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Pricing is …

Pricing is … a KPI

tape measure

What KPI’s (Key Performance Indicators) do you track in your company? You are probably monitoring revenue, profit, certain expenses, and hopefully more. Do you use price as a KPI? If not, you should consider it.

Your marketing and development team created a product, built in value, and set a price to capture that value. Your sales department does their best to sell at that price. But what happens over time, as new competitors and technologies come into the market, the value our customers perceive relative to the alternative declines. They become willing to pay less.

If we are tracking our ASP (Average Selling Price) over time, we will likely see that it declines. When it declines too much, that is likely an indicator that market conditions have changed. Small decreases in ASP may be noise in the market or measurement, or they may be early indicators that the market is changing.

Another great use of price as a KPI, measure the average discount each salesperson uses. (You may want adjustments for volume, industry, segment or other factors.) This is an indicator of who is selling value and who is selling on price. Can you get one group to train the other? Better yet, publish the results internally. Salespeople are highly competitive and nobody wants to be on the bottom of that list. They will find a way to move their own ASPs up.

Other price metrics you may want to monitor include gross margin, pocket price (realized price after all discounts and considerations), level of variance in quotes, and more. Think hard enough about price and you’ll find that using pricing metrics can be a great measure of the health of your business.

Mark Stiving, Ph.D.

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Pricing is … the Nuclear Bomb of Business

Of all of the tools business people have, pricing is the most powerful and the most dangerous. It’s like having a nuclear bomb, especially in 3 areas.

First, pricing can be very destructive. When you lower your prices, that certainly hurts your competitors. When they retaliate, and they almost certainly will, that will hurt you as well. In the end, the most likely result is lower industry profits, including yours.

Second, you can’t un-explode a nuclear bomb.  Similarly, it is extremely difficult to raise prices again once a price war begins. Companies rarely want to unilaterally raise prices and risk giving up market share to their competitors. Coordinating price increases in an industry is challenging; and it’s illegal if done through direct communication.

Third, pricing can be considered a a deterrent. Your competitors are much less likely to lower prices if they believe you are going to follow suit and not let them easily take your market share. The real trick to this is to monitor and control your costs. You never want to be in the position where a competitor can price below your cost of doing business.

When it comes to doing battle with your competitors over market share, pricing should be the last weapon you pull out, if ever. Just like all nuclear equipped countries don’t use them aggressively, you too should avoid using your most powerful weapon aggressively. Feel free to chase market share with branding, marketing, sales, features, advertising … anything but pricing.

Mark Stiving, Ph.D.

Photo by The Official CTBTO Photostream

Pricing is … a Magnifying Glass

Magnifying glassManagers who understand pricing well have a unique view into the health of their company. Here are several examples.

How well do our marketers use Value Based Pricing when setting the initial prices? When we do this well, we truly understand our market. We know what our competition offers and at what price. We know how our customers make their purchase decisions. If we expect our product development teams to build the best products, they must have and utilize this information.

How do our realized prices compare with our competition? If we are lower priced, it’s an indicator that our product development team didn’t build enough value into the product. Earning prices higher than our competition show we intentionally build differentiated products that our customers value.

Can we explain our price dispersion? We want to charge different customers different prices based on their willingness to pay, so price dispersion is good. However, it shouldn’t be random. When we can explain which customers get the best prices (or the highest prices) we show we understand our customers decision processes which will help in future product development decisions.

Are we watching ASP (Average Selling Price) on a product by product basis? Declining ASPs are an indicator that something in the market is changing. New competitors may be entering. Competitors may be lowering their prices. Customers may be changing their preferences. Monitoring ASPs creates an early warning into market dynamics.

Do we monitor our pocket price? This is the price we realize after taking into account all of the costs to serve a customer (e.g. shipping, early payment discounts, damage reserves). Careful scrutiny on pocket price keeps our profitability high.  Decreasing pocket price, especially if ASP is not decreasing, is a strong indicator that we are giving too much away in the sales process.

How well do our salespeople achieve the target prices? The salespeople who sell at higher ASPs for the same product are the ones who are selling value. They are communicating our features and benefits to our customers. The ones who sell at lower ASPs may be relying too much on price. They need to be trained.

As you can see, understanding and monitoring pricing provides a powerful lens into many aspects of your company. What are you watching?


Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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Pricing is … Risky

If you’re a regular reader you know that pricing is by far the most powerful of the marketing mix variables.  For a company that yields profits of 10% of their revenue, a 1% increase in pricing can potentially increase their profits by 10%.  That’s powerful.  So then why is pricing so poorly understood and vastly underutilized?

Because pricing is risky.  There are three big risks when changing prices.

1.  Price increases result in reduced revenue.  If you increase prices, your customers may not purchase from you any more and instead they will purchase from your competitors.  This is why you want to carefully increase prices where you are sure you can still win.  You do this by determining which customers highly value your products and finding ways to increase prices to them.  You do this by only increasing prices on new customers.  You do this by determining which products have the most value over your competition and making sure you are charging for that value.  There are no easy answers, but there are answers.

