What gets measured gets managed - How to measure your pricing
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
“What gets measured gets managed.”
One hears this almost everyday in business. The quote is often attributed to Peter Drucker, though this appears to be apocryphal, and it is the source of much debate in the management literature, for and against. But there is some truth to it. I can see this in my own behaviors. Like many cyclists, I chart my rides and can tell you how far and where I rode on any day over the past decade (longer than that actually). Because I track my riding, I ride farther and am always looking for that little bit extra to improve on my performance.
So how should we be measuring our pricing?
Ed Arnold, who combines expertise in product leadership, value management and pricing, has a good framework for thinking through this. He calls it the Value Waterfall. Leveraging the classic pocket price waterfall, introduced by Michael Marn, Eric Roegner and Craig Zawada (see our interview with Craig), Ed paddles back from pricing to value.
You can read more about this in Ed’s post Paddling Up the Value Waterfall.
Ideally, you should have a plan to measure all six of these steps. That is ambitious though, so start with the foundation, Value to Customer or V2C. This is the actual value delivered to a specific customer over time. As suggested by the value waterfall, this needs to be higher than the price paid by the customer over time. Note that the price paid by the customer over time is the Lifetime Value of the Customer or LTV.
V2C > LTV
V2C and LTV anchor how you measure your pricing. Your goal is to understand how value and price impact these two uber measures over time.
LTV will depend on your average selling price and your churn. You have to be concerned with how price changes impact both of these numbers.
As subscriptions move through the economy, and more and more offers are converted to some form of subscription model, there is a trend to separate thinking about the Initial Price and the Renewal Price. Magazines have known this for a long time, but awareness of the importance of thinking about this for all subscription business is just beginning to sink in. This is something that Ibbaka will be doing more work on in 2021.
"Understanding the impact of pricing on LTV requires clear thinking about the initial price and the renewal price. Measure the impact of these two price components on LTV.
The Sales Price Index
Dick Braun is one of the leading pricing practitioners, and has long led the pricing function at Parker Hannifin, the global leader in motion and control technologies.
His pricing teams are distributed around the globe and embedded in the business. Every quarter they are required to report on the Sales Price Index. This is the impact that price changes had on revenue on a quarter to quarter basis.
Dick’s team calculate the Sales Price Index as follows:
(Average Price This Period – Average Price Last Period ) x Volume for This Period
If prices have gone down for the period you are measuring, because of price cuts or discounting, then the SPI will be negative. This may be the right thing to have happened. There may have been a change in strategy or the competitive situation. But you should know this number and be able to explain it. If there is a long term negative trend, well, that is something you will have to do something about.
Price Dispersion or Is your pricing model how you actually price?
Most companies have some form of pricing model. Pricing is not customized for each deal. Unless you are a purely self serve model, where price is set in advance and there is no negotiation, then there is probably some variation in how the model is applied. There may be discounts. Sometimes there is a fudge factor that the salesperson can apply. In most of Ibbaka’s pricing calculators we allow for discounts at several levels.
The above graph is a typical price dispersion. In this case, the R squared curve is where volume predicts 70% of the actual price. There are two clusters paying higher prices (in green) and a large cluster paying lower prices (in red). As with the sales price index, there can be good reasons for this variation. The lower priced customers could represent a segment that does not get as much differentiated value. The customers paying a higher price might be a potential high value segment, that can be given additional high-value added functionality. Or … there could be a lack of pricing discipline. Whatever the reasons, you need to understand them.
(At Parker Hannifin, Dick’s team rever to this as Segmented Price Variance Analysis or SePVA.)
Summary - the three key pricing measures
If you are just getting started with pricing measurement, what are the three key things to measure, and track over time?
Measure value delivered
This may be difficult. And at first your measurement may be not much more than a SWAG (Scientific Wild Assed Guess). But by beginning to do this you put your focus where it matters, on creating value for customers. Good pricing begins here.
Track price dispersion
Is your pricing model being used or is there a lot of noise in the system, from discounting or arbitrary and undisciplined pricing? Is the price dispersion showing you potential segments?
Know how price is impacting revenue
Price may be the most powerful tool for increasing revenue and profit. But that means it is also one of the ways you can reduce revenues and erode profit. Know how price is impacting revenue and track this number over time.
Measuring pricing is important, and it is a critical input into your pricing strategy, but it is not the pricing strategy.
To jump start your 2021 pricing strategy check out How to plan your 2021 pricing strategy.
We have also provided you with a template you can use to apply the strategic choice cascade to pricing choices.
You can download the Strategic Choice Cascade for Pricing template here
Ibbaka is providing these downloadable tools under a Creative Commons license.
Attribution-NonCommercial 4.0 International (CC BY-NC 4.0)
Looking for tips for enterprise software pricing strategies?
See our related posts
How to use indexed pricing as the economy recovers from the pandemic
How to price your learning resources
When to price predictive analytics
How to hire a pricing consultant
Pricing professional services is a challenge for SaaS companies