We recently conducted a webinar in conjunction with the Professional Pricing Society where we discussed the 8 Myths of Pricing Optimization.  The webinar was so popular and highly rated that we decided to expand upon it in eight blog posts over the coming weeks.

If you missed the first blog post on this topic, we offer the link for your convenience.

Based on Myth #2: Rules or Policy-Based Optimization is Not Really Optimization

Every company operates with “rules of thumb” for customer pricing. For example, a healthcare distribution company may know that plastic surgeons are generally less price sensitive than general practitioners. Or a delivery service may know that legal offices are more price-sensitive when they send letters – which they do a lot – versus sending large packages. In the pricing community, the most generic version of this rule of thumb is that changing pricing for larger customers is more risky than smaller customers since they have more negotiating power. While all of these rules-of-thumb seem intuitive and, in general may even have some basis in truth, they fail to recognize the individual customer differences.

Let’s say I’m a large industrial manufacturer that produces rivets for a number of industries.  My rivets are used in many applications, and I have customers large and small. Conventional wisdom tells me that the larger the customer the more I should discount my products.

But take an example of a smaller company that uses my rivets in its machines that produce a single, commoditized product. To drive down costs, its procurement department makes sure to price-shop each and every purchase. I am constantly price-shopped, and since my rivet is a commodity itself, I can never get more than a 5% margin. Contrast that with a large, multi-national company that I supply machines and hundreds of parts to on an annual basis.  The rivets are a critical part of their operations, but represent a small purchase that’s never scrutinized when it’s time for re-ordering.

Which one sounds like the more price-sensitive customer to you?

If I used conventional wisdom, I’d bucket the larger customer into a group that receives a lower price or a lower-price increase.  How does that make sense?  This rules-based methodology, also known as heuristics, is often misnamed as pricing optimization by a cadre of consultants and technology providers who have no idea how to help you – other than automating your existing process.

If you just automate and speed sub-optimal pricing in your business, what happens when your competition uses true customer-centric optimization against you in the marketplace?  Better get your resume ready.

So exactly how do you optimize, based on an individual company’s willingness to pay?  Stay tuned for the answer in Part Six of this series.

Patrick

So, you jump in your car, switch on the ignition, put on a blindfold, floor the accelerator and speed through oncoming rush-hour traffic. No surprise, the journey is a short one with potentially catastrophic consequences. Such an outcome is highly predictable; however, today many corporations needlessly approach running their businesses in a similar fashion. The issue, you ask? They can’t use the data they have at their disposal to support business strategies. More often than not it’s about having too much data and not enough ability to see the woods for the trees.

McKinsey Global Institute recently released a research report – Big Data: The next frontier for innovation, competition, and productivity – that raises a number of interesting questions about how today’s corporations can turn their big data into actionable management information and thereby remove the “corporate blindfold.”  Big data examples may well include the fact that for 15 out of 17 industry sectors in the U.S., each company has more data at its disposal than the entire U.S. Library of Congress. The demand for storage to support this explosive big-data growth continues at around 23% year-over-year. Aside from the cost of storing all this information, the deluge presents many challenges. And it also provides significant opportunities to leverage kaizen, or continual improvement, to create and maintain their own competitive advantage.

In a number of industries – from global service-parts, manufacturing, chemicals and travel – many innovative companies are embarking on the pricing kaizen journey. They’re embedding pricing science in their businesses for sustained competitive advantage. Top-performing corporations are moving away from “gut-feel pricing” to a more automated and scientific approach. Behind this move is the need to deal with market volatility, erratic commodity costs, multiple product sets and uncertainty in turbulent markets.

All these variables are changing in real time, leading to businesses handling huge amounts of data as part of their pricing decisions. By using their existing investments in big-data analytics, innovative corporations are unlocking their inner pricing kaizen.  However, many business leaders haven’t yet been exposed to the power that pricing can have on their overall performance, and how optimizing their approaches can increase profitability and sustain corporate performance.

A recent pricing study by Deloitte validated the fact that a simple 1% increase in price performance can potentially boost profits up to 12%.  Such a compelling uplift is surely worth investigation, bearing in mind the information to deliver on the promise of pricing kaizen exists today within big-data repositories.  Our business leaders – the profit hunters – are ideally placed to tear off the corporate blindfold; to accelerate performance and outperform their markets.

We recently conducted a webinar in conjunction with the Professional Pricing Society where we discussed the 8 Myths of Pricing Optimization.  The webinar was so popular and highly rated that we decided to expand upon it in eight blog posts over the coming weeks.  Enjoy!

