Making Pricing Fade Into the Background

Terrific story last week in USA Today about the continuing strength of the “low-cost” airlines.  While airlines such as Southwest and JetBlue rose to prominence through their mutually reinforcing use of low-cost operations and low prices.  This isn’t the case any more.

With a little bit of work, flyers can find fares on the legacy carriers that are as low as what is available on the Southwests and JetBlues of the world.  As one frequent traveler put it.  “For a lot of us (frequent travelers), the shift toward the low-cost carriers isn’t about price.  You can get pretty much the same prices in coach on the Uniteds and Deltas of the world as you can on the Southwests. And a lot of us still don’t mind paying more for first-class service. The shift really is because of flight availability,” he explains. “You can get to so many more places these days on the low-cost carriers that you couldn’t 10 years ago.”

So this isn’t a price game anymore?  Increasingly, it is not.  And the irony is that this the mark of a highly successful implementation of a specific pricing strategy.  The “low-cost” carriers used low-prices to initially attract customers but their pricing strategy has always been deeply intertwined with their business strategies – and perhaps as important – a willingness to stick to their strategic guns.  The result has been achievement of the critical objective for pricing – increased revenues and profits – which have been used to improve service and expand coverage.  As this occurs, pricing strategy is still critical but it has begun to fade into the background in the eyes of consumers.  One mark of a successful pricing strategy is when it disappears before our very eyes.

Walking the Talk

Effectively pricing communications is one of the most difficult and essential tasks that an executive has to tackle. Unfortunately, despite the rewards for doing the job right, many executives punt and take the easy way out. This enables them to “keep their options open” (act as discounter in chief) and avoid the hard work of implementing and sticking to a real pricing strategy.

One executive that is willing do this hard work and walk the talk is Hugh Grant, CEO of Monsanto. While we have criticized him in the past for a statement he made about holding the line on pricing despite signs of a price war (and thus inviting competition to attack using price) the fact is that this was a rare and as it turns out, relatively minor misstep. For proof look not further than Monsanto’s Q409 earnings call.

This is from Carl Casale, EVP and CFO. “As I just mentioned every financial and operational choice we make should drive farmer profitability. Embedded in our growth rates for seeds and traits is the underlying belief based on our technology, that we have created more value then we have priced for and that irrespective of the swings in commodity prices, the farmer should receive a positive return on the investment from the use of Monsanto seeds and traits… This pricing conversation correlates to my second tenant. If we succeed in increasing grower profitability our execution then drives our earning growth.” Yes, the CFO…let me say that again, THE CFO, is explaining how value-based pricing works at Monsanto

Hugh Grant then explains Monsanto’s pricing philosophy.  “We priced our Roundup Ready 2 Yield against the incremental yield that we deliver so we’re not pricing it against the competitors offerings. We’re pricing it against the new bushels that we deliver on farm and that’s the deal that we have with the grower and if we’re successful in delivering those incremental bushels, its going to be a significant product. But that’s been our pricing philosophy…”

“I’d look at two ends of our portfolio, one end is SmartStax on 200 bushels per acre corn and a 10% yield improvement and if you take last week’s corn price at $3.50, that’s a 20 brand new bushels at $3.50 is $70 of value and that $70 of value times three acres in a bag more or less is $200 of brand new value.

So whether its last week’s price of $3.50 or today’s price of $4.00, or the doom and gloom pricing of $1.95 there’s a very positive economic return at that far end of the portfolio…”

And on the balance between pricing and market share… “So in a world of (flat share) I feel really good because we priced for the value that we deliver and that was a tough call, but it was the right thing to do given the technologies that are coming and we increased our technology penetration in a difficult market.”

There isn’t much analysis that needs to be added to these words. Monsanto has achieved the ultimate objective for pricing; using it as a tool to continually increase both revenues and profits.

The Absurdity of Price Negotiations

I hate to sound jaded but there a lot times when we go into to a firm only to be told that the ideas outlined in “Pricing With Confidence” sound great in principle but…”Our business is different.  You just don’t know how hard it is.”

It could be easy to dismiss those comments out of hand but they are well-intentioned and generally on-target.  Each business has unique issues that complicate pricing – and they are often hard to deal with.  One key to cutting pricing issues down to size is to recognize that there are some predictable patterns – particularly during price negotiations.  Another key to take a step back every once in a while – and have a laugh.

This video (brought to my attention by the excellent team at RainToday.com) serves both of these purposes.  It features three seemingly absurd price negotiations.  When watching, see how easy it would be to substitute your product or service and your sales team and customers for the ones featured.  It is frighteningly easy.  Enjoy.

