Is your pricing a frozen accident?
By Steven Forth
Many of us are lazy when it comes to setting prices. We take a look at what our closest competitors are doing, and price using the same basic pricing metric at about the same level. This is pricing on cruise control. It is not strategic, does not establish your position in the market and locks one into an industry structure that may not be in anyone's best interests. If enough people in an industry do this, one gets what is called, in evolutionary terms, a frozen accident.
A frozen accident is and idea from evolutionary theory. It was proposed by Francis Crick (of double helix fame) and basically states that the genetic code is an "accident" because it was not designed for optimality; there may never even have been a competing alternative. It simply provided a functional system for self-replication, and wound up being used. Sounds like a lot of pricing models.
These frozen accidents exist at the level of specific products and for entire industries.
To test if the pricing of your product or service is a frozen accident, ask the following questions.
How did we choose our pricing metric?
If no one can answer this question, or the answer is 'that is how things are priced in our industry, chances are your pricing is a frozen accident.
How does the pricing metric track the value our customers receive?
If this draws blank stares, or a shrug and the comment "we don't really know how our customers get value" then it is even more likely you are dealing with a frozen accident.
Can we change our pricing metric?
If the answer is 'no, this is the way everyone prices' then you probably have an opportunity to disrupt pricing.
Why would you want to disrupt pricing?
In most industries, the value chain is structured so that profit pools in one part of the value chain. It is rare to see an even distribution across the whole value chain. In the Apple value chain almost all the profit flows to Apple. It does not go to Foxconn who manufactures the phones, or to the many parts makers, and certainly not to the many development shops building and publishing apps. The same used to be true of the old Wintel duoply (the combination of Microsoft and Intel) that in the 1980s and 1990s absorbed almost 90% of the PC industry's profits. Pricing metric fossilization is one of the ways in which the profit distribution in the value chain gets locked in. If you are one of the companies where profit is pooling, then you will do everything you can to maintain this system. If you are not, then there are some advantages to disrupting pricing. The best way to do this is to find a pricing metric that better tracks customer value.
Why disrupting pricing is advantageous: a case study
One way to understand the shift from in-house servers to Amazon Web Services is as a shift in the pricing model. It is worth studying the AWS pricing page to see just how close they get to connecting the value metric to the pricing metric.
Amazon did not like the way it had to buy servers and could see just how much of its profit was being sucked out by the big server vendors. It changed the game, first for its own purposes, and then for the rest of us. This has made a big contribution to the current explosion, first in Software as a Service and now in the Internet of Things and increasingly in all forms of product and services.
This brings to mind another piece of evolutionary theory, punctuated equilibrium. Closely associated with the late Stephen Jay Gould, punctuated equilibrium suggests that evolution goes through periods of explosive speciation and variation, followed by major die offs and the emergence of standard forms, which can remain stable for long periods (equilibrium), followed by another phase of divergence and speciation (the punctuation).
Of course, the truth is likely somewhere between the gradual and punctuated models. Evolution, whether of biological species or business models, probably looks more like episodic evolution.
We can see this happening today in many industries. One of the catalysts for this is pricing innovation. (We will write another time on what is enabling this golden age of pricing innovation.) Pricing innovation can break open value chains and redistribute profits, shaking assumptions about business as usual and thawing frozen accidents to allow new forms to emerge.
So if you answer the three above questions and conclude that your pricing is a frozen accident, don't accept your fate. Companies that do so are likely on the path to extinction. Instead, look for the innovations that will allow you to innovate on your pricing and unlock the value chain.
