Like any ideology, blanket statements about the “right way” or the “wrong way” to price are provocative but rarely useful when practitioners attempt to apply them. I worry that for many, the concept of “value-based pricing” is becoming more of ideology than a productive means for improving business performance. I have been in the pricing game for close to twenty years and a great deal of what I do is help companies envision and implement productive approaches to value-based pricing. I have also seen enough to know that the reality of implementing changes in pricing approaches is far messier than simply saying that companies should go out and understand value to customers and then price accordingly.
The truth is that the overwhelming majority of companies are currently using some form of cost or market-based pricing today. It is also true that by objective financial standards, there are many very successful companies where value-based pricing has had little to no impact. At the end of the day, the only thing that matters is whether an organization can achieve sustainable improvements in profits due to improving pricing capabilities. In short, the objective is to make more money, not implement value-based pricing per se.
Having said that, the majority of firms selling into B2B markets should have a plan to move most of their offerings to a value-based approach. In many situations a value-based approach is the one that will maximize both revenues and profits. In this light, the drawbacks to pure cost-based and reactive, market-based pricing are significant. On the other hand, each day you go to war with the army that you have, not the one that you wish you could have. That means in the short to medium-term most firms need to make improvements to their current pricing approaches and prepare the rest of the organization for the ultimate move to value-based pricing.
This move is a non-trivial journey. At the strategic level, it requires new skills in being able to quantify customer value, using value insights to create an array of high to low-value offerings, and creating new pricing strategies and models. At the tactical level, it requires training the sales organization on how to work with customers to analyze value and to stand their ground by forcing price-value trade-offs during negotiations. It requires creation of tools to enable the new sales process and it requires pricing professionals and processes to set prices a new way and to maintain price integrity in the midst of tough negotiations. First and foremost, it requires an executive leadership team that will support these changes and help the organization hang tough when the new approach is tested by customers.
In the meantime, the firm still has to price offerings and deals and make money. So for many, no matter what theory says, that means getting better at cost-based and market-based pricing approaches. Simply improving the accuracy of the costing data used to make pricing decisions will help. Including an assessment of opportunity costs into your pricing decision-making will help. Understanding, even on a qualitative basis, where your offerings provide more or less value than the competition helps as you can adjust your cost multipliers or target prices accordingly.
Finally, the first test for many organizations is trying to kick the discounting habit. If you can’t do this, all of the work to transform your pricing approach is a waste of time. For most companies this first step may have nothing to do with value-based pricing. It usually begins with a process of putting together some simple scatter plots or doing some waterfall analysis and then addressing the biggest drivers of price and margin leakage. It is purely tactical in nature – and when well-executed, very profitable.
We know from our own experience and research that successfully implementing value-based approaches to pricing can result in massive improvements in profits. We also know that the interim steps are also quite profitable. No matter what your pricing approach is or what you want it to be, its a commitment to the pricing journey that’s important. With that commitment, firms will see continuous improvements in financial performance as they improve their pricing maturity.
This $50 Light Bulb Could Save You A Small Fortune
BusinessInsider.com, March 13, 2012
Would you pay $50 for a light bulb? Manufacturers of new energy-efficient, long-life LED bulbs are betting that you will. In response to regulations that mandate the phase-out of the majority incandescent bulbs by 2014, lighting manufacturers have been experimenting with an array of replacement technologies. Because they have the best combination of energy efficiency and low environmental impact, new LED bulbs that screw into traditional sockets are seen as the most promising. The challenge is that like many new technologies, LED bulbs are expensive – roughly 25 to 50 times the price of an incandescent bulb.
I give leading manufacturers like Philips Electronics a lot of credit for how they have been introducing, this very pricey new technology. They have relied on simple, quantifiable value messages aimed at the needs of specific segments. The value story is simple. A replacement for a traditional 90 watt bulb, uses 18 watts energy to generate the same level of light. Under similar use, the traditional bulb will last about a year. The new halogen has an average life of 22 years. This results in savings of around $200 over the life of bulb.
Value calculations are not the be-all and end-all that pricing professionals sometimes make them about to be. To be used effectively, you have to follow the golden rule of value-based pricing: sell value where it’s valued. This is perhaps where Philips is doing their best work. The first segment that they attacked, owners and managers of large facilities, is very value sensitive. And the technology has been well-received.