Is Abercombie Violating the Second Rule of Pricing Strategy?

From “Skimpy Profits Pressure Abercrombie’s Pricing Attitude,” The Wall Street Journal, August 14, 2009

It is easy to make pricing more complicated than it really is.  This is particularly true with pricing strategy. There are only three strategies (skim, penetration, and neutral) and only two rules to live by. The first rule of pricing strategy is–you have to have one. Sounds obvious but most companies don’t. While they may make significant investments in processes and technology to control discounting, pricing without a strategy is like a runaway train–sooner or later, it’s going to go off the rails, which brings us to the second rule of pricing strategy. Once you have one, be prepared to change it in accordance with substantial shifts in the nature of customer demand and the competitive environment.

In the past, we have held retailer Abercrombie up as a great example of an organization that understands and plays by the two rules of pricing strategy. Last fall, while other retailers were running panic sales to dump inventory, Abercrombie CEO Mike Jeffries made it very clear that they would not follow suit. In a January earnings call, he offered up the following, unambiguous statement. “We believe what drives in store traffic is a fascination with what we do in store, and that is made up of an in-store experience that is second to none and compelling fashion. That’s how we drive volume in the stores. We are not promotional and will not be promotional.”  Strong stuff–and we admire CEO’s who focus on value and positioning and recognize the critical role that pricing discipline plays in maintaining them.

Jeffries gets high marks for adhering to rule 1. The question is whether he is ignoring rule 2. In sticking with a premium pricing strategy during tough times, Abercrombie has seen 30% sales declines at stores open at least a year in each of the first two quarters. This is a sure sign that its time to reconsider their strategy. “They don’t want to destroy the brand positioning that they have, which is the cool shop in the mall,” says Marie Driscoll, a retail analyst at Standard & Poor’s Equity Research. “But cool is changing. And part of cool now is value.” Time will tell if Jeffries is a visionary or whether by sticking with a pricing strategy for too long he is violating the first law of holes–once you find yourself in one, stop digging.

GPS Maker TomTom Beats Out a New Rhythym

Interesting story in the July 7th New York Times about how smart phones seem to be taking share away from the makers of dedicated GPS devices (“Move Over GPS, Here Comes the Smartphone”.) Some 40% of all smartphone users and 80% of iPhone owners use their phones for turn-by-turn directions.  What’s more sales of stand alone GPS units are suffering.  TomTom saw first quarter sales plunge 29% compared to a year ago and Garmin saw a drop in Q1 of 13% compared to last year.

What is happening is that makers of dedicated products and services are seeing their market positions come under attack from providers of platforms that can add similar capabilities for relatively low incremental costs.  This is a phenomena that is repeating itself in other markets as well.  For example, dedicated job posting sites such as Monster.com are losing share to platform providers such as LinkedIn and Twitter.  This seems to be the toughest kind of competition – a firm that managers never really viewed as a direct competitor uses their platform to make an adjacent move into your business.  And because it is an incremental play, they are often able to do so with lower costs and prices that are much lower than what the providers of dedicated products and services are charging.  It’s at times like this that the great pricing strategists earn their keep.  While many firms would respond with desperation price cuts to hold share, pricing leaders play a different game.

In Pricing With Confidence we come out pretty strongly against using price to drive market share.  Simply using price to try grab customers inevitably leads to increased price competition and the destruction of industry profits.  We do make an allowance for one related but very important exception – when a change in pricing (and likely offering) strategy will enable a firm to dramatically change its footprint.  There is one caveat here – that change in footprint must lead to increased revenues and profits.

Makers of GPS devices are currently facing such a decision and one of them, TomTom seems to be playing the game the right way.  Their plan is to introduce a TomTom branded GPS application for the iPhone and support it with simple mounting hardware to make it easier to use the iPhone as an in-car GPS device.  While exact pricing hasn’t been released, TomTom will charge a one-time fee for the application – and you can bet that the price will be lower than it is for some of their dedicated GPS units.  Many firms would shy away from such an approach for fear of cannibalizing existing revenue streams.  The leadership at TomTom is wise enough to understand that those revenue streams are going to get cannibalized anyway and that the best way to view the firm’s capabilities is not as a maker of GPS devices but a provider of navigational capabilities.  Making this jump enables TomTom to deploy an ever-widening range of high to low-value solutions configured in the way that customers want to use them.

We have a favorite little saying that we use frequently:  Pricing problems are almost never about price.  Pricing problems usually arise when companies miss the mark on what customers value and fail provide offerings that customers really want to buy.  Incumbent competitors can be particularly susceptible when customer needs or tastes change.  Reacting with price cuts will only make the situation worse.  Rethinking what you do to provide customers value and then creating new offerings- even if it puts the existing ones at risk – is the right way to go.  The folks at TomTom clearly get this and have shown the courage to act on it.

