The design of pricing projects
Over the past few years a set of best practices has evolved in the design of pricing projects. These best practices have emerged from more general approaches to the design of adaptive, data-centric systems and the specific needs of pricing, packaging, revenue generation and monetization.
Ibbaka applies these best practices to the design of pricing optimization work.
Many large, data-centric solutions have been developed and with the explosive growth of big data and AI many more are coming. Alex ‘Sandy’ Pentland from the MIT Connection Science Research Initiative summarized the components of a well designed data-centric initiative in the conclusion to the important book Building the New Economy: Data as Capital, by Alex Pentland, Alexander Lipton and Thomas Hardjono (the book also covers important topics in the economic properties of data as an asset, healthcare, and distributed ledger technologies and their applications for Virtual Asset Service Providers).
Five components of a successful data-centric solution and their application to pricing
Pentland identifies five components of a successful data-centric application.
Specification of Performance Goals
Measurement and Evaluation Criteria
Testing
Adaptive System Design
Continuous Auditing
Let’s go through each of these and see how they apply to pricing work.
Specification of Performance Goals
Pricing can be used for many different purposes and the pricing lever can be pulled to improve different metrics. But it cannot be used for everything at once. One needs to make choices. At Ibbaka, we have adapted Roger Martin’s Strategic Choice Cascade (also known as ‘Playing to Win Choices) and applied it to pricing.
The most common pricing goals can be put in three buckets:
Category Goals
Profit and Loss Statement Goals
Unit Economic Goals (these are especially important for SaaS companies)
Measurement and Evaluation Criteria
Once you have goal alignment it is important to agree on how to measure progress towards the goals. There are four aspects to this.
Define the metrics or KPIs that are to be impacted
Understand the baseline - look at existing data and determine the baseline and trend for each of the key metrics
Automate data gathering - define and as far as possible automate the process by which the metrics will be generated
Develop the causal model - ‘success has many parents, failure has none,’ create simple causal diagrams that show the assumed impact of pricing and other interventions on the outcomes (this is an advanced practice, but one that will become more important as we move to outcomes based pricing, see ML beyond Curve Fitting: An Intro to Causal Inference and do-Calculus)
Testing
Early on one needs to get out into the field and test assumptions. This can be done in different ways but they all begin in the same place, talking to customers.
Interview customers to understand how they perceive value. Use a structured interview process so that results can be coded and compared. Cover all three aspects of value: economic, emotional, community.
Interviews alone are not always enough. Use them to
Inform a preliminary value model and then use that odel to analyses existing customer and usage data
Structure a market survey
The market survey can be a value survey or you can go further and invest in a Conjoint study that will help you to understand the part worth of each function or value path and even to estimate customer willingness to pay (WTP).
Market testing is not a one time thing, it needs to be built into a continuous auditing process (see below).
Adaptive System Design
Pricing is about a lot more than picking a number and putting it on a price tag. A good pricing design is an adaptive system.
It is a system because the pricing model has multiple interacting parts and is connected to packaging and bundling, which are a system in their own right.
The organizing principle of this system is value, in its economic, emotional and community aspects. Economic value is captured in a value model, a simple system of equations estimating how economic value is created for a specific customer or segment.
It is adaptive because pricing needs to adapt to changing market dynamics, customer needs, competitor actions and the economic environment.
At Ibbaka we believe a good pricing design has five characteristics.
Connects to value
Is scalable (can cover the full range of customer sizes)
Observable (can be tested an audited)
Fair (treats similar customers in the same way and is not subject to arbitrary discounting)
Extensible (new functionality and modules can be added)
Continuous Auditing
Pricing is not once and done, and the impacts of any pricing action unfold over time. Pricing needs to be monitored and adjusted regularly.
How regularly?
It takes three time cycles to begin to define a trend. At least one cycle to act on the trend. And then another three cycles (at least) to see the impact play out. So if you review your pricing every year you are going to be on an OODA loop (Observe Orient Decide Act) of seven years. In today’s volatile environment this is a losing approach.
To some extent, one can map the pricing cycle to the sales cycle. The faster your sales cycle the faster your pricing audits need to work. If you measure your sales cycle in months, then audit pricing every month. If you measure in weeks then use weeks to set the rhythm (as there are fifty two weeks in the year and each action takes seven cycles you will be able to have seven pricing action cycles a year). Some companies have a sales cycle measured in days, and with certain eCommerce applications the cycles could be in hours or even minutes. Automated trading systems work in milliseconds.
One goal of a pricing project should be to build internal capability
The best performing SaaS companies have a distributed understanding of how value is created for customers and how a fair part of that value gets captured in price. Pricing is too important to leave to experts, whether these be external experts like the Ibbaka team or pricing internal experts. This does not mean you should not work with Ibbaka or hire pricing experts, but your pricing efforts will only be successful if there is an understanding of value and pricing across the organization. Pricing and value touch every part of the customer journey. Everyone who contributes to successful customer journeys needs to be involved. The design of the pricing project should support transfer of this capability to everyone concerned.