Now they are bringing this same message to consumer markets. Will it work? Yes, but only to a point. Again, this is where segmentation comes into play. Some early adopters in the consumer market will buy based on value but consumer markets are different. Purchase decisions and price perceptions are often based on more qualitative, attitudinal drivers. This means that there is a significant portion of the market that won’t switch until prices come more into line with a frame of reference that is built on prices for the old technology. This is where the magic of cost curves comes in. As volumes build, costs will come down and prices will become low enough to capture the mainstream market. Until then, consumers that see the economic benefits even at $30 – $50 per bulb* are a good place to start.
*Yes, I have started buying the new bulbs. The only thing that I hate more than changing light bulbs is taking out the trash. If anyone has new system for getting rid of trash that is supported by a good value story, I am your target customer…
One College Slashes Tuition by 22%, Promises No More Silly Financial-Aid Games
Time Magazine Moneyland, February 7, 2012
In the Boston area we have car dealer named Ernie Boch who inherited a group of auto dealerships from his father…Ernie Boch. Both Ernies are famous for their home-made looking commercials urging customers to “come on down” and negotiate a great price on a car. While we have come to grudgingly accept this approach from car dealers, we don’t expect it in other markets – like higher education.
When we talk about examples of different types of pricing strategies, we often use the way that colleges and universities set tuition as an example of using a neutral pricing strategy. When firms deploy a neutral pricing strategy, they generally set price levels close key competitors. The objective is to get customers to focus their decision criteria on attributes other than price. In higher education it is easy to implement such a strategy because the tuition rates for peer institutions are published. So establishing published tuition levels is just a matter of determining where within the peer group an institution wants to fall.
At least, that’s the way that it appears to work. The reality is significantly different. Colleges and universities have a number of ways to lower the cost of getting an education. Savvy parents and students understand this and know how to play the game. I have a niece who once got a significant increase in financial aid simply by threatening to transfer. There wasn’t anything artful about it. She issued a challenge and her school caved in.
Now we have the University of Charleston going rogue and adopting what appears to be an “everyday low-pricing” approach. Instead of offering discounts of off its former list price of $25,000. They have cut to the chase and lowered tuition to a no-haggle price of $19,500 per year. In order for it to work a number of things have to happen. First, the University of Charleston has to closely monitor their peer groups’ financial aid practices and ensure that they aren’t losing students to competitors that continue to negotiate. Second the University has to maintain discipline in managing net tuition costs. Finally, they have to be ready to enforce pricing discipline in their market. This last point may be the toughest as the number of competitive alternatives is high.
Will it work? I actually believe that it has a chance. After all “over-priced” is a commonly used modifier for the term “higher education.”
Big accounts are critical to just about every business. They help drive significant chunks of the revenues that are critical to meeting financial goals. And, in many cases, high-volume customers help keep costs down through economies of scale. As such we often shower large accounts with special terms, discounts, or extra support and give them superlative labels by conferring “Strategic” or “National” account status on them.
One of the best feelings in business is landing a major new account. The team pulls together around a common goal and works for months or years to achieve it. They plan solutions and do battle with the competition and then come away victorious. Sure, there are concessions made along the way but big accounts have purchasing power and sharpening the old pencil to get the deal is necessary.
This is all true to a point but managers often take this old adage to the point of self-delusion. The biggest lie that they tell themselves? “This account is unique and so are the concessions. What we did here won’t affect other accounts.” Many managers are realistic though. Their version of the story is “Yes, we did it here and it will probably spread to some of our other strategic accounts but we will keep it contained.”
This is all very nice thinking but here is what really happens. Any special concessions that you make for major accounts now become standard practice for the majority of all accounts within a few short years.
A while back, we worked with a firm that was wrestling with the fact that many of their largest accounts were starting to demand “signing bonuses.” They ultimately gave in but assured me that there was no way that this would ever happen for any but a handful of really important accounts. You probably know where this is going…I returned a few years later only to find out the majority of accounts were now negotiating…and receiving signing bonuses.
How did this happen? The way that it always does. Smart customers and sales people learn of the practice and push to extend it. Those same senior managers that promised discipline get desperate for business – and then it’s Katy Bar the Door
It can be a struggle to get managers to see past the deal in front of them. The key is to do the analysis to show what the potential impact of the “once in a lifetime” concession of the day will have on the whole business when it spreads. This can be done in a matter of hours with a simple spreadsheet and a few basic assumptions. Doing so may not stop the problem immediately but it will define the full cost and leads to more formal discussions and support policies to keep things contained. If you have more time, you can do a little forensic work and track the spread of a particularly nasty concession from one account to common practice. Infectious disease specialists call this finding the “alpha patient.” While the first analysis is somewhat speculative, finding the alpha patient allows you define actual historic costs to the business.
