The Pricing Journey: The Organizational Transformation Toward Pricing Excellence
240
The Pricing Journey: The Organizational Transformation Toward Pricing Excellence
240eBook
Available on Compatible NOOK devices, the free NOOK App and in My Digital Library.
Related collections and offers
Overview
Product Details
| ISBN-13: | 9780804794411 |
|---|---|
| Publisher: | Stanford University Press |
| Publication date: | 04/29/2015 |
| Sold by: | Barnes & Noble |
| Format: | eBook |
| Pages: | 240 |
| File size: | 8 MB |
About the Author
Read an Excerpt
The Pricing Journey
The Organizational Transformation Toward Pricing Excellence
By Stephan M. Liozu
STANFORD UNIVERSITY PRESS
Copyright © 2015 Board of Trustees of the Leland Stanford Junior UniversityAll rights reserved.
ISBN: 978-0-8047-9441-1
CHAPTER 1
What Is Pricing Excellence?
Renowned investor Warren Buffett once said, "The single most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. And if you have to have a prayer session before raising the price by 10%, then you've got a terrible business" (Frye and Campbell 2011).
Although the Oracle of Omaha is far from alone in seeing pricing strength as closely linked to the health of a business, the actual practice of pricing receives scant attention in most companies. McKinsey & Company estimates that fewer than 15 percent of companies conduct any systematic research before they set their prices (Mitchell 2011). One reason for the lack of interest may be that nearly two thirds of companies lack pricing power. In their 2011 study of global pricing practices, Simon-Kucher & Partners found that 65 percent of companies had low pricing power and only 35 percent had high pricing power, which Simon-Kucher defines as the ability of a company to get all or nearly all "the money it deserves for the value it delivers."
Most companies with low pricing power blame a cutthroat environment of competitive pricing (71 percent) and customers with strong buying power (36 percent). But at least one statistic suggests that many companies are overly pessimistic: Simon-Kucher found that nearly half (46 percent) of those surveyed believe their company is fighting a price war, and most of the besieged (83 percent) blame their competitors for starting it—a combination that doesn't quite make sense: how could a price war always be the other company's fault? By contrast, companies with high pricing power tend to believe they deserve it, thanks to a stronger brand (75 percent) and a premium product (49 percent), according to Simon-Kucher's survey (2012).
End of story? Not quite. In fact, neither the winners nor the losers are right about how they got to where they are. As you will learn in the next section, pricing power does not automatically correlate with value. Instead, pricing power correlates much more closely with pricing skills. My research suggests that price setting and price getting require discipline, not luck. A survey of 748 members of the Professional Pricing Society, conducted in April 2011, found that although external factors such as competitive intensity affect pricing power, companies have much more control than they think they do over the prices they charge. Even controlling for firm size, nature, main activity, and function of respondents, pricing capabilities had a positive and significant correlation with firm performance (pricing performance, sales performance, and financial performance). The evidence suggests that almost any business can improve its pricing performance, provided it approaches pricing in a structured way.
More specifically, the survey found the following:
• The behavior of an internal champion for pricing had a positive and significant impact on relative firm performance, pricing capabilities, and organizational confidence for pricing.
• Center-led pricing management had a significant impact on the design and development of pricing capabilities.
• The capacity of an organization to change its prices relates positively and significantly to the level of pricing capabilities, to the level of organizational confidence in pricing, and to relative firm performance.
• Pricing capabilities had a positive and significant influence on organizational confidence in pricing.
• And this confidence is a good thing: as with pricing capabilities, organizational confidence itself has a positive and significant influence on relative firm performance.
Most significantly, the analysis showed that pricing capabilities are the most important survey factor in a firm's relative overall pricing performance—accounting for over 34 percent of the variance—more than any other factor, including organizational confidence (22 percent), change capacity (11 percent), and championing behaviors (10 percent). Several other studies have likewise confirmed that pricing has a substantial impact on company profitability. Simon-Kucher & Partners estimates that two thirds of all companies give up as much as 25 percent of their profits through weak pricing practices (2011). Even small variations in price can raise or lower profitability by as much as 20 to 50 percent (Hinterhuber 2004).
But firms that decide they would like to achieve pricing excellence face two problems. First, no one can quite agree about how to define pricing excellence; ask 100 pricing practitioners what pricing excellence means and you'll get 100 different answers. Second, nobody can fully agree on a road map or process on how to achieve it. You can learn a lot from the great pricing thinkers—Tom Nagle, John Hogan, Ken Monroe, Hermann Simon, Gerald Smith, and Robert Dolan, just to mention a few—but no one in the profession, not even the profession itself, has really developed a standard road map that shows how you make the long journey from pricing weakness to pricing strength. Until now.
The Pricing Capability Grid
The Pricing Capability Grid changes that. It defines pricing excellence and suggests the best paths you can take to get there. It frames the concept of pricing excellence into a grid on two axes: pricing orientation and pricing realization.