2.  Price decreases are met by competitors which just lowers industry profits.  If you attempt to lower price to gain market share from your competitors, it is very likely your competitors will respond by lowering their price to keep their own share.  You have essentially lowered the profit for the entire industry.  To avoid this you carefully lower prices for a few select reasons like meeting competition or to make room for a next generation product.  Using price to chase market share is almost always a bad decision.

3.  Price decreases have an instantaneous and almost irreversible effect.  The great thing about price decreases is they can change customers minds today.  Other marketing mix variables take months to move customers.  But remember, customers hate price increases.  Once you lower a price, you may get that quick bounce in revenue, but your customers will expect that lower price forever.  This means even testing the effects of lower prices may be irreversible.

The reason pricing is underutilized is it is risky.  Remember how a 1% improvement in price can increase profits by 10%?  Well, the same 1% can decrease profits by that much or more.  Is it worth the risk?

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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Pricing is … Dependent

Of course it is.  The question is “dependent on what?”  The answer is the 5 C’s.  Costs, Customers, Competitors, Corporate Strategy, and Constraints.

Let’s start with what most pricing texts call the 3 C’s.

Costs – We have written many times on how costs should influence pricing.  Fixed costs have no effect. Variable costs have a direct effect when using TIOLI (take it or leave it) pricing and influence your price floor for negotiated pricing.

Customers – Can we ever say enough?  Value based pricing is all about charging what our customers are willing to pay (WTP).  They are the ones that decide how much they are willing to pay.  Our pricing ability is completely dependent on their WTP.

Competitors – We wish we didn’t have them, but our pricing is dependent on the product offerings of our competition.  If they offer identical products at very low prices, we won’t be able to win much business at high prices without doing something unique.

These 3 C’s are covered in detail in most pricing texts.  The next two C’s are “new” but are added because pricing is dependent on them and pricing professionals have no real influence on them.

Corporate Strategy – The CEO gets to set the corporate strategy.  Pricing must follow.  If the CEO is after increased ASP, pricing has a big role.  If the corporate strategy is market share, pricing has a different (and dangerous) role to play.

Constraints – Market constraints influence pricing.  Try buying a ticket to a sold out concert.  Airlines and hotels use yield management to price higher when it looks like they will sell out.  They price lower when demand looks very low.  When factories reach their capacity, pricing can influence that the company sells more of the most profitable products.  Constraints in the marketplace offer opportunities for intelligent and strategic pricing.

So yes, pricing is dependent … on the 5 C’s.  The better you understand these 5 C’s the more effective and profitable your pricing will be.

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Photo by IronRodArt – Royce Bair (“Star Shooter”)

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Pricing is … Specific

(12/8/12  I just noticed I posted this blog a second time.  It was first posted in October.  I owe you one.  I’ll post two this weekend.)

One of the best things about studying pricing is no two situations are the same. Of course there are big differences, like hardware vs. software or B2B vs. B2C. But differences exist in almost any two pricing situations. Apple must think differently when pricing an iPad vs. an iPhone vs. an iPod. Samsung must think different than Apple when pricing Android phones.

This is important to you because it tells you that you will not read the perfect solution to your pricing problem in a book. You won’t hear it in a speech. The best you can do is learn the fundamentals. See how other people applied the fundamentals to their different pricing situations and determine if this can apply to you.

Even though pricing is specific to your situation, these fundamental pricing concepts are universal and apply to almost every product. These fundamentals are Value, Segmentation, Portfolio Pricing, and Pricing Dynamics. Much more on each of these concepts can be found throughout the blog history.

Value – Know how your customers value your products and you’ll know how much to charge. Use Value Based Pricing.

Segmentation – Different customers are willing to pay different amounts. Find ways to charge them close to what they’re willing to pay.

Portfolio – When you have more than one related product you have an opportunity to enhance your profits through smart pricing. Be aware of the nuances of pricing substitutes and complements.

Dynamics – Markets change, prices must change too. Know what to expect and how to minimize any damage to your profitability.

If you understand these four fundamental concepts and apply them to your company, you will be more clear and confident about pricing in your specific situation. If not, consider contacting a pricing expert.

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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Pricing is … Ubiquitous (?)

Everything has a price.

Supposedly, Winston Churchill had the following conversation.

Churchill: “Madam, would you sleep with me for five million pounds?”

Socialite: “My goodness, Mr. Churchill… Well, I suppose… we would have to discuss terms, of course… “

Churchill: “Would you sleep with me for five pounds?”

Socialite: “Mr. Churchill, what kind of woman do you think I am?!”

Churchill: “Madam, we’ve already established that. Now we are haggling about the price”

Although this is a fun story, it has a point. Everything really does have a price.

A long time ago people bartered. They traded a filet mignon for a fine bottle of wine. (OK, maybe the details are a little off). How many bottles of wine is a filet worth? It was different for each transaction, very inefficient and definitely unpredictable.