Pricing With Confidence: Rules for Returning to Growth

On June 25th I will be presenting a webinar with our friends from Vistaar on steps that you can take now to ensure you get the best returns on pricing as the economy wakes from its slumber.

Register here

Why Apple is One of the Best at Pricing

Two articles describe it better than I can.

First, The New York Times explains that iPhone prices are really more like subscriptions and discuss how this enables simplicity in pricing.

Second, Wired.com discusses the recent price cuts on MacBooks.  Apple responds to the times with systematic price changes rather than lose control of its pricing through discounting.

http://bits.blogs.nytimes.com/2009/06/10/the-iphone-is-a-subscription/?scp=2&sq=iphone&st=cse

Procter and Gamble Gets on Its Horse

Well timing is everything in life.  Two days after my last post on the increasing success of store brands and their importance in retain cash-strapped customers, Procter and Gamble announced that they will boost their offerings of lower end products. As reported in The Wall Street Journal, CEO A.G. Laffley said “that every business at P&G is working to reach more consumers by widening the price range of its products. He cited the recent success of the company’s bargain-priced Gain detergent and Luvs diapers. In recent quarters, both products have outpaced the sales gains of their premium-priced sister brands, Tide and Pampers.”

Laffley went on to say: “You have to see reality as it is.  In every recession there are hosts of compensating consumer behaviors as they manage a more modest budget. We have to expand our portfolios to serve the needs of those consumers. I think a lot of that is going to last…The whole game for us is to manage the premium and super-premium segments in a way so we can deliver affordable entry offerings…in a way that grows revenue and [profit] margins.”

He said the magic phrase – “increase revenues and profits.”  This is the only purpose for price.  To achieve this purpose requires strong product management, marketing strategy, and field level execution.  You innovate for growth (even at the low end of the line) and price for profits.  As these moves show, P&G understands this.  As a result, they will be able to grind out lower, but still healthy profits this year.

Beating a Dead Horse – On the Flanks

If you read enough of what Reed Holden and I have to say about how to manage difficult negotiations with customers that know they will be rewarded for playing pricing poker, you know that having low-value flanking products is critical to grabbing control of the negotiation – and keeping price-sensitive customers.

Here’s a question, what would you do if you didn’t even get the opportunity to negotiate prices?  If you are a grocery retailer, that is the environment that you operate in every day.  Yet they have a solution – private label store brands.  The use of private label store brands has been common for decades and it is a critical customer retention weapon during tough economic times.  Consider the following data points.  According to Nielsen, sales of store brands have increased 10% since the middle of 2008.  And in March of this year Kroger reported that an all-time-high 27% of its fourth quarter revenue came from store brands.

Now, it could be said that since grocery stores are essentially distribution businesses, it is easier for them to use this kind of multi-brand approach.  While it may be easier, that doesn’t make it any less important for businesses that sell directly to their customers.

Consider what happens if you don’t have a low-priced option.  You either negotiate heavy discounts on your higher value products or you lose the customer.  How much does that cost each year?  In most organizations the costs of not having a low-value flanking offering are far greater than the investment necessary to create and support one.  In Pricing With Confidence we talk about how Dow Corning introduced the Xiameter brand to fight low-cost Asian competition.  In the year before the launch of Xiameter, Dow Corning lost $28 million.  In the year after the launch, they produced a profit of $500 million.  Do you think that Dow Corning management is happy that they took on the challenge of getting Xiameter launched?

GE Healthcare Races to the Bottom …and it’s a Beautiful Thing

Earlier this week General Electric announced that it is investing $3 billion to develop low-cost medical imaging and diagnostics equipment.  Long known for dominating the high end of these markets, GE has built a $17 billion-a-year business.  So the question is why in the world would the market leader invest so much money in offerings that could cannibalize existing business?

The answer?  Because GE understands pricing strategy.  While they have built a formidable business selling top-of-the-line equipment, growth has stalled.  First quarter revenues actually fell 9% – in a business that should be growing.  This points to a need for an update to their strategy.  As CEO Jeffrey Immelt put it “The high end in health care is never going to go away, but this will make us broader in terms of price points and offerings.”

This is a classic move in adjusting your strategy as the technology and market lifecycle moves ever forward.  When targeting early adopters, who are price insensitive, it is best to use a skim pricing strategy.  Companies can maintain this strategy for a while as demand picks up and the market moves into the high growth phase.  The risk however is in sticking with only a skim strategy for too long.  This retards growth and leaves the low end of an already developed market open to new competitors.