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I have talked to hundreds of companies in my nearly ten years in the pricing space.  Invariably, when the subject of pricing segmentation comes up, they say, “we already segment our customers.” They discuss how for years they treated all customers the same. Now they can classify customers based on spend, sales geography and possibly total available market. Salespeople are happier, and these companies are seeing a downtick in discounting. They call this segmentation.

The challenge today is that almost all companies have the ability to classify customers in this way. It is no longer a competitive advantage, and, more often, executing on this segmentation remains  dependent upon the data held in your data warehouse rather than the real knowledge of your customers and how they buy. Without a customer-centric segmentation, millions of potential profit dollars are left on the table.

Here are three tips to create a real pricing segmentation:

Solution #1:  Pricing segmentation requires that companies take an outside in – not inside out – approach to their markets. For example, why would you constrain your segmentation based on how you classify your sales regions? Best-in-class pricing segmentation uses direct attributes like sales spend, but it also takes into account derived attributes like the intensity of the competitive environment and product-centricity or which products command the most customer sensitivity. Remove yourself from internal constraints – what data you have and how you can classify customers – and start looking at your company through your customers’ eyes.

Solution #2:  You have the data to develop a good segmentation. Most companies review only customer, product and sales dimensions, without leveraging transaction data. What do I mean?  Customers vote with their pocketbooks. A customer can tell you what they value by the products they buy.  Does your customer purchase your premium or your discount product lines? How often do they purchase? When they purchase, do they need it tomorrow or next week? By analyzing customer-buying patterns and how they buy from you, you’ll be able to drill down and get to the core of true value-based pricing. Segment based on what your customers buy, not how your systems identify them.

Solution #3:  Lots of attributes can be used to classify customers.  But classifying customers really isn’t   a segmentation since it doesn’t give you a determination with attributes about which customers are the most statistically significant. While both customer-spend and location may affect their willingness to pay, what’s more important? Classifying customers is the not the same as segmenting them based on statistical analysis. Use this analysis to determine not only what is important to customers, but also exactly how important it is.

We have more than 100 possible attributes that drive customer-purchasing behavior and pricing sensitivity, and we have hundreds of customers go through this pricing-segmentation process with us.

One of the most interesting attributes we ever encountered came through our work with an animal health products distributor, where  one of the segmentation attributes was species. Care to venture a guess as to which owners will pay more for exactly the same medicine:  cat or dog owners?  Contact us to find out.

Thanks.

Patrick Schneidau

I’ve been in the pricing space for two years now, and I can comfortably report that pricing is a cause.   It’s a cause centered on the belief that better pricing can fundamentally and dramatically improve the way companies market and sell their products and services, as well as serve their customers.  And it’s a belief that better pricing makes better companies, and better companies make better employers … and better investments. High-performing companies invest in pricing, and turn it into a strategic advantage.

I’m a believer. And that’s why I am so excited about the incredible boost of visibility the pricing cause received in CIO Magazine. The February cover story says it all:  New Mission for CIOs:  The Art and Science of Pricing.

This feature provides a great example of the extraordinary impact price optimization can have on a business. Waste Management reports generating $218 million through smarter pricing and expects an additional $3-5 billion in the coming years. Just as important, the company pursued a price optimization strategy as a means for fending off commoditization of its services. This is an excellent case of a company that recognized the role pricing could play in solving an important business challenge and then reaped the financial rewards. It’s good for everyone in the pricing industry when a company reveals the truly extraordinary impact that pricing excellence can have on their business.

It’s also important to note that it took underlying technology – in combination with a sound pricing strategy and organizational commitment – to make pricing optimization a reality at Waste Management.  Technology delivered on the promise of pricing.

These data points should get the attention of any CEO, CFO, CMO or CSO looking for the highest yielding growth and profitability initiatives, not to mention those looking for a competitive edge. $218 million in ROI simply cannot be ignored, nor can the use of price optimization as a means to fend off commoditization – or said another way, to realize the true value that a company offers. Name one other technology or organic-growth strategy that can yield a hard-dollar return even close to $218 million in a single year. And I can comfortably say this result from Waste Management is not an anomaly. I know of many companies that have realized returns like these, and even higher.

As a CMO, I have to decide which initiatives to pursue at PROS that will yield the highest return against company goals. So does our CFO, CSO and every other executive. If I were informed about a strategy or technology that could have the magnitude of impact on my business that price optimization did for Waste Management, it would be irresponsible of me not to investigate the possibility of doing the same for my business.