The grid is the outcome of our own experience as pricing practitioners and extensive research. In 2011, I interviewed 44 executives to learn more about the nature of pricing capabilities. Their companies varied in size from about 50 to more than 2,000 employees and differed dramatically in their pricing capabilities. I spoke to CEOs and CFOs, heads of business units and professionals in marketing, and heads of pricing and finance functions in fifteen U.S.-based industrial companies about their pricing practices and capabilities, and tried to find out why pricing skills tended to be so undervalued (Liozu et al. 2011).
To capture contrasting perspectives on pricing within companies, I narrowed my search down to businesses with at least three respondents, each at a different management level, including at least one respondent from top management (either a CEO, a managing director, or a member of the board of management), one respondent from middle management (either a business unit manager or a head of a functional unit), and one respondent from lower management (a functional manager). Of the 36 companies meeting these criteria, 15 agreed to participate in this research project. At least three interviews were conducted at each company. Respondents included 15 CEOs or top executives, 18 sales and marketing managers with full or partial responsibility for pricing, and 11 finance and accounting managers with decision-making authority.
In the course of this research, I concluded that pricing power is not a destiny that depends on your market position, but a learned behavior. While competition, costs, and price sensitivity within a market affect the parameters within which companies set prices, superior pricing is almost always based on skills. The companies in my survey that had achieved better pricing all had high-level managers who championed the development of skills in price setting (price orientation) and price getting (price realization). Regardless of their industry, the degree to which managers focused on developing these two capabilities correlated with their success in getting a better price for their product than their competitors (Liozu and Hinterhuber 2012b). Without managerial engagement, companies typically fall back on historical heuristics, such as cost information, to set prices, and yield too much pricing authority to the sales force.
To rank the relative development of the company's pricing function, we created and operationalized the Pricing Capability Grid (Figure 1.1). We categorized pricing abilities into five major categories: the Pricing Power Zone, the Value Surrender Zone, the Price Capture Zone, the Zone of Good Intentions, and the White Flag Zone. Companies in the Pricing Power Zone command significantly higher prices and profitability levels than companies in the White Flag Zone. Most of these companies had undergone a long and difficult transformation that enabled them to evolve from traditional, cost-based pricing toward higher-margin pricing with more disciplined pricing execution. But when they finished, they had achieved something impossible according to traditional pricing theory: they had essentially learned their way to better prices.
Pricing capabilities have two dimensions: price setting and price getting, and all companies fit into one of five squares it creates.
Price Setting
Price setting (price orientation) is how a company determines its final selling prices. Companies differ wildly in their approach to price setting. However, although companies that sell services to individual consumers, for example, may price differently than companies that sell jet engines to sophisticated purchasing centers, and pricing approaches in India may differ considerably from pricing approaches in France, my own experience—and most academic research supports this—suggests that pricing methods across industries, countries, and companies usually fall into one of three buckets: cost-based pricing, competition-based pricing, or customer value-based pricing (Liozu and Hinterhuber 2013; Hinterhuber 2008b).
• Cost-based pricing decisions are influenced primarily by accounting data, with the objective of reaching a certain return on investment or markup on costs. Typical examples of cost-based pricing approaches are cost-plus pricing, target return pricing, markup pricing, and break-even pricing. The main advantage of this approach is for the price setter: the data you need to set the prices are usually easy to find. The main weakness of cost-based pricing is that aspects related to demand (willingness to pay, price elasticity) and competition (competitive price levels) are ignored.
• Competition-based pricing uses data on competitive price levels or on anticipated or observed actions of actual or potential competitors as a primary source to determine appropriate price levels. The main advantage of this approach is that it incorporates a view of the competition. The main disadvantage is that it again ignores demand. In addition, an aggressive response to a competitor's price can raise the risk of a price war, which at extremes may not only hurt the profitability of one company but destroy the profitability of an entire industry. The kinds of scorched-earth wars that hit the U.S. domestic car market between 2005 and 2009 and the U.S. airline industry around the same time are good examples of the damage an all-out price war can inflict. Competition-based pricing approaches are frequently justified on the grounds that price is one of the customer's most important purchase criteria, but if it triggers a war that leads to widespread bankruptcies, it's hard to see how those unsustainable bargains benefit the consumer in the long run.
• Customer value-based pricing, often called "value-based pricing," uses analytics about the customer's perceived value of the product or service as the main factor for determining the final selling price. Instead of asking, "How can we realize higher prices despite intense competition?" customer value-based pricing asks, "How can we create additional customer value and increase customer willingness to pay, despite intense competition?" The subjective value of a purchase offering to actual and potential customers is the primary driver in setting prices. Customer value-based pricing approaches require a deep understanding of customer needs, customer perceptions of value, price elasticity, and customers' willingness to pay. Or as one executive explained to me:
Value-based pricing I think is, in my mind, simple. It's what the customer is prepared to pay based on what the product does for the customer, and that they perceive it will do for them.