Top pricing organizations know that when the growth of premium priced offers starts to slow, it’s time to expand the pie.   In order to increase their market footprint and bring in incremental business, GE is “breaking for the bottom.”  They doing this not by lowering prices on their high-value offerings but by introducing low-priced flanking offerings that won’t appeal to their high-end customers but will bring in customers who don’t have the budget for the latest in phased-array, high-definition, four-dimensional ultrasonic imaging.

Making this transition is critical because it address a number of critical business needs.  First, it restarts growth by targeting underserved customers.  Second it increases pricing power by giving sales the ability to offer a lower-value, lower-priced flanking offering to customers that try to negotiate for a straight price discount.  Finally, it drives innovation by forcing a rethink of how beautifully engineered products can be made even more relevant for changing customer needs.  These all add up to one beautiful image – increased revenues and profits.  This after all, is the only purpose for pricing strategy.

It Shouldn’t Be Complicated

Last week, I spoke with the owner of a successful window washing business. His business was healthy and growing but he had a few concerns because growth had slowed and he was starting to lose some business based on price.

We spoke about how helpful a low value flanking offering can be when you start to see some price sensitive business leak away. He said that he has defined a lower-priced service – second story windows get washed with a squeegee instead of by hand. This reduces costs – no scaffolding and less time on site – that he can pass on through lower prices.

His big concern was how to avoid cannibalizing his very loyal, high-value business. We discussed who the price sensitive customers were. Turns out they typically found his number (and those of his competitors) in the Yellow Pages and/or were from a few specific towns. With this little insight, he developed two simple screens. The first was to note the telephone exchange the call was coming in from. The second was to ask the caller how they found out about his firm. If they said through the Yellow Pages and/or were calling from specific telephone exchanges, they are now offered the low-value flanker as an option. His regular customers that keep returning because of service and quality will continue to get the same premium offering at a fair price.

So often we over complicate the idea of price and offering segmentation. All it takes is a little knowledge about you customers and two or three simple questions to enable sales people to identify who they are speaking with. Much easier than getting streak-free windows!

Another Reason Pricing Matters Now More Than Ever

Came across this quote in Jack and Suzy Welch’s weekly column in BusinessWeek.

“Sure, not that long ago, you could still take a competitor’s service or product, tweak it or slap on a new feature or two, and persuade customers to buy it at a premium. But with everyone in hunker-down mode, the days of marginal up-selling are gone, and could be for some time to come.”

Think about this for a minute.  If the days of the  marginal upsell are gone, then firms have to get smart about how they are going to extract the most value from their existing offerings – particularly those at the lower end of the line where price-sensitive customers are going to focus.

This is one of those things that is easy to say but often difficult to do.  Conceptually it is simple.  You only need a couple of things in place.  First, you need to have viable lower-value, lower-price options.  This is second nature in areas like consumer electronics where the concept of “good, better, best” rules.  For a great example just check out Apple’s iPod line.  Second you need to have strong fences that prevent poker playing negotiators from getting the high-value offering for the price of the low-value one.

So what makes this challenging?  As with many simple to articulate but challenging to implement ideas it usually comes down to a couple of things: organizational beliefs and capabilites and measurement systems.

It is not uncommon for many to worry that introducing low-value flanking products will cannabilize sales of existing offerings.  This is a valid concern but when done correctly flanking offerings substantially increase revenues and profits by protecting prices of existing offerings through reduced discount and by bringing in new customers that might not otherwise buy from you.  Cost measurement systems may also get in the way.  If your product costing systems include averaging then the chances are that many ideas for flanking offerings will appear to produce margins that may be below standard.  The trick is to look at the costs that are incremental and avoidable and measure that margin dollars that are generated over and above those marginal costs.  The results are often surprising.  Finally, your sales team may need to learn how to sell differently moving from negotiating price to negotiating price-value trade-offs.

Soon, the press will be trumpeting even more loundly about the coming “value decade” and the talk about how customers control pricing will begin.  Here’s the truth, they will control your pricing if you let them.  One of the best ways out is to make sure that you have a full line with multiple price-value landing points.

Someone Will Have to Cure the Hangover

Came across this article – “Shoppers Say Let’s Make a Deal” – in the April 2nd edition of the Boston Globe.  It made me think a bit about the origins of the modern pricing profession.

While it is always dangerous to point to one time as having a huge influence on the actions of very smart and creative people, indulge me for a moment.  During the brutal recession of the early 1980’s companies were scrambling for business as they are now.  Influenced by the bleak economic conditions and the mantra that came out of TQM that we must always delight the customer, companies started discounting the heck out their products.

