What the Textbooks Don't Teach You About Price Management

By Moira McCormick on March 15, 2016

Students of economics are taught that a business maximizes profits by producing up to the point at which marginal cost equals marginal revenue. This is true in theory - and actually irrelevant in practice. I'm not advocating you throw the textbooks out of the window just yet but take a long hard look at your current pricing strategies – and see where improvements in the real world can be made.

New pricing approaches frequently require new organizational priorities, a new organizational structure, new capabilities, new processes, tools and different goal/incentive systems.

 

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Setting Prices

The first area that may require a fundamental rethink is the way your company sets prices. You need to differentiate yourself from the competition by learning how to create, quantify, communicate and capture customer value by implementing customer value-based pricing strategies.

 

Price Realisation

A second area concerns price realization - that is, the process of translating list prices into profitable net prices. Your company may lack the information systems, negotiation capabilities, incentive schemes, controlling tools and confident sales personnel. Small improvements in any of these areas can lead to quantifiable results very quickly.

 

Price Ranges

As you think about pricing your own products, remember that pricing is not a point, it's a range - between the lowest price at which you are willing to sell and the highest price at which the customer is willing to buy.

What can you do to move into the higher end of that range, or to even price your product or service so that the range itself moves upward?

 

1. Know the limits of consumer research

The textbooks may be telling you (rightly) to carry out extensive research. However, the truth is that when consumers are asked about a new product, they generate a price point by thinking of other products with which the new product can be compared.

So, when you yourself conduct research, don’t do what surveys typically do and ask consumers to price products for which they have no concept of price. Instead, ask about substantive value. This draws consumers away from jumping to the nearest point of comparison and instead encourages them to really consider the value they would get from what you are offering.

 

2. Use "anchoring" to your advantage

Set the right point of comparison. Psychologists have established that we make judgments based on the first piece of information we have, even if that “anchor” is entirely unrelated to the problem at hand.

In retail, this phenomenon is harnessed by presenting three options of ascending quality: the cheapest option, the premium option and the luxury option - commonly called “good-better-best.” Consumers will often pick the premium option even when they would not have picked it had it been presented on its own.

 

3. Rethink your 'fair' price

We are hard-wired for fairness and this makes fairness the most important rule in pricing. However, what we believe is “fair” is more of an emotional rather than rational response.

So, try this kind of language to your potential customers: "we can make things easier for you". This is also where brands, which increase user satisfaction by offering trust, make a big difference. So, know the importance of a fair price and study how you can convince consumers that they will not do better elsewhere.

 

4. Offer value, value, value!

If you make your pitch to the customer by focusing on price, it could suggest low quality. Instead, indicate your high quality: highlight unusual features, promote any endorsements you have or show users how they could benefit in the long term from consistent use of your product or service.

In the world of “freemium” business models, a focus on value is even more important, because customers won't pay anything until they have had a good experience.

 

The Ultimate Guide to Discounting

 

Practise the Art of Negotiation

One way of dealing with customers who seem to be expecting a discount is to build negotiating room into your price structure. Of course, not everyone will attempt to negotiate - some people will just pay the asking price. Conversely, you may not wish to negotiate with some customers. Perhaps you know that serving some customers can be more expensive or just plain 'trouble'. In those situations, you won't be in the mood to offer any discounts or incentives.

In some industries, refusing to negotiate can result in adverse selection. That is, not all customers are created equal so having one fixed price can result in you ending up with more less attractive customers and fewer attractive customers.

Prospective customers should know up front if the asking price is firm and there will be no negotiation. Some customers will admire this honesty but unless you have a much lower cost structure than your competitors, they'll always be able to price slightly below you – so make sure your product or service can be differentiated from the competition so that customers are willing to pay your higher price.

 

Implement Personalised Pricing

Personalised pricing is as old as commerce itself but the digital revolution and online shopping has given retailers a new set of signals to play with in understanding how much a prospective customer will pay. Device type, IP address and previous interest are all data sets that help set a price at a level to maximise revenue.