So that’s my challenge to all readers of this blog. I challenge each of you to share with your executive teams this incredible story about Waste Management and see if it moves the discussion about pricing excellence to a C-level imperative … and brings more business leaders into the pricing cause. A world where every company prices smarter means a world where more companies can hire and retain their people, can invest in innovation, and provide a greater return to shareholders. Take the challenge and spread the word!

Thanks!

Tim

Most of us accept that if we go to a convenience store late at night, the items we purchase will be priced higher than a major grocery chain during regular hours. Yet when it comes to operating our businesses, many of us are convinced that cost has no bearing on price. 

When we buy something and pay more than we want, we may complain that the cost couldn’t have been that much. In truth, we’re really indicating that we’re offended by our assessment of the seller’s greed. We’re using cost as a baseline indicator of what we think a more equitable price should be, and simply don’t like to admit we’re willing to pay for the incremental value this specific product or service brings us. In this case, we’re conflicted by an assessment of fairness based on cost, and a reality that we’re paying for the benefit of convenience.

So it’s easy to understand why the practice of cost-plus pricing is today’s most common approach to price setting. It seems fair, and it’s relatively easy to determine. Further, we well comprehend that cost has everything to do with profitability – and profit is why most of us are in business – so we spend a fair amount of time and energy managing and tracking our costs. 

We also want to make sure we’re not selling below cost, which would indicate that we’re not competing well, and we’re spending too much on time and materials. It can also help us consider the least amount we’re willing to accept for our products or services. It’s clear that as good business people we must evaluate our costs and margins. This evaluation can be a determination of our willingness to be in a specific customer segment, to produce a particular product, or to serve a certain customer. But, we must not confuse this activity as a price-setting exercise.

Consultants often discuss setting a floor price, which may also be referred to as determining the bottom of a “pricing envelope.” This helps determines the lower limit of a product or service price-range we’ll offer to a market. Let’s be clear though; this isn’t about setting a cost-based price.  

A cost-based price is not a price we ever want to offer the market. It has nothing to do with either what the market will pay – based on perceived value – or how our offer is viewed relative to competitors. Our potential customers are thinking about themselves, wondering about the benefits they’ll get relative to what they’re going to spend; and also asking if our price is cheaper than other offers.

When we dig further into cost, the whole matter of spreading fixed overhead becomes very messy. As my graduate school cost-accounting professor said when she wrapped-up a very long and tedious semester, “No cost-accounting approach is accurate, but it is better than nothing.” 

It’s easy to get sucked into the vortex of which costs are most appropriate to apply. It is also easy to spend energy determining which version of margins we’ll use:  gross margins, contribution margins, net margins, etc. 

At best, understanding costs and margins are introspective and don’t address our would-be customers’ “willingness to pay.” Alternatively, we should think about our bottom-price as the lowest we’ll quote in a given market. 

Our bottom price can be based on the lowest price for which our product or service has sold thus far. Ideally, this lowest price was given to our largest customer or for our largest transaction – the one that bought the largest quantity of units or spent the most money at any one time.

The lowest price could also be based on a contract that guarantees our “best customer” the best price – a “most-favored customer” clause. But, we should determine the lowest price before it’s introduced into a contract. 

In summary, a cost-based price isn’t an indication of what we should charge for our products or services. It provides an understanding of when it’s no longer viable to sell our products to certain customers or market segments. As such, it’s an important activity that every organization must undertake. But, if we want to improve our margins and drive sales revenue, we must focus on creating an understanding of what our prospects will pay for our offerings. And we must understand this with a solid understanding of the price our customer can pay to get that need fulfilled elsewhere.  

Yes, cost-based pricing is almost a natural instinct due to our sense of fairness and the ease with which we can generate numbers. But, if we study our own behavior when it comes to our willingness to pay for items beyond the cost of the goods, e.g., convenience, then we know we should also be able to add value to our products and services, and our costs are irrelevant to our customers.

Pricing as a profession has come a long way – from a role that has evolved out of someone’s part-time job (marketing, finance, contracting, etc.), and that wasn’t long ago, to a full-time profession accompanied by a title having the word PRICING in it. I happen to be one of those fellows who has been a part of the pricing revolution. However, it seems that the overall message of pricing hasn’t spread as quickly as, say, the Internet, social networking, cell phones or iPads. To be quite frank, the message that I am about to share is simply based on my own personal observations made over 10 years in the profession, as opposed to some scientific study. Nevertheless, it is based on my experience spanning four different industries – services, semiconductors, hard drives, and recently medical devices – in both B2B and B2B2C environments, ranging from a small S-Corp business to a Fortune Top 50.