What does a stable approach look like? Firms that manage discounts well do a couple of things. First, they track the effects of negotiated discounts. Second, they recognize that discounting can be an important tool but that it must be done by policy and based on objective criteria that are available to all customers with similar attributes. Finally, they back everything up with specific sales tools, training, and incentives.
If your firm doesn’t adhere to these basic principals, we have one word of advice for you. “Look out below.”
The idea behind Clayton Christensen’s Innovator’s Dilemma is that given huge investments in the status quo, market leaders often lose their positions to upstarts that attack the market with seemingly inferior technologies and low prices and then work their way up the food chain – think Xerox versus Canon in printers and copiers or the US auto industry versus Honda and Toyota. Given how long this powerful idea has been around and the numbers of companies that have been victimized by it, you would think business leaders would know better, but here we go again – maybe
In this case a firm called Mobisante is introducing a field-portable medical ultrasound device/app that runs on smartphones. The scanner will cost $7,495 in a market where even entry-level equipment can cost tens of thousands. While the hardware is currently a dedicated smartphone that you must but from Mobisante, we know how this usually plays out – over time the technical limitations get worked out and an interesting technology becomes a disruptive technology that wreaks havoc with the pricing of incumbent suppliers.
The battle is usually bloody but the outcome inevitable with the attacker displacing incumbents who can’t discount their legacy products far enough to remain competitive. In this case, the outcome may not be as inevitable as one of the incumbents in GE Healthcare. A few years ago, GE introduced a low-priced ultrasound machine for emerging markets. That device, the Vscan, is now available in the US for roughly $7,900. While Mobisante is a mouse to GE’s elephant, the competition will be interesting. GE may have the technological advantage and a strong price for now. But, if equipment makers can successfully use smartphones as low-cost universal platforms, all bets are off and we will see more giants fall to the curse of incumbent technologies, cost structures, and uncompetitive pricing.
Pricing Tactic Spooks Lawyers: Companies’ Use of Reverse Auctions to Negotiate Legal Services is Accelerating
The Wall Street Journal, August 2, 2011
I know, I know the instinctive gut reaction to anything that upsets lawyers is one of evil glee but this story about the increasing use of reverse auctions to procure legal services should serve as a cautionary tale for every business. Every product or technology-focused company worth its salt knows that their core business is in constant danger of commoditization. Many are making significant investments in services as a way to differentiate and maintain pricing power. So when the hardest of hardcore procurement tactics start getting applied to high-end services, it is only a matter of time before the pricing of services of all types gets put under the microscope. Our recent experiences with a broad range of high-value service providers show that the problem is already widespread.
The issue isn’t whether reverse auctions are appropriate for services – in the majority of cases they currently are not. The issue is whether those who are selling those services are well-prepared to deal with the procurement buzz saw. In professional services, all too often the answer is “no.” Professional services have long been thought of as the ultimate relationship sell. “Technical” competence is the ante to get in the game but developing an intimate understanding of clients’ organizations, their business priorities, processes, and culture used to win the day. Procurement professionals want to take all of this off the table. In some cases, they have a valid point. In others they are dead wrong.
Services organizations need to think about this challenge at two levels. The first is to assess pricing potential through the lens of the product life cycle. Services naturally move through this same cycle. In new fields, service providers have information and expertise advantages over clients so they can charge higher prices. For services that have moved well down the life cycle, service providers rarely have unique knowledge relative to clients. These routine services will be commoditized and providers need to develop high-efficiency models that drive out costs and lower prices.
The second (and often the most urgent) level is development of processes, tools, and techniques to ensure that rainmakers have the ability and willingness to play hardball with procurement – particularly when they are selling and delivering high-value services. Even small changes in deal performance can drive major increases in profitability. In many professional services firms, “selling” and “negotiating” are dirty words. Those firms that get over their inhibitions will adapt and thrive in the new world. Those that don’t will shrink their way to irrelevance.
Whenever we meet with organizations that are eager to reap the benefits of adopting more sophisticated pricing approaches, we always ask executives what they want to accomplish through better pricing. The nature of the answers that we receive ranges from spot-on to muddled to being in open conflict with sound business practices. Often there is someone in the organization that either has some good experience with pricing, has been to some conferences or has read one of the many great books on pricing that are out there. Their typical position is that their firm needs to implement “value-based pricing.”