Then someone invented money (probably the guy with the printing press). This made it much easier to trade filet’s today for wine tomorrow. You could even throw wheels or hut-cleaning into the transactional mix because money gave everything relative values.

Finally we get to Kent Monroe, who invented pricing. The art and science of understanding how much a customer is willing to pay and trying to get as much of that as possible.

Come to think of it, pricing isn’t that ubiquitous. Prices are. Pricing is still a new and growing field. It is extremely underutilized in most companies today.

But let’s look at the half full glass. Because everything has a price, pricing has the potential to become … ubiquitous.

Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

Photo by Paul Watson

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Pricing is … Unintuitive

The other night a colleague from Ireland told me this story about his father. 

Jack managed a small grocery store in Ireland many years ago.  In Ireland, Strawberries and Cream were a popular dish, so Jack would buy strawberries for a Shilling and sell them for 2 Shillings.  (The numbers are made up, but go with the point.)  However, the store was closed on Sundays, so any strawberries that were not sold by Saturday night were thrown out.  And that is what they did.

Then Jack got a new boss.

When the new boss heard of the practice of throwing away unsold strawberries he told Jack to lower the price of strawberries on Saturday afternoon to a shilling.  Jack protested, “we can’t make any money selling them for a shilling, that’s what we bought them for.”  But he did what the new boss ordered.  They sold all of their strawberries by the time the store closed on Saturday, but many of them only at their cost.

As my friend tells the story about his own father, “It wasn’t until Sunday afternoon that he suddenly realized how brilliant this was.”

What makes this brilliant?  Two things:

First, purchasing the strawberries was a sunk cost.  Once the store owned the strawberries, they would either sell them or throw them away.  It is better to sell them at cost, or even below cost, than to trash them.  The choice is some revenue or none.  Pretty obvious when you look at it that way.  Sunk costs (dollars already spent) are never relevant to pricing decisions.

Second, customers who bought the strawberries (at cost) also bought cream.  The store made plenty of money on cream.  Notice that this is an example of pricing a product portfolio with complements.  Pricing aggressively on one product, strawberries, influences the sale of complementary products, cream, at better margins.

If you are a regular reader of this blog, then you probably immediately saw these two points in Jack’s story.  For you experienced pricers, here is your lesson from this story.  Those around you who don’t study pricing probably didn’t get these two points until after they were explained.  The world is full of Jacks.  Not stupid, just not aware of the nuances of pricing.  We are always teaching.

Mark Stiving, Ph.D. – Pricing expert, Speaker, Author

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Pricing is … Externally Focused

At first glance, this seems obvious.  Charge what customers are willing to pay.  Customers are external, so pricing is … external.

So why don’t more companies behave this way?

Cost plus is an example of internally focused pricing.  Most companies still use versions of cost plus pricing.  Determine the cost of building a product, add a markup, and that’s the price.  Nothing external about this.

How about finance requirements to raise prices to achieve higher gross margins?  If implemented across the board, this is obviously an internally focused pricing exercise.  What if, instead, the company implements price hikes only on products that can justify them.  Then I have a very important question … Why didn’t the pricing team do that before?  If customers are willing to pay more, then we should have been charging them more.

For pricing to be done right, it has to be focused externally.  Always start with the question, “How much are my customers willing to pay?”

Mark Stiving, Ph.D. -Pricing Expert

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Pricing is … Information

A price is the amount of money someone has to give up to acquire a product or service.  Duh.  Everyone knows this. But what seems to be irrational is that customers also use price to infer characteristics of the offering.

We expect customers to analyze the quantity and quality and then decide if it is worth the price.  However, many of our customers use price to help them determine the quality.  This seems wrong.

We’ve seen that pricing can be a signal of quality.  When people see higher prices, they infer higher quality.  Does this make sense?  Yes.  Shoppers have probably not thought about this logically, but they have experienced unlimited examples of where they could get more quality if they were willing to pay more.  It’s all around them, so they subconsciously learn that higher prices mean higher quality.

If they wanted to justify their behavior, they would probably think something like this when looking at a higher priced product: “The manufacturer (or the retailer) knows this one is better so they priced it higher.  Besides, many other people who know more than I do have done the analysis and think this one is worth more.  Otherwise nobody would buy it and the company would lower the price.” And most of the time they would be right.  Higher quality products have higher prices.

Customers have subconsciously learned other meanings from observed prices.  Prices that end in 99 are considered to be good deals because sale prices are usually priced with 99 endings.  Prices that end in 00 are considered higher quality.  The lowest and highest prices seen by the shopper bracket the quality levels under consideration.  The higher the high price point, the more the customer will expect to pay.

But in every case, this only applies for non-expert customers.  The shoppers who are looking for clues, don’t want to become an expert in the field.  True experts know the real value and use price for the purpose it was intended, what they have to give up to acquire the product.

As you can see, price is more than just what the customer needs to buy your product or service.  It is also telling the customer more about your offering.  Take care that your prices are telling them what you want.

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Mark Stiving, Ph.D. – Pricing Expert, Speaker, Author

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