My view on why the message of pricing hasn’t spread wider is that companies neither have embraced nor fully understand the role and power of pricing. There are good reasons why this is occurring, and I would characterize them in three categories. First, pricing is a victim of successful business models in favorable market conditions. Second, pricing can be under-represented in role and priority within an organization, and often is. Finally, solid pricing efforts that actually deliver strong financial results can go largely unnoticed. I believe these are the internal and external forces constraining pricing from becoming a rapidly growing focal function within corporations.

First, pricing is a victim of successful business models in favorable market conditions. Imagine you are leading a company that is rapidly growing with innovative products. Financially, you are highly profitable. In two of the companies I’ve been with, this was exactly the situation. While the pricing function was a necessity, it simply wasn’t the focal point. In fact, I would argue bad pricing practices and processes went largely unnoticed until the business climate changed. An economic slowdown, the entry of more competition or industry transformation leads customers to more options. Couple any or all of these with the customer becoming savvier in price negotiations, and bad pricing will stick out like a sore thumb. Some companies will learn to embrace pricing, but many will fall back and lean on what made them successful in the past.  Those that don’t embrace the pricing function quickly enough will face more difficult business conditions than they would have otherwise. For these companies, the old cliché of “you don’t know what you don’t know” applies. They are simply “stuck in the mud” during both good and bad times where in such environments the message of pricing doesn’t get the traction it needs.

Second, pricing is under-represented in role and priority within an organization. Put another way, where does pricing reside in an organization?  In my experience, more than half the time it sits with groups like product marketing, as opposed to a central pricing organization. There are good reasons for either approach, or even a hybrid, which I won’t get into here. The point is this:  When pricing entirely resides in a role like product marketing, it gets lost when competing for attention among the other 4Ps of marketing. Put yourself here for a moment. When you are balancing your workload to define the product, putting together the value messages and positioning, along with everything else, honestly, best-practice price setting and management take a back seat. Further, more often than not, the priority of pricing relating to attainment of revenue, profit, and share hasn’t even been defined. This inevitably leads to conflicting objectives among different groups. In this environment, trying to spread the pricing message gets quickly muted because of competing organization interests.        

Third and finally, efforts to deliver strong pricing results can go largely unnoticed. Even when things go favorably for pricing, the reason behind attaining the strong financial results can get murky.  I recall entering a situation where the business was actually losing money, and through lots of hard work on the price management side – and other efforts as well, to be fair – we turned the business around in a year by posting the best financial performance in the history of the business. However, here is where the fun begins. Finance tries to rationalize the high performance as product mix, constrained environment, costs and so forth. Sales take credit for managing prices high — if you can imagine that, especially after countless hours of re-adjusting their low price requests. Product marketing takes credit about placement strategy, revenue planning and so forth. However, anyone who understands McKinsey’s “Power of One” framework can tell you that the most profitable lever to pull is price. It’s actually all in the math, yet organizations and leaders rationalize away that it’s everything else. The take-away for those fortunate companies that have strong price performance is this: Don’t take pricing for granted.  Organizations may not fully understand what’s actually under the “pricing hood” making the wheel turn to attain these high-performing financial results. In this environment, the pricing message can get lost because it gets rationalized away.                        

In the end, there is an uplifting message to be had. Overcoming all of these “pricing hurdles” is possible.  It is not easy, but the journey is quite rewarding. I don’t have any transformational magic bullets for you, but I can say this: If you’re passionate about the pricing function and willing to be a champion for it inside your company, you can spread the word successfully.       

What are your thoughts on this matter – would you care to share?

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.

Yesterday, Google announced a rare miss to earnings:  Year-over-year, revenue grew ONLY 25% and profit a mere 7%.  Analysts cited pricing as one of the key reasons for the miss, as the average pay-per-click price decreased by 8% despite growing volume 34% from a year earlier. Does Google have a pricing problem?

If you look beyond analyst reports, the answer is not so simple. The trend in web advertising has shifted in the last year, with individuals clicking on ads from their mobile devices rather than their desktop computers.  Of note, mobile devices inherently drive lower price points than desktop clicks. Despite the lower average price, the growth in volume could not offset the decrease in revenue. This is a MIX challenge, not a pricing issue. 

