No Vices

On a warm, smoggy Friday in Sao Paolo four or five years back, our team crossed the city to sightsee after finishing our work.  A traffic jam immobilized our vehicle for a bit.  Our driver began laughing at a sticker on the rear window of the car ahead of us:

He translated it:  “I have no vices… I only drink and smoke when I gamble.”

Impeccable Pricing Discipline

I remembered that clean-living Brazilian in recent months as executives and field sales managers assured me that their organizations are quite disciplined in their pricing.  Except when they aren’t…
• “We only lower our prices to meet a competitive price.”  Is this rare?  “Uh, no, we have to do that all the time.”
• “No one below the branch manager has the authority to override prices in the system.  Although we did find out that at one location, every single computer terminal in the place was used to override prices numerous times last month.  We think the manager gave his sign-in [credentials] to the customer service reps.”
• “On our regular pricing, we have pretty good controls in place over discounting.”  What do you mean by Regular Pricing?  “That’s the prices we sell at when there isn’t a promotional price.”  How common are promotional prices?  “We [lack the data to know, but] think they account for about half of our revenue.”  Who decides the promotional prices?  “Our pricing group at headquarters does.  Oh, and the regional VPs can also do their own.”

Symptoms, Causes and Consequences

On one level, frequent pricing exceptions indicate problems with decision authority and process controls.  Other root causes are usually at work, too:

• The organization hasn’t developed a systemic view as to where and when lowering prices would increase the probability of getting orders enough to be a good business decision
• Without a strategy to guide price-volume tradeoff decisions, individual managers, sales people, and customer service reps make their own judgments
• Those individuals typically aren’t trained and equipped to make profitable decisions As a result, such companies operate with unaddressed contradictions in their pricing strategies and little alignment of their people.  The combined effect is to depress the margins these companies need to prosper and invest for the future.

Using the Pricing Profile from Daring Caution to Solve These Issues
Undoing that tangled set of issues requires a mechanism for making intelligent tradeoffs among valid pricing decision factors.
As people in companies make pricing decisions, they can and should take four major factors into account:

― Comparative Pricing: the company’s current and/or past prices, competitors’ prices, and the prices of substitutes

Customers’ price expectations are usually conditioned by comparative prices.

― Cost + Margin: the estimated cost to provide a particular product or service, marked up by a multiplier of cost, or adding a target or minimum margin percentage to cost.

When combined with the next factor, Cost + Margin is quite useful in determining a floor for prices.

― Concern with Volume / Share: the desire or need to obtain and retain a sufficient volume of business
This is the usual motivation for lowering prices.  It can be a valid consideration, especially if well-grounded in analysis.

― Qualified Customer Value: the price that a qualified customer would be willing to pay if based solely on the perceived value of the offering and the customer’s degree of Brand Preference

Among the four factors, Qualified Customer Value usually receives implicit consideration at best, and far too little weight compared to the other three.  Giving explicit and greater weight to this factor often presents a margin improvement opportunity.

I recommend applying these Pricing Profile factors in a couple of ways:

1. Pricing strategy and price-setting.  This applies to every business, from Fortune 500 to solopreneurs.  The highest prices at which customers willingly buy are a function of Qualified Customer Value and Comparative Pricing, which are usually in an unequal tug of war.  The lowest prices at which the company is willing to sell are a function of the interaction between Cost + Margin and Concern with Volume.  These forces set the bounds within which prices are set or negotiated. I like to use a structured process to determine a realistic balance of the four factors for each product or service cluster, quantify the implications, and plan how to achieve a more favorable balance in the future.
2. Alignment.  The Pricing Profile provides a framework for understanding and communicating how various people in companies weight the four factors differently as they make decisions about prices.  You can use the Pricing Profile to align the company’s people with senior management’s objective of getting paid for the value the organization creates for customers.

Benefits & Outcomes

Pricing discipline is sustainable only if the pricing strategy strikes a purposeful balance between the Pricing Profile factors, and the process for making and executing pricing decisions is guided by that balance.  By using the Pricing Profile to define a strategy and pricing stances, then aligning the organization accordingly, companies can realize more favorable prices.  Margin rates then improve – typically by 1 to 3 full gross margin points.
What would 1%, 2% or 3% more gross margin mean for your business, or one that you know?