85% of sales still take place offline and personalised pricing is barging into this world too. The smartphone and its interaction with the connected store environment, through Bluetooth beacons, in-store wireless or some other means of identification, is the catalyst for this new level of personalisation. By identifying the customer on arrival, the retailer is able to offer both a more personalised experience and pricing designed to maximise the chances of a sale.

In many retail sectors, the platform for delivering this personalisation will be the smart shelf. This is likely to incorporate sophisticated sensors enabling it to react to the consumer to provide reviews, suggestions and, of course, pricing and offers, in a way that is natural, comfortable and useful. These shelves will not only know what products they have loaded on them, but also understand and interact intelligently with the consumer.

At the very least, in the more commoditised sectors, smart shelves will allow retailers to implement dynamic pricing, reacting to competitors’ pricing changes or costs in real time. But the potential is there for prices to change dependent on the individual customer profile in a way that maximises the chances of a sale. B&Q are already testing electronic price tags that change price based upon the profile of each customer.

In high-end categories, such as fashion or electronics, the identification of the customer is likely to be used in a more discreet way to help sales assistants tailor their approach. Knowing what the customer has bought before or whether they have responded to promotions could enable the sales assistant to ascertain whether a discount or a bundled offer would be most appropriate.

The technical challenges of offering the right price, for the right person, for the right product, in store, in real time, are not insignificant. What’s even more challenging is managing the consumer perception of personalised pricing. How consumers and the media will react when it becomes well known that some individuals end up paying more for the same item in store remains to be seen. As the Competition & Markets Authority has said: “Businesses need to be clear if they are using personalised pricing. If they are using it and it’s not clear, that could erode trust.”

Retailers will need to be transparent and on the front foot about the practice, in order for it to be perceived as personalised discounts for loyalty and not another example of “rip-off Britain.” Either way, as the blurring of the online and offline worlds continues, the rise of personalised pricing seems assured.

 

 

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Champion the cause of dedicated pricing personnel

Companies with a culture dedicated to pricing, sophisticated tools to quantify customer willingness to pay/customer price elasticities and robust pricing processes all have one thing in common - dedicated personnel responsible for pricing, such as a chief pricing manager, a head of revenue management or a director of pricing. These senior positions are responsible for implementing robust organisational processes to ensure discipline in price setting and price getting. This means that pricing decisions are embedded in robust structures and processes, rather than being left to the discretion of sales personnel in the field.

These pricing executives thus drive the internalization of customer value-based pricing throughout the company and motivate the organisational changes required to support it. If you have to make organisational changes to your pricing culture, nobody is saying that this will be a short process - it requires intense and sustained attention to restructure – and also perhaps a change in the business mentality of your marketing and sales departments.

CEO involvement in the whole process of pricing culture change is a critical requirement. If he or she is championing the cause then it takes on greater significance than just another project, leading to organisational confidence, new capabilities and transformational change.

 

Conclusion

Pricing is rooted in human psychology and a touch of game theory. The lesson, then, is to show substantive value to the customer, or offer a point of comparison to anchor pricing options.

It's true that virtually all companies aspire to set prices close to the value that their products and services deliver, and virtually all companies aspire to close the gap between list prices and actual in-pocket prices. Yet few companies have successfully made the transition from cost - or competition-based pricing to a customer value-based price setting with strong price-realization capabilities.

As long as you are upfront about this, consider personalised pricing – it is certainly the way forward in retail, both online and offline. There will be many opportunities in the future to implement this pricing strategy in other industries.

Never underestimate the importance of negotiation – and keeping the lines of communication open between you and your customers in order to realise the best price for you both. If you appoint a dedicated pricing professional he or she could be the jump start you need to your successful pricing journey.

The textbooks do not have all the answers – you will also have to call upon your experience and expertise with pricing - to be able to look to the future with confidence, and with the reassurance that you are doing everything possible to prioritise this vital aspect of your business. The highest accomplishment is to set the right price that rewards both you and your customers for building a long relationship.

 

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