Google may still command a premium price for both its desktop and mobile pay-per-clicks relative to alternatives. However, due to structural changes in how people use the web, the mix of price points is causing a revenue challenge. The larger question for Google is twofold:

1)      Are they able to maintain or grow their pricing power in each segment?

2)      Are they able to maintain or grow their market share in each segment?

If the answer to these two questions is yes, then it certainly is a mix issue and not a pricing issue. 

If you were in charge of pricing at Google, what actions would you take?

My barber recently left the salon he had worked at for the past 25 years and relocated.  I visited him earlier this week at his new location and he shared his journey and why he chose this particular spot.

I thought there were some interesting lessons to take from his experience and that I’d share them with you.

He checked out three different salons.

The first place he investigated was a good location but according to Antonio “was not well maintained …. there were chairs with rips in them …. my customers would not be happy in that place.”  I happened to walk by that place today and would agree with Antonio. Even if the price was cheaper, I would not like going to that place at all; it was rundown.

Then he described the next stop on his search, “….. a great location, but they charge $40 bucks for a haircut …. I told them that my customers wouldn’t go for that……they’ll pay $4-5 more, but not $40 for a haircut.  The owners said to me that was their price and they were sticking to it ….. they wear bow ties ….. I bet that’s to justify $40 bucks!” We had a good laugh and as a customer I agreed that $40 was a lot more than I was willing to pay.

That lead Antonio to his final destination located closeby in a Fairmont hotel. “Good location and the price is $4 more than what I was charging before …. $4-5 to my customers …. they don’t mind.”  And in my case he is right. I’ve been seeing Antonio for 12 years, I enjoy seeing him; it’s like a little break from the hubbub. We talk about restaurants and travel and our families, at Christmas he sneaks me a glass of wine. You get the idea, it’s personal.

Antonio’s story included wisdom as well as an example of a typical behavior that leads to missed opportunities when it comes to pricing.  I have summarized it into 3 lessons:

1. Antonio instinctively knew what wouldn’t work for his customers.  The first salon was in poor repair and “was not right for his customers” even if the price was cheaper.  He also knew that the high end location that charged 60% more was too much for his customers even though it was a fantastic location.

• Lesson:  A good value proposition consists of many components and price is only one of them.

2. The salon that charged $40 for a haircut stuck to its pricing strategy; they knew their value proposition and did not deviate.

• Lesson:  Segmentation is the name of the game. You need to know who your core customers are and stick with them. If they are Wall Street bankers then go ahead and charge $40, put on a bow tie and feel good about it.

3. He knew he could charge his customers $4-5 more and they “would not mind.”  Based on this insight Antonio missed a golden opportunity. He should have adjusted prices at the old salon 12 months earlier.

• Lesson: We are usually too risk averse when it comes to pricing, thus forgoing significant opportunities.

(Editor’s Note: Paul Hunt’s story originally appeared in the Financial Post, and we have received his permission to use the story on our blog: http://natpo.st/xgRJT9)

One of the biggest challenges for pricing professionals – especially those who work for technology companies – is the lack of control over a coherent pricing strategy.  At PROS, we see quite a few technology companies experiencing accelerated price erosion among their products, primarily due primarily to shorter product lifecycles, an ever-more sophisticated buyer, and overall economic uncertainty and volatility.

The lack of a clear and consistent pricing strategy is often demonstrated by the absence of proper pricing guidance to field sales. Without proper pricing guidance based on a pricing strategy, field sales people tend to request pricing based on customer demands, perceived competitive responses, intuition and emotion.  Without a disciplined price-setting strategy, companies can easily end up accepting too many price approvals via exception. The exception process then becomes an emotional internal struggle that ultimately results in very low pricing in the name of competitive matching. It’s a perfect storm that greatly increases the risk for an acceleration of price erosion due to inconsistent price approvals and confusion between the pricing team and field sales.

To help take back control of pricing, technology companies are finding ways of gaining better insight into list-price setting and automated methods to determine price-guidance targets for negotiated deals. Fortunately, pricing software can help create a consistent pricing framework based on objective measures. Companies can then use pricing software tools to establish logical, price-band ladders for a product group. This will slow the rate of price erosion and ultimately give organizations higher revenues, while protecting market share.

Here at PROS, we’ve developed a new white paper titled “Price Erosion Challenges for Technology Companies:  A Better Approach with Pricing Software.” It describes how companies can address the issue of accelerated price erosion through the adoption of software pricing tools.  We invite you to download it free at http://www.prospricing.com/Resources/White-Papers.aspx.