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.

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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.

The Diaper Economy

I recently had a chance to speak with a pretty savvy pricing manager who understands the nature of demand in his business and how that demand should shape his pricing strategy.  Since his firm sells business services he understands that demand for his offerings is driven by downstream factors that are largely beyond his control. 

The technical term for this condition is derived demand.  That is, demand for his firm’s services is derived from demand generated in downstream markets.  When the rules of derived demand are in play, prices are generally inelastic.  Changes in your prices will have no impact of the total demand for your products or services.

When I looked at last week’s producer price index (PPI) and consumer price index (CPI) reports, it became clear that many firms don’t get this.  We all suspected that CPI would take a hit due to huge declines in oil and home prices as well as the massive discounting that retailers did during the the holidays.  What caught my eye was the level of softness in a number of elements of the PPI.  This implies that a significant number of firms are chasing declining demand by lowering prices – despite the fact that due to derived demand, those lower prices will do nothing other than drain revenues and profits from their industries.

The problem is that so many executives view pricing as a tactical tool – a means to try shore up demand.  As a consequence, their firms don’t have defined pricing strategies that focus their actions on taking steps to limit price erosion not only for themselves but also for their industry as a whole.

My friend described this phenomena as “the diaper economy.”  When I asked what he meant, he answered with a question.  “If offered you a gross of diapers for $1.00, would you buy them?”  My answer was actually “yes” (new additions to the Burton clan due any day now) but ordinarily it would have been “no.”  His point was obvious, when demand is sidelined a low price won’t make it magically reappear.  The demand that is remaining in the market is a result of real requirements and satisfying those requirements isn’t any less valuable than it has been in the past.  In this “diaper economy” all your pricing decisions and competitive moves need to be oriented on this fact.  In other words have a pricing strategy rather than a “rash” of undisciplined price reactions.

A Quick Poll – Your Pricing Environment

There have been some rumblings in the press recently that the spectre of deflation is starting to rear its ugly head. What is happening with pricing in your business?

New Year’s Pricing Resolutions

OK, so I hate the concept of “New Year’s resolutions.”  After all if you’re only sitting down once a year to develop plans on how to improve your business and to grow personally and professionally, you’re doomed to a life of treading water (or maybe taking on water.)

Now that I have that off my chest, I do think that it is time for managers and pricing leaders of all stripes to sit down, take stock, and make plans for pricing on purpose in 2009.  It seems that much of the business world went into hibernation during the month of December and now that we are all back after the extended holidays many of us have our heads firmly stuck within the confines of our offices finalizing plans for 2009.  Before you finish those plans make sure you incorporate the following ideas on pricing.

1. Have a plan for pricing. I’m still amazed at the amount of time and effort that companies put into their yearly planning processes formulating projections on sales volumes, costs, market positions, headcount, etc.  The problem with most of these planning efforts is that they fail to incorporate any thoughtful analysis of the one thing that could blow these carefully crafted masterpieces sky high – pricing strategy.  Making a link between key elements of your strategic plan and a pricing is critical.  It doesn’t have to be complicated.  One semiconductor company I know just started tracking actual pricing against assumptions for ASP erosion that were already baked into their operating plan.  Another, an outsourced services firm, started by defining pricing objectives for each service line and region.
2. Follow-up: Each of the two firms I just mentioned also did something else, they got a group of senior managers together each quarter to review their key plans and metrics.  It takes very little time, keeps the whole team communicating about pricing, and ensures accountability and visibility.
3. Maintain Your Pricing Dignity:  The usual din from customers about price discounts has risen to a deafening roar during the recession.  But now is time to plan for better times.  How?  By making sure that your price lists have integrity.  If you are giving unprecedented discounts to unprecedented numbers of customers recognize the situation for what it is – a game.  To end the game manage prices by policy.  If that means lowering your list prices to reassert the principle that your price lists mean something – do it.  Its easy to position the move as an unprecedented action to help your customers during unprecedented times.

So what are these resolutions really about?  Creating meaning – both for your employees and your customers.  Your prices mean something.  They represent your value to the outside world and are your only means to capture some of that value to make a profit and keep people employed.  Give up on that principal and you are casually throwing away your integrity, taking the value of your products and services for granted, and ensuring that customers will not respect you when times get better and you look for opportunities to raise prices.  Those times will come again.  And what you do during the depths of this recession will determine whether you merely survive – or thrive – when they do.