Over time some firms realized the utter foolishness of this statement – particularly when it comes to prices.  Egged on by pioneers in the pricing field such as Dan Nimer, Mike Marn, Reed Holden, and Tom Nagle a few visionary firms started efforts to recover from the discounting binge that they had been on.  Thus was born the modern profession of pricing and along with it many of the pricing practices at influential consulting firms.

If you are a pricing professional and are concerned about your future, know hope.  In the not too distant future, the demand for your skills will skyrocket.  Somebody has to cure the discounting hangover that desperate executives are now creating.

Thinking Big

Tough times like this require that we rethink many of our basic assumptions.  When you look at the world this way you realize that despite all of the anxiety and uncertainty that we face these times really are a gift.  Its not often that we as a society get “permission” to rethink foundational principles – and have so many others keeping us company along the way.

For us in the pricing profession it is clear that the skills we have been using over the last several years are necessary but totally insufficient if we wish to continue to add value for our organizations and to continue to grow personally and professionally.  So I’ve spent a great deal of time thinking about skills that we as pricers have that apply well beyond the day-to-day of establishing price lists, pricing deals, and managing the price waterfall.

The two most valuable but often underutilized skills that great pricers possess are the ability to think strategically – that is to link disparate elements of our organizations’ strategy into a coherent whole – and the ability to clearly and concisely analyze business value.  These skills have very broad application.

When it comes to thinking strategically, great pricers understand that any flaws in strategy will ultimately lead to an accelerating loss of pricing power.  They are truly the canary in the coal mine when it comes to strategy.  We need to use these skills to insert ourselves more directly into the strategic planning process (or pushing to create one where it doesn’t exist) and the daily dialog around strategy and measures of success.  The measures of success?  When the executive team meets regularly to review pricing goals and when the team also weighs the impact on pricing of any major strategic decision.

The same is true with understanding business value.  This starts with the ability to research how offerings reduce costs and increase revenues for our customers but has the potential to go well beyond that.  The basic skills required to analyze value apply to business processes and systems as whole because they boil down to two things; identifying inefficiencies (cost drains) and opportunities to grow revenue.

Think for a minute about what this skill really amounts to.  It is really the ability to analyze profit models and how to improve them.  Professionals that do this well are pretty rare – and enormously versatile.  They can do everything from creating extraordinarily effective value propositions and sales tools to identifying new business opportunities.  As an example – did you know that 20% of the power consumed in the state of California is used to move water?  Now how easy is to calculate this business value in making a dent in that number?  For a well-trained pricer its like falling out of bed.

Which brings me full circle.  In uncertain times we have the unique opportunity to take stock in what we know, how we know it, and how our skills can be used in areas that we might not think about during the day to day rush of “good timess.”  Given this, I’m beginning to think that these are the good times.

It’s About the Strategy Stupid

As Reed so simply put it, you can’t price your way out of a recession.  Too many firms have gotten caught flat-footed and are using price discounts in a panic to try to keep demand that is going away no matter what they do.  The firms that do this are creating two very significant long-term problems.  First, they are destroying the integrity of their pricing and the value of their brands.  Second, they are training their customers to negotiate for every last penny thus undermining their most valuable asset – trusting customer relationships.  Both of these forces will make it extraordinarily difficult to bring prices back up when the economy finally does turn around.  In addition, it will take much longer to bring prices back up to a level that reflects the true value of the goods and services being sold.

The way around this is to look objectively at pricing as a strategic tool that must be managed systematically based on value, market demand, cost structure, product lifecycle, and firm capabilities.  This view leads one to make decisions on the basis of preserving and gaining pricing power – be it through reducing capacity to match demand, introducing low price – low value offerings, or making systematic adjustments to prices lists so that list and street prices are more in line.

Two weeks ago we spoke with one of the most capable pricers that we know about how he is getting through these times – “Fred.”  He is thinking strategically.  What has he done?  First he recognized that much of the incremental revenues that had come from pricing last year were going to disappear this year.  Next he engaged with his CEO and they came up with a plan to reduce capacity to well below current demand levels.  This creates pricing power and protects them against further downside risk from collapsing demand.  It also paved the way for passing through a 20% price increase to their least profitable accounts.  Some accounts will walk away – that’s ok because there isn’t enough capacity to serve them any more.  The others will take the increase because they value the service that they get.  And Fred’s firm has now set the stage for a stronger recovery by enforcing a pricing strategy.

Clever pricing tactics and working the “price waterfall” are necessary but woefully insufficient for these times.  The firms that understand that pricing is all about strategy will come through these tough times stronger and more formidable competitors.  Those that don’t will be lucky to survive.