Value-Based Pricing’s Senior Statesman Tom Nagle on the Skills Needed for Pricing Expertise
By Steven Forth
Tom Nagle is the source of many of the ideas and frameworks used in pricing strategy. His book (with many co-authors over the years) The Strategy and Tactics of Pricing is now in its Sixth Edition and remains the foundational text for pricing experts. I keep a copy on my kitchen table and another beside me in my office. We even have a reading group for people who want to work through the new edition together. So as we plunged deeper into our research into the skills required for pricing expertise we wanted to speak with Tom.
This interview is part of the joint Ibbaka and TeamFit research project on skills for pricing excellence. The results of this research will be presented at the Professional Pricing Society Spring Workshops and Conference in Chicago May 1 through 4. We have also interviewed Chris Herbert of SV Pricing (the top recruiting firm for pricing experts) and Tim Smith of Wiglaf Pricing. To widen our perspective, we also spoke with top sales coach Reg Nordman of Rocket Builders.
Ibbaka: What skills do pricing experts need today?
Tom: I would like to start by answering your other question about the barriers to companies adopting effective pricing strategies. One needs to understand this before talking about skills. I am going to talk mostly about B2B as that is where a lot of my experience is, but we need to learn from all of the different industries and business models.
Most companies have a short-term view of pricing. They evaluate deals as “one-offs” against profit hurdles and manage discounts based upon authority levels to make “price exceptions”. This is a short-sighted approach. One needs to take a holistic approach when pricing and realize that each deal impacts all the others. There may be a few exceptions to this, like highly customized services where every customer is buying something unique, but in most businesses each deal will impact others in the future. This is truer today than ever before, as information gets more and more transparent and you can assume that your customers will know the prices you gave to other companies. Each deal is part of your go-to-market strategy for a market segment. You can try to position the deal as an ‘exception’ or as a ‘one-off deal’ but your customers will see through this. The pricing risk to other deals should be part of how each deal is assessed. Instead of policies that focus on who can make exceptions, they need to develop policies for discounting that is transparent and based upon trade-offs between price and the variation in the product or service the customer will receive (e.g., terms) or what they will do for the seller (e.g., purchase volume commitment).
Most companies have a short term view of pricing
Another thing that companies need to do is to track win/loss performance. It is surprizing how few companies do this. They often have data on their wins, but there is a lot to be learned from losses. Companies sometimes justify discounts by saying that ‘we discounted and won this deal’ when in fact they lost other deals with the same discount. You judge the success of your policies and their profitability, as well as anticipate turns in a market, by watching your win/loss ratio.
Another problem is that most companies do not manage profit. Understanding costs is important to pricing. Most companies do this very poorly and do not really understand their costs at a granular level and how these interact. Sales and marketing are seen as being responsible only for revenues. Some combination of human resources and the supply chain is responsible for managing variable cost per unit. Operations is responsible for capital costs and utilization. By assigning responsibility for these three elements of profit to different functions, top management assumes they are managing profit because they are managing revenue, variable costs, and fixed costs. After all, revenue less the variable costs and fixed costs equals profit, right?
The problem with this is the interactions between the three. Sales and marketing are making decisions that impact costs but are measured only on managing revenue. At the same time, operations is often making decisions that impact the attractiveness of the offer, its positive differentiation value, without understanding how this will effect price. It takes a lot of data and work to connect all of these together and these connections are not part of typical accounting systems. They are key, however, to building price structures and policies that maximize a firm’s profit realization.
One has to be able to answer the question ‘What impact will changes and variations have on the costs?’ In most cases, sales and marketing cannot answer this question and so do not have the information or incentives they need to optimize profit when making pricing decisions.
Finally, I am often asked, ‘Should we set our prices higher or lower?’ Before you answer this question, you have to know who you are selling to?’ ‘How are they getting value?’ ‘How do they perceive value?’ In other words, you have to segment your customer based on value before you can set value-based prices. This is a new concept for many people. Pricing experts have to have a deep understanding of the different value drivers and how they work across different markets. Understanding value and value drivers are central to pricing.