While familiarity with the principles of value-based pricing gives organizations a huge leg up, some significant perspective is required. To help with that perspective, here’s a question to ponder: Over the last ten years what percentage of the revenues and profits of the Fortune 500, Russell 2000 or any other group you choose can be attributed to the adoption of value-based pricing? While I haven’t done the research, as a bit of a pricing insider, I can assure you that answer ranges from negligible to very low.
Don’t get me wrong, organizations that focus on improving pricing performance often see major jumps in both revenues and profits. The questions is what is at the root of those results. There are typically three stages that lead to improved pricing results over time. The first stage typically involves getting control over unearned discounts and closing loopholes in the full set of terms under which transactions are conducted (a.k.a. the price waterfall.). Since most firms do some form of cost-based pricing, Stage 1 benefits are often a result of becoming better at cost-plus pricing.
The second stage is focused on setting list prices that more accurately reflect customers perceptions of value and the alternatives presented by competitors. By tempering the view of what competitors are doing with a sense of the unique value that they offer, firms at this stage are often engaging in what we call disciplined market-based pricing. They look at competitor prices but they also adjust price levels according using data that helps define their value position relative to those competitors. At this stage, that value data doesn’t necessarily have to be overly scientific. It could be based on something as simple as a survey of the sales team regarding the circumstances under which they have or do not have pricing power. It might also come from traditional, attitudinal market research that shows customers preferences or perceptions of one product vs another.
This brings us around to Stage 3: full-on value-based pricing. While this should be every firm’s objective, the truth is that implementing a sustainable value-based pricing program is extremely difficult and can take years to become standard practice in the organization. It requires sophisticated knowledge of the economic benefits received by customers; changes in market research, how competitive strategies are conceived, product management, sales practices, and incentive systems at all levels of the organization – just to name a few.
The thing to remember in all of this is that the primary purpose of doing the hard work on pricing is to achieve sustainable, long-run improvements in profitability. Value-based pricing is not a prerequisite for achieving this objective. All it really takes is a commitment to improving on whatever pricing approach that your firm is currently using – whether it is cost-plus, market-based, or value-based.
One of the most challenging aspects of pricing is setting a pricing strategy – particularly for a high-profile new product. Recent press reports have Motorola launching its iPad competitor, the Xoom at a price point of around $800. This is roughly at parity with Apple’s first generation iPad. At first blush, this might seem like a reasonable strategy. After all, in terms of basic technical specifications, the Xoom comes out well ahead. In addition, its use of the Android “Honeycomb” operating system will enable to outperform the iPad on a number of relatively standard customer needs like maps and navigation and viewing of videos in multiple formats. So, pricing at parity while enjoying some significant advantages seems like a good idea…except that it’s not.
One of the most poorly kept secrets in the world of consumer electronics is that Apple will drop the iPad 2 on us sometime this spring. When this happens we can expect a couple of things. First, the iPad 2 will meet or exceed the Xoom on basic performance specifications. Second, the price point for the highest end version may increase somewhat but Apple will generally maintain existing prices. Finally, Apple typically uses the launch of a new generation of portable devices to reposition the previous as a lower-priced flanking product (admittedly we are in uncharted territory here with the iPad.)
If Apple does all of these things – which are based on prior actions with products like the iPod, iMac, and laptops – then Motorola will be forced to make a price move within a few months of introducing the Xoom to maintain reasonable positioning. This will create the perception that they are reacting to rather than anticipating a rather predictable (but prodigious) competitor. The key question for Motorola is: “If it is highly likely to happen why aren’t you getting out in front of it?”
Interesting piece in the August 19th Wall Street Journal on airline bonus mile programs that allow customers to purchase additional frequent flier miles directly from the airline. We’ve all seen this when you check in at a kiosk, there is invariably an offer to buy additional bonus miles for your flight at what seems to be an attractive price. But there is a catch; there’s always a catch. The typical cost per mile is about 3 cents. But when those miles are redeemed, the typical passenger can expect to get a rate of around 1.5 cents.
Two things stuck me about this apparently illogical transaction. The first is that this is a growing revenue stream for airlines – meaning offering a bad deal to many customers is paying off. The second is why this appears to be working. There are two elements to this – one rational, one not-so-much. The rational play is that some frequent fliers buy the bonus miles to top off their accounts and get to an award level that enables them to redeem miles earned the hard way – flying. From an economic standpoint this one makes sense, it may enable me to spend $100 in order to redeem miles for a $500 ticket – a pretty good deal.
