative positioning to major competitors and how to preserve it, but not at all costs. The managers have clear ceilings on how high they can price their products to consumers – even at times of scarcity or at times of peak demand.
Likewise, they have clear pricing ﬂoors which they must not breach, so that they can protect margins and prevent price wars.
The right mix of incentives helps, but this in turn depends on having “one set of numbers” that allows you to control and monitor the pricing process. Beyond the ﬁve major ﬁnancial metrics, you can ask for additional key performance indicators (KPI’s) to track pricing performance. What percentage of a planned price increase did the business unit achieve on a net basis? How has product mix shifted after a price increase? How has the won-loss rate for deals changed?
A few years ago, Albert M. Baehny, the CEO of Geberit, the European market leader in sanitary technology, summed up his role in pricing nicely.
“Wherever there is active price management, a clearly deﬁned pricing process, explicit rules of price determination and well-deﬁned responsibilities for price implementation and price controlling, margins may be increased signiﬁcantly and sustainably,” he told Germany’s Handelsblatt newspaper in June 2008. Then he warned: “When pricing is delegated or – if worse comes to worst – left to the market, you will never get beyond mediocrity.” But sometimes, improving these metrics and growing your pricing power requires some imagination. Is there a better way to go to market, in terms of how you price your products and services? Some companies would answer that question for themselves with an emphatic “yes”, as the next chapter on revenue models explains.
Ensure that your revenue models reﬂect both the value you deliver and the costs you incur M anagement thinker and marketing guru Peter Drucker once said that “customers don’t buy products. They buy the beneﬁts that these products and their suppliers offer to them.” The challenge in ﬁnding the right revenue model for any business is that it needs to match up with the value you deliver and with the costs you incur. Neither of these remains ﬁxed for long, long periods. Many companies might therefore be working with outdated revenue or price models.
Please think back once again to the circumstances described at the beginning of this
eBook, which are ﬁndings from the Global Pricing Study 2012. In short:
• over 80% of companies have come under increased pricing pressure
• almost 60% of companies are embroiled in a “hot” price war
• the vast majority of companies feel they can’t justify a price increase above current levels of inﬂation
• even when they dare to raise prices at all, they manage to get only half of what they ask for These circumstances should create enough urgency for you to intervene rather than accept these circumstances as givens. You need to take measures to counteract price pressures and other symptoms of weak pricing power. This includes re-examining your price models and adjusting them to the tougher economic situation or to changes in your market situation. You can also treat this as an opportunity to redeﬁne the nature of competition in your market by focusing more on value to your customers.
The Key to Higher Proﬁts: Pricing Power - Page 16 Fortunately, some 37% of respondents in the study said their companies have set plans in motion to change their revenue models. An additional 29% indicated that some sort of initiative is underway, but not yet as advanced.
The most obvious change in a price model is to move away from per-unit pricing to price per unit of value. Perhaps the oldest example of such a model is Xerox, which charged its customers on a copy basis rather than saddling them with capital investment in several machines.
Enercon (wind turbines) and General Electric (aircraft engines) take similar approaches with their pricing models. Instead of taking a “build it and forget it” approach to pricing that transfers all the product risk to the customer, Enercon charges a price based on what the wind park yields. The more electricity generated (in KWh), the greater to the value to the customer, and the higher the price that Enercon ultimately receives.
Instead of charging for jet engines on a piece basis, GE decided to price per mile ﬂown.
The logic is identical to Enercon’s and Xerox’s. The beneﬁt to an airline or an aircraft leasing company is not “having engines”. The beneﬁt comes from using those engines to ﬂy planes further and longer with less maintenance.
Michelin sees even more beneﬁts from this kind of model, which they use for their tires for industrial vehicles. The default option for a price model for tires is to charge your customer The Key to Higher Proﬁts: Pricing Power - Page 17 a certain price per tire. But simply having x number of tires is not the beneﬁt a customer wants most. More beneﬁcial to them is performance, in terms of factors such as responsiveness and durability.
Recognizing this beneﬁt, Michelin switched its price model from “price per tire” to “price per kilometer”. The idea that a better tire lasts longer is intuitive to a customer. If Michelin’s product falls short, Michelin bears the risk. But if the tire outperforms, Michelin shares in the additional beneﬁt it provided the customer.
Now let’s say that Michelin comes up with an even better tire, one which lasts 20% longer than previous tires. With the new “price per kilometer” revenue model, they don’t need to make any adjustments when they launch it. Customers pay as before and revenue stays stable. But Michelin now needs to supply fewer tires.
They essentially implemented a price premium for the innovation without taking any additional or extraordinary action. Can you imagine the effort required for Michelin to achieve a 20% higher price with the old price-per-tire revenue model?
A good price model provides a number of beneﬁts. Customers understand the link to value intuitively in a good model, which can help increase the chances that they perceive both the model and the resulting prices as fair and also as an easier way to do business. They can also allow a customer to move away from high upfront investments and manage their payments in smaller, but regular installments. In the best cases, they can create enough goodwill to discourage a customer from switching or even considering another supplier.