In 2020 develop a portfolio of pricing actions
By Steven Forth
Most of us understand the power of pricing to shape markets and categories. We understand that all things being equal, a price increase will have a bigger impact on gross profit than any other action you can take (see as one of many examples this piece by McKinsey). Pricing is where all the different aspects of marketing come together. Your customer probably does not care what segment you think they are in, they may or may not believe your value propositions, but if you can’t agree on a price then you don’t have a customer.
That said, many B2B companies agonize before making a decision about pricing. They dither and worry, go back and forth on what to do, and often end up not making a decision or making a random action.
Why do B2B companies struggle with pricing decisions? We think there are three reasons.
People do not calculate the impact of a price change on volume, revenues and profits.
Companies lack a process for making pricing decisions.
Pricing is treated as a one time decision, rather than as a portfolio of possible actions.
The impact of a price change
This seems basic. “If I change the price, what will happen to volume, revenue and gross profit?” It is a simple question and it is easy to explore a range of answers. Few people bother to do this though, and it leads them to be too cautious about making price changes. Let’s look at a simple example, using the Ibbaka pricing calculator.
Assume a price of $100 per unit, variable costs of $50 per unit, fixed costs of $5 million and initial volume of 1,000,000. If you increase price by 5% to $105, how much volume can you afford to lose and keep revenue or net profit at the same level? This is one of the foundational pricing questions that everyone involved in sales, marketing and pricing should be able to answer. To save you some time with a spreadsheet, here is the answer.
One can afford to lose 9% of volume and keep profit constant or 5% of volume and keep revenue constant. Let’s assume that we do lose 5% of volume, what will this do to profit? Even with the loss in volume, profit is up more than $2.3 million. One would have to think very carefully before turning down $2.3 million plus in profit.
(Interested in trying out the Ibbaka Pricing Calculator? Contact us at info@ibbaka.com).
Develop a process for pricing actions
The failure of many companies to assess the impact of a price change is part of a larger problem, the lack of a process to make price changes, or rather, to take pricing actions.
Why ‘pricing action’ rather than simply ‘price change’? Price is closely tied to value, or more specifically, to differentiation value. Anything that happens to change your differentiation value should lead you to consider a pricing action.
What is ‘differentiation value’? Basically, it is the economic, emotional or community value that you provide that the alternative does not. The alternative may be a direct competitor, an inhouse developed alternative, or doing nothing! The value that you provide that can also be realized from an alternative is the commoditized value. The price of the commoditized part of your offer is set by the market. The final price is a combination of the commoditized market-based component and the price you claim for your differentiation value.
Pricing actions are more than just price changes. They are anything you do to align value and price with your overall strategy. Pricing actions are changes to
the list price
what is included for the price (change packaging)
the tier architecture and pricing (a specific approach to changing packaging)
the pricing metric (the unit of consumption on which pricing is based)
discounting policies
One can also impact the value-price connection through better marketing. This includes a market segmentation that is based on differences between how different prospects understand value, value propositions that are aligned with these value-based segments and better evidence for the value propositions. Although not pricing actions per se, these should be considered together with any potential pricing action.
How does one know when to consider a pricing action? There are internal and external triggers for action.
Internal triggers for pricing actions
Differentiation value has been enhanced (normally by adding new functionality, services or data)
Market segmentation suggests the need for new or different packages
Company strategy has changed and pricing needs to be aligned with the new strategy
Pricing has not been reviewed or adjusted for more than a year and is no longer in alignment with value or strategy
Discounting is out of control (more than 30-to-50% or inconsistent as shown by pricing dispersions - graphs that map price to the pricing metric)
Competitor triggers for pricing actions
Competitors have added new capabilities that increase their differentiation value (the red area in the above Venn diagram) or reduce your differentiation value (the blue area in the above Venn diagram)
Competitors have changed prices in a way that changes their positioning and either threatens your own positioning or opens up new opportunities for you
Customer triggers for pricing actions
Customers change their business model or add new business models that change their perception of value (this can change both pricing and segmentation)
Customer economics change in ways that change their perception of value (it is worth extending this to your customers’ customers)
In heavily regulated industries, like healthcare or utilities, one also has to consider changes in the regulatory environment which can force pricing changes.
A simple pricing process
One can put all of this together into a simple pricing process.
Check alignment between pricing goals and corporate strategy
Build a value-based market segmentation
Choose target segments that will guide your pricing
Design packages for target segments
Map value metrics to pricing metrics
Choose pricing metrics
Design the pricing model
Set prices
Define the data model that will help you track pricing and value
Set up a discount management system
Track pricing performance (the impact of price on other key business metrics)
Have a review system (monthly or quarterly) that identifies internal, competitor, customer and regulatory triggers for pricing actions
Develop a portfolio of potential pricing actions (see next section)
Take pricing actions regularly and systematically (and measure the outcomes)
Manage pricing actions as a portfolio
Pricing is not a once and done thing. Nor is it a single point action. Pricing actions are part of a system, so to manage pricing effectively you need options. At the same time, pricing is such a critical activity that you generally don’t want to be taking multiple pricing actions in parallel. There are too many unintended consequences that you need to watch for and taking multiple actions at the same time will make it much harder to anticipate and respond to these.
Preparing a pricing action can take time, as the different stakeholders are consulted, systems such as the CRM (customer relationship management system) or billing and financial systems are configured and the financial and legal ramifications worked out. Some pricing actions can be planned and executed on in a manner of weeks, especially if a good process is already in place, others may need months or even years of preparation.
One may also want to research pricing actions that you will hold in reserve, to be prepared to act rapidly in case a certain scenario is realized.
The only way to manage this effectively is to think of your pricing actions as a portfolio, a set of past, present, future and potential actions that are all being worked on. Basically, you should always be
Tracking past pricing actions to see what impact they are having and if they achieved and are still achieving their goals
Taking a current action by
preparing the company, customers and the market for the action
executing
providing immediate back up to marketing, sales and customers
making any immediate course corrections
Planning future actions at different time horizons (next month, next quarter, next year, future years)
updating market segmentations
revising value propositions for each segment
developing evidence
modeling possible outcomes
preparing the company, customers and the market for the action (note how this segues into taking a pricing action)
Developing options for future pricing actions (there is not commitment to taking these actions, but developing options is critical to having a resilient company)
developing data models for value and pricing and collecting the data
discussing value metrics with customers
developing alternate pricing models, levels, discounting strategies
identifying triggers that would suggest when to move to planning
All this may sound like a lot of work. For 2020 we suggest a simple way to get started.
Test goal alignment
Review all your pricing through the lens of your offer pipeline, your customer needs, your competitors possible actions
Develop a modest portfolio of thee-to-five potential pricing actions
Pick on pricing action and begin to execute (you should always be executing on one pricing action)
We hope 2020 will be a great year for your business!