The not so rational play owes to the faulty ways that we humans often process pricing information. We see what appears to be a relatively small out of pocket expense – particularly when compared against the cost of the ticket – in order to get something that we place a high value on; frequent flier miles. While I’m sure that there is an official behavioral economics term for this, let’s call it the Law of Small Numbers. It applies when customers have a strong psychological reaction to what they are buying or when the price difference is small enough that it is not noticed. We don’t feel that it is necessary to do the math. These effects are why airline passengers will pay 3 cents per mile for something that is worth half that.
The Law of Small Numbers is a very important tool for pricers. As even small increases in prices can have a dramatic impact of profits. Think about it, what would be the impact on your bottom line of an increase of 0.25% or even 0.5%? Given the minimal effort to implement and the fact that most customers won’t even notice, it’s a no-brainer.
There has been an enormous amount of press recently about tiered pricing for technology-based services. AT&T has moved away from unlimited data plans and broadband service and content providers such as Comcast have drawn fire for trying to throttle download speeds of the highest volume users. At first, actions like this seem pretty counter-intuitive. Why do something that will anger your high-volume customers and possibly slow the growth of internet usage?
What AT&T and Comcast are doing makes sense once you consider the nature of a pricing model that includes an all-you-can-eat-option. Your highest volume customers pay the lowest per unit price while consuming significant resources. This is fine when there is plenty of capacity and marginal unit costs are effectively zero. And this was the model for service providers for many years as the supply of bandwidth was virtually unlimited.
Times and costs have changed. AT&T and Comcast both have made significant investments in their networks to keep up with demand. Since the costs of these upgrades are both incremental and avoidable, they need to be considered when making pricing decisions. Conversely if either provider were to forgo upgrades they would have bottlenecks in their systems. Where there are bottlenecks, there are opportunity costs which, in turn, need to be considered when setting prices.
Which brings us back to fully-bundled pricing -To maintain margins, these new costs have to be borne by somebody. If the all-you-can-eat option is maintained, the full impact of these costs has to be passed onto the majority of customers who are more modest in their demands. They, in turn, subsidize the highest volume customers. Problem is that this makes lower-volume (and lower cost-to-serve) customers prime pickings for aggressive competitors who can offer lower prices and still make a good margin. This type of pricing problem is pervasive and poorly understood. With our business-to-business clients it is caused by “strategic” accounts that drive big volumes. What AT&T and Comcast have figured out is that you need to look at your customer base as a portfolio with each segment returning different margins. The key to effective pricing strategy is to understand and manage trade-offs and subsidies between and amongst these segments to maximize revenues and profits.
I have had a number of recent conversations with organizations that are working hard to make pricing changes but are struggling. Quite often the biggest roadblock isn’t the business value of making the changes – putting together a business case for pricing change is pretty straightforward. In the abstract, pricing initiatives are high ROI activities. No, the biggest challenge that many organizations face is that they haven’t set any meaningful goals for what they are trying to accomplish as businesses. Quite often they get interested in pricing because they see it as a powerful means to achieve the ultimate business objective – to make more money.
Unfortunately, taking on a pricing improvement initiative “because we want to make more money” is a recipe for a waste of money – and time. While I like simple, clear goals this one is too big and broad to be useful. The problem is that pricing needs to be aligned against a broader set of objectives. They don’t have to be complicated but they do have to be clear and easily understood. The best ones are related to a clear vision for how to grow the business: which customers are being targeted and why? which offerings promoted? what position is being established against which competition?
The inability of management teams to answer these basic questions is a surprisingly common problem. Yet, these are the very types of questions that are needed to guide an organization as they help to define “success.” Without clear answers even the best managers feel like they are lost in the woods without a compass. Under these conditions, pricing becomes a lowest common denominator activity. Managers use it in the most conservative way possible; to close deals and keep revenues flowing. So while it may be possible to cobble together enough support to take a hard look at pricing, the effort is not likely to garner any real support when it comes time to do the hard work of making changes. When you think about it, this makes perfect sense. If managers are not sure where they are going but feel like they’re making some progress against even hazy objectives, without either a strong directive from above or a clear and compelling statement of business objectives and purpose for price, all but the most confident managers are going to keep their heads down and avoid the hard work of taking on pricing change.
