Time to step up your pricing game!
A surprising number of companies treat pricing as merely an operational consideration and relegate pricing decisions down the ranks of their sales organizations. This is usually rationalized by the information advantage that people working at the customer interface hold over top management on key pricing considerations, such as local market conditions or customer willingness to pay. Bringing the relevant data and market intelligence to bear on pricing decisions is of course highly valuable, but the decentralization of pricing decisions often comes with major drawbacks. All too often we see limited coordination, narrow suboptimization, misaligned incentives, vague or impractical pricing instructions, and insufficient analytical and strategic capabilities leading to poor pricing decisions that quickly erode profitability.
To turn pricing from an operational headache into a powerful strategic instrument, companies must rethink their pricing approaches. In our experience, great progress can be made by (1) actively coordinating and managing pricing decisions, (2) creating a deep understanding of competitive dynamics, and (3) combining strategic thinking with the power of data and analytics to determine how the pricing game should be played. We have helped our clients approach pricing more strategically, and putting the above-mentioned building blocks in place has allowed them to reap remarkable returns from their development efforts.
1. Coordinating and managing pricing decisions
In order to utilize pricing as a strategic instrument, companies must start coordinating and managing pricing decisions in a structured manner. The traditional approach of management through target-setting works poorly for pricing in many cases, because top-down pricing targets provide very little pragmatic guidance for making the actual trade-offs between raising prices and losing volume that salespeople typically face. Instead, companies should invest in creating the necessary management infrastructure to support coordinated price setting and execution. This means putting systems, processes, and structures in place for compiling market intelligence from the customer interface, maintaining visibility into the overall status of own supply chain—including capacity situation and marginal costs—and feeding pragmatic and easy-to-follow pricing guidance to the sales responsibles.
Moving from isolated pricing decisions to a broader perspective, making relevant information easily and widely accessible, and realigning incentives across the whole organization opens up great improvement potential, as pricing decisions tend to have important systemic implications that siloed decision makers simply fail to account for. Supply chain considerations and competitive responses, among other things, make pricing outcomes highly interdependent with individual pricing decisions changing the capacity situation or competitor pricing behavior for subsequent sales cases. Handling such interdependent decisions jointly rather than in isolation, prevents suboptimization and yields sizeable profitability gains.
2. Understanding the competitive dynamics
Even in companies that effectively coordinate pricing decisions and utilize seemingly sophisticated pricing technologies, the failure to think strategically about pricing can seriously undermine pricing performance and constrain profitability. There is a strong tendency towards static and inward-looking price setting, despite the fact that most companies are not price takers, but their pricing decisions are likely to trigger strategic responses from competitors. In many situations, competitor behavior plays a key role in determining the success of different pricing moves and ultimately shapes the attainable profits for the whole industry. Volume seeking, for example, can often appear attractive in a static, isolated scenario, but once you factor in the competitive dynamics you may realize that a more restrained approach would actually improve long-term profitability.
Creating a deep understanding of competitive dynamics and incorporating that into pricing decisions is an immensely valuable, but challenging proposition. The better companies can anticipate the competitive responses to their pricing moves, the more they can tilt the playing field to their advantage through pricing. On this regard, we have helped several clients shift away from the price-taker mindset and incorporate strategic views into their pricing practices with great results.
3. Modeling the pricing game and playing it right
Jointly optimizing a broad set of pricing decisions in complex and dynamic competitive settings can get very complex very fast. We have found modeling approaches from economics and game theory to be very valuable tools in these situations. In helping our clients dynamically optimize their pricing in long chains of interdependent contract negotiations, for example, we have ended up building quite complex and computationally intensive optimization models. Luckily modern analytical approaches and on-demand computational resources can handle much more complexity than even the brightest of people can track in their heads. To turn the tables on sourcing specialists, who have utilized data and analytics for years and are growing ever more sophisticated in their sourcing practices, ramping up both strategic thinking and analytical capabilities is clearly becoming more and more essential for sales organizations.
In addition to helping management design successful pricing strategies and providing pragmatic pricing guidance for the sales responsibles, careful modeling and optimization of the pricing game helps companies further develop and refine their management infrastructure for pricing. By forcing added structure into pricing decisions, mathematical modeling highlights the key assumptions that the pricing decisions should depend upon and directs management attention to creating, maintaining, and sharing the information that is most critical for successful pricing.
All in all, we strongly believe that most companies would be well-advised to invest in stepping up their pricing games. Pricing is among the most powerful profitability levers, but tends to feature surprisingly little on the strategic agenda. By rethinking the management models for pricing, focusing on the competitive dynamics and strategic implications of pricing decisions, and building advanced analytical capabilities, we can help companies turn their pricing practices into a major strategic advantage.