Dow Chemical: That was Then – This is Now

Over the summer we at Holden Advisors held up Dow Chemical as a shining example of how to manage pricing.  The catalyst (pun intended) for our praise were the double-digit price increases that Dow announced.  While skyrocketing oil prices provided a reasonable basis for increasing prices, many companies dithered.  Dow acted decisively and profited handsomely for their efforts.

Now, scarcely six months later Dow has announced that it is idling a third of its capacity and is laying off five thousand workers and terminating another six thousand contractors.  What gives?  Did Dow mismanage its business after all?  Quite the contrary.  They are still managing in the business in a way that gives them the most pricing power given current business conditions.  The result of the current economic turmoil has been an evaporation of demand.  Dow recognizes an important point that many managers miss – there isn’t any price that is low enough to bring that demand back.  Instead they are working the other side of the supply-demand equation by cutting back supply until market conditions point to the ability to profitably restart idled plants.

We are experiencing perhaps the most volatile pricing environment that any of us will ever experience.  Just a few months ago smart firms were pursuing price increases.  Now many are faced with severe deflationary pressures (when the NFL reduces the prices of playoff tickets by 10% we are in a deflationary environment.)  These changes will whipsaw the unprepared and hamstring their ability to recover pricing power when things eventually turn around.  So what should we be doing with pricing right now?

1. Focus on maintaining the integrity of your price lists.  Ad hoc discounts to help suffering customers and maintain at least some revenues might seem like a good idea – but they are a ticking time bomb.  Customers learn that if they squawk, they will be rewarded with discounts.  Here’s a simple solution if you find yourself faced with a lot of these special cases – lower your list prices.  You can always bring them up later as conditions improve.
2. Make sure that your price-setting processes are efficient and transparent.  Given that the “future” is now defined in hours and not quarters or fiscal years, it is essential to have the capabilities to rapidly and systematically change prices.  If it takes any longer than a few days to implement price changes, you are going to be forced to respond in an ad hoc manner (see point #1) and it will cost you dearly.
3. Never stop playing for the future.  It’s tempting to say that the focus on survival is paramount and that things like value-based pricing are quaint ideas of times gone by.  Nothing could be further from the truth.  Your offerings still have value and you still need to fight for every miliwatt of pricing power.  Tieing prices to value and requests for price cuts to concessions on the part of the customer are the bedrock of profitable pricing.  Price levels may go lower still but how you manage that process now will have a dramatic impact of current and future profits.

How to Keep Your Pricing Dignity

Steel makers and the companies that sell them iron ore and scrap metal are getting absolutely hammered right now.  In a vivid illustration of what it means to live in a world where derived demand rules, the collapse in demand in markets for automobiles, construction materials, and appliances is killing demand for steel.  The steel makers are in turn taking putting a gun to the head of their raw materials suppliers by  suspending or renegotiating contracts.  The Wall Street Journal reports that in China, it’s even bloodier as some customers are waiting until shiploads of scrap metal arrive in port and then telling their suppliers that they can’t offload unless they agree to massive discounts.

So what do you do when your largest customer gets out their brass knuckles, lays a right hook on your jaw and promises another if you don’t agree to major price concessions?  The first step is to determine whether the threat has any credibility.  In the case of the steel producers, it clearly does as the collapse in demand in end markets is well understood.  So the next question becomes “How do we give ground and still maintain our pricing dignity?”  Answering this question effectively is critical.  Customers and their procurement organizations have long and highly selective memories.  They will remember your low prices but none of the extenuating circumstances that led you to the conclusion that it was a good idea to drop prices.

Here’s what some of the suppliers of scrap metal and iron ore are doing.  Cia. Vale do Rio Doce is renegotiating volumes but not prices and is having some success in doing so.  BHP Billiton is showing flexibility by allowing contract customers to delay delivery and is working with others to find ways of reselling contracted volume on the spot market.  The volume moved to the spot market is being sold below the contract price but how BHP is handling it is important.  They are not letting customers just walk away.  BHP are putting some responsibility on customers to help address the shortfalls in their contracted commitments.  In doing so they are willing to help the customer by taking a haircut on prices.

In both cases, the firms are giving ground on price but they are clearly not just rolling over.  This principled stand will be critical in reestablishing a balance of power in their customer relationships in the future when economic conditions change.  It’s very easy to go into survival mode right now and many managers will be overly aggressive in giving price concessions – and they will be rewarded for doing the right thing to keep their companies afloat.  But the really good ones are playing a much bigger game.  They’re already playing for the future