Many of us are pinning our hopes for economic renewal on innovation and the innovation economy. Companies like Apple and Google are seen as beacons of hope in troubling economic times. And many companies in more traditional sectors continue to invest in innovation and in bringing new value-added products to  market. Given upward trends in commodities prices this is a good thing. Even with a 100% pass through of increased commodities prices companies will see profit margins decline if they are unable to execute prices increases.

Innovation without pricing excellence is fruitless, and companies like Apple and Google are known for their pricing excellence as well as innovation. When their pricing practices falter, their stock prices suffer punishment. See for example the recent post on this blog “Google Earnings — A Pricing Challenge?” by Patrick Schneidau. So what is ‘pricing excellence’ and how does it combine with innovation to generate economic health?

There are three core competencies underlying pricing excellence.

Pricing is Data Driven – Know your actual prices, including the price waterfall, and the granular trends by configuration, customer and competitor (it is surprising how few companies actually have this kind of insight into pricing data). Only by knowing your prices can you identify risks and opportunities.

Pricing is Context Dependent – Understand how you create value for your customers. Specifically, what is the differentiated value of each configuration for each customer relative to competitors? Only by understanding value can you build value into your offerings and capture it in prices.

Pricing Implements Strategy – Connect pricing strategy to corporate strategy. There should be line of site visibility between corporate goals and pricing. How does your pricing strategy reflect your corporate values? Is your pricing strategy delivering your margin goals? Are you using pricing to target market segments? Almost every corporate goal maps to one or more pricing actions.

Pricing excellence is necessary to deliver a return on innovation. Google and Apple are often held up as companies with world-beating product and technology innovation. But they marry this with pricing excellence. Google is the company that executed on — not invented —  the pricing metric of pay per click, generating billions of dollars in shareholder value in the process. Apple manages to  capture a lot of its differentiated value back into prices. Companies that invest in innovation without appropriate investments in pricing excellence will not capture the value of the innovation and over time will be unable to sustain these investments. This is the path into a downward cycle of increasing commoditization. (See my post:  Value-Based Pricing Driving Innovation in the Supply Chain.)

The importance of pricing excellence can only grow over the next decade. Increasing global competition and accelerating innovation are two reasons for this, but even more important are underlying trends in commodities prices and demographics. The rise of the Brazilian, Chinese, Indian and other economies is likely to continue — let’s hope so as they are the main engines of economic growth – and this will put pressure on commodities prices. So will environmental concerns and the move to factor environmental costs into commodities costs. The power of demographics is less well understood. Most of the world’s industrial democracies have entered or are about to enter a period of population decline.  Japan is the most advanced example of this trend, and Japanese companies are struggling to make the transition to Shrinking Population Economics. In his book of that title, Japanese economist Akihiko Matsutani suggests that companies operating in markets with shrinking populations will need to shift focus away from market share and focus on margin. As we all know, pricing is the single most powerful lever that executives have to impact profit. And in a shrinking population it will be easier to grow margins by delivering more value than it will be to grow the top line with undifferentiated offers.

All of us who lead companies, or who play a governance role on corporate boards, should be asking about pricing excellence:  Do our companies have it? Is pricing being used to further our strategies? Are we claiming enough of the value of our innovation to continue to make investments. Pricing excellence is critical to the future health of the economy.