Ibbaka: Once you get people thinking more strategically about pricing, what skills do they need to execute?
Tom: One of the missing skills sets is management accounting, which is usually different from the arbitrary “cost accounting” that companies use to value inventories for tax purposes. People in pricing should be able to do at least rough calculations of costs and how they interact. This is an essential skill to know what trade offs you are making and how they will effect profitability. When costs all get dumped into overhead one cannot see the real consequences of price changes.
Another key skill set is identifying the appropriate market research technique for what you need to understand about the impact of your product or serve on value for the customer. Before investing in marketing research, the pricing expert needs to do qualitative research into how the customer gets value and what the customer values.
Some common techniques, like Van Westendorp, are basically useless. Others, like conjoint, can help you understand the relative value of specific features for a segment, but are useless to understanding overall market price elasticity. That usually requires some sort of real market test.
Ibbaka: Are there skills that are becoming more important?
Tom: In industries where there are a lot of transactions, we have new ways to analyze data. A company that can see market changes before competitors do can gain a huge competitive advantage. In the beer industry, Anheuser Busch was the master of this. Wal-Mart was the leader in retail. Now Amazon appears to have the lead. The best companies use data to understand the sales cycle and so are better able to manage inventories so they can avoid either too little or too much inventory to meet demand—either of which cost profit.
A company that can see market changes before competitors do can gain a huge competitive advantage
Ibbaka: Are the lessons from retail being applied to B2B?
Tom: This is happening, but slower than one would have expected. One place it is happening is elevators. For example, Otis has put really good diagnostics into its elevators. It is able to service them before they breakdown. This means Otis has a much higher likelihood of retaining the contract to service its elevators. Because it is confident it will win the service contract it can price more competitively on the up-front sale. Data is enabling new pricing strategies.
Ibbaka: When you are looking to hire new pricing consultants what do you look for?
Tom: Pricing is something that needs experience. People need to work on many different pricing projects over the years to get the knowledge they need to advise on pricing strategy.
Of course, people need some quantitative skills. They have to be able to analyze data. But just as important is the ability to find and organize data and to do so in creative ways. The real skills here are to understand the problem, ask clarifying questions, and then structure hypotheses. Once one has gotten the structure of the problem clear one can generally find or collect data to make an informed decision. Having at least some data, even if only qualitative, is always better then making decisions in ignorance. Many years ago when I was a student I took an econometrics course. I was not looking forward to it, but the instructor introduced me to Bayesian approaches. The Bayesian approach can really help one to structure problems.
Ibbaka: Yes, now that you say this I can see Bayesian thinking in how Economic Value Estimation is structured. The Next Best Competitive Alternative is a sort Bayesian prior. EVE is a way to structure questions about the value a product provides a customer.
Tom: I think of this as hypothesis-based accounting. The goal is to structure the problem to make clear what hypotheses you need to test. You can’t know everything and you don’t want to. You don’t want to boil the ocean to cook a fish.
Ibbaka: What are other skills that pricing professionals need within an organization?
Tom: Pricing professionals need social skills because pricing has such broad, cross-functional impact within a company. Sometimes rather than hiring a whiz-bang analyst with all the newest quantitative skills one is better off promoting a person who knows people and understands their relationships and who can get stuff implemented in the organization. Then you send that person for training or hire pricing consultants to work with that person to teach him or her what structures, policies, and processes need to be implemented to improve pricing within a particular organization.
People need to work on many different pricing projects over the years to get the knowledge they need to advise on pricing strategy
Ibbaka: How will strategic pricing change over the next decade? What new skills will be needed?
Tom: There will inevitably be more and more data and we will get better at processing it and finding the relevant patterns. But what will really matter is making decisions with this data. That will generally be a team exercise.
The best companies I work with tend to have very international teams. People who come different backgrounds and have different skill sets. One of the most important skills will be the ability to work with cross-functional and cross-cultural teams to make effective decisions. No one person can have all the answers or even know all the questions to ask. What is really important is to be able to build the team that can ask the questions, then goes out and finds the answers so they can execute.