There was a great piece of analysis on the seekingalpha.com website by the folks at Trefis that connects changes in the average selling price (ASP) of Motorola mobile phones to changes in stock price forecasts. As I review company research and commentaries I am surprised by how little attention is paid to pricing. On the one hand most firms rightfully consider pricing to be a very sensitive subject. Public discussions of pricing are fraught with potential competitive and legal problems. On the other hand pricing is the longest, strongest financial lever that there is. In addition, pricing power is perhaps the most compelling sign that a firm has a strong market position and a compelling story to tell investors. As such my sense is that many analysts could do more to understand it. Furthermore pricing professionals exacerbate the problem through an inability to connect their actions to measures that investors care about. Without this linkage, pricing often fails to make the cut as an essential part of the dialog that senior management has with investors.
Here are a few key points of analysis that can help paint a clear picture of how a firm is managing pricing. For each major product line:
- What is the delta between list prices and ASP? What are the trends? This is one of the most fundamental measures of pricing performance. Firms that are heavily reliant on discounting to drive sales are not in a secure position and tend to become even more reliant on discounting to move units as competition intensifies.
- What impact do changes in ASP have on earnings and share price projections? This is what the Trefis analysis is doing. In the Motorola example a 1% increase in ASP correlates to roughly a 0.6% increase in share price. Keep in mind that according to their methodology the handset business accounts for only 27% of the share price. It’s easy to see how the share prices of firms that have fewer product lines are going to be far more sensitive to product pricing performance.
- What is the sensitivity of revenue and earnings projects to changes in price, product volumes, and product mix? This is really a test of the quality of revenues. Are key products falling out of favor and/or requiring more discounts to move them? Is the company ceding the low end of the market to more aggressive competitors and thus seeing the size of its market footprint shrink? Are they doing desperate things in the market to hit revenue projections?
- Finally how does the firm being analyzed compare to its principal competitors? At the end of the day, firms that have pricing discipline will outperform less disciplined competitors, their revenue and earnings projections will be more reliable, and they will have healthier businesses over the long run.
If pricing professionals want to rivet the attention of senior management on the benefits of connecting prices to value, they have to become much more proficient in speaking the language of value themselves.
This week IBM introduced an innovative new line of servers. The eX5 line of servers features some truly exciting technology and after reviewing IBM’s press release, it is clear that they have done their homework on how much that technology could be worth to customers. They have done a nice job defining in simple terms key value drivers and the financial benefits that customers can get – and some of the number are big, really big. Here are a couple of nuggets from the release.
- IBM eXFlash technology would eliminate the need for a client to purchase two entry-level servers and 80 JBODs to support a 240,000 IOPs database environment, saving $670,000 in server and storage acquisition costs.
- A 1,000 user SQL Server 2008 database will cost $50,000 on a two-socket eX5 system. IBM is expected to be the only vendor to deliver a two-socket system in this space, therefore users of competitive systems will have to purchase a four-socket server to run a 1,000 user SQL server database and pay $100,000. Pricing based on Microsoft List Pricing as of January 2010. Pricing model used is per processor licensing which is based on $24,999 per physical socket on the server (logical cores are not counted)
These numbers don’t take into account additional savings in space, power, labor, or maintenance. So what we have here is a really interesting dilemma. How the heck do you price something that potentially brings hundreds of thousands – maybe even millions – of dollars of benefit over and above competitive offerings when those competitive products cost around $7,000?
In theory IBM could get a significant premium here. Based on the data above, a pure value-based pricing approach would point to prices that range from 3 to 50 times what the competition is charging. After doing a little internet sleuthing, I found prices on the IBM Canada website that seem to indicate that new machines are priced roughly at parity with inferior competitive offerings.
Pricing innovations really does present a dilemma. On the one hand, why not go with premium pricing? Maybe cost-conscious customers won’t buy, no matter how compelling the value is. Also, it is a safe bet that IBM wants to move quickly to grab share before competitors move in. And yet, the value seems so compelling. This is the other side of the Innovator’s Pricing Dilemma – worrying too much and under-pricing what seems like a breakthrough technology. Unfortunately this is what usually happens as nervous managers take the safe route.
So let’s assume a market share grab has something to do with this but let’s also give IBM credit for being a well-run company. What questions should they have addressed to support such low pricing?
- For each unit sold, is there a significant stream of ancillary revenue from additional hardware, software, and services? If so, how much is it?
- Do customers tend to be loyal? Put another way is market share sticky? If so what is the value of each point of market share gained?
- Is IBM’s technological advantage going to be short-lived? If so, how long before a credible competitor appears and what is their likely price point?
Pricing is so much more than analyzing value and setting price levels proportionally. As these questions indicate, it has to be conducted with a view toward a specific set of strategic goals and honest assumptions about the competitive environment. Did IBM get it right here? It’s hard to tell but my bet is that they have left a lot of money on the table.
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.
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.