The advantage of customer value-driven pricing approaches is their direct link to the customer. Their big disadvantage is that data on customer preferences, willingness to pay, price elasticity, and size of different market segments are usually hard to find and interpret. Customer value-based pricing approaches may also lead to relatively high prices, especially for unique products. That may sound good, but if your prices are too high you can encourage new entrants to join the market or create a huge opportunity for competitors to sell comparable products at slightly lower prices. Finally, customers must first recognize value before they are willing to pay for it, which can be a problem if you have just introduced a genuinely superior product. Often, marketers must educate prospective customers to recognize the product's superiority before linking price to value.
Despite these shortcomings, many pricing scholars consider customer value-based pricing to be the best way to set new-product prices or to adjust prices for existing products (Anderson and Narus 1998; Anderson, Wouters, and van Rossum 2010). Some businesspeople have also found that customer value-based pricing can have important benefits, especially in highly competitive industries (Ingenbleek et al. 2003). This may seem counterintuitive, but it's not. Many managers mistakenly assume they are stuck in a "commodity" business. They overlook possibilities for differentiation and customer value creation and resign themselves to competing solely on price. While some segments in an industry may become severely price competitive, most of us give up the fight too easily. In fact, thinking of your product as a commodity is a good way to make it a commodity. Through deeper research into customer needs, almost any product or service can be differentiated. Such research can also be a powerful weapon to overcome price pressure by retailers. Armed with data on customer willingness to pay, price elasticities, and perceptions of value and price, manufacturers can demonstrate to retailers the total value jointly created through their value-based pricing strategy.
Price Getting
Companies also differ in their abilities to realize the prices they set. Price getting (or more formally, price realization) refers to the capabilities and processes that ensure that the price the company gets is as close as possible to the price the company sets. Why would those two numbers differ? One reason is inconsistent discount systems (Sodhi and Sodhi 2005). The abilities of sales reps to negotiate and levels of authority among sales managers vary widely, enabling some customers to obtain much more favorable conditions than others. Also, in order to reach their sales quota, IT-savvy sales associates sometimes override the discount control systems, even as colleagues try to protect prices and margins, preferring to walk away from deals below well-defined target prices. Price-getting capabilities are thus fundamentally related to a company's ability to translate goals into results; they reflect the capacity and will of a company to enforce—both internally through sales personnel and externally through customers and trade partners—its list prices and to translate these list prices into the prices the company actually gets (Nagle and Holden 2002; Dutta et al. 2002).
Our research indicates that differences in price-getting capabilities reflect a slew of factors:
• The existence of pricing rules specifying maximum discount levels for any given order size
• The extent to which these rules and guidelines are followed
• The individual and organizational consequences for not following these guidelines
• The extent to which sales personnel have to justify and ask for approval for deviating from list prices
• The negotiation skills of sales personnel
• The degree to which sales associates understand a customer's best available alternative
• The customer's maximum willingness to pay and the differential value to customers of the company's product and service offering
• The existence of clear target prices before sales personnel enter into negotiations with customers
• The amount of pressure (self-imposed or organizational) that pushes sales personnel to conclude unprofitable deals
• The confidence to walk away from unprofitable deals
• The extent of free services offered to customers to close a deal
• The systems in place to monitor and communicate price deviations to sales personnel, marketing managers, and other decision makers
(Continues...)
Excerpted from The Pricing Journey by Stephan M. Liozu. Copyright © 2015 Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of STANFORD UNIVERSITY PRESS.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
Table of Contents
Contents and Abstracts0Introduction chapter abstractThis introductory chapter makes the case for a different look at the pricing function, the pricing discipline, and how pricing is deployed in organizations. Pricing tends to be a technical and scientific discipline that is often deployed in organizations without proper attention being paid to the social and organizational implications. Pricing transformations are hard and often fail because of that. The introduction lays the foundation for the need for a different approach to pricing transformations.
1What is Pricing Excellence? chapter abstractThis chapter discusses the concept of pricing excellence as the end goal for any company wishing to improve their pricing power. It introduces two critical dimensions of pricing excellence: pricing orientation and pricing realization. Both dimensions of pricing need to be managed intentionally to ensure success in price setting and price setting. This chapter describes the pricing capability grid and the five zones within the grid. Firms that embark on a pricing journey towards pricing excellence have to pay close attention to pricing orientation and pricing realization levels, as well as the path they take in order to eventually reach pricing excellence.
2The Transformational Journey chapter abstractThis chapter discusses the concept of pricing maturity as well as describes the concept of a pricing journey. Reaching pricing excellence is a journey requiring deep and sometimes tenuous change. This chapter introduces a structured five-stage transformational model derived through academic research and proven with dozens of pricing case studies. It also provides the initial description of the 5C transformational model developed over the last five years and applied to several real-life transformational projects.
3Champions Lead the Organizational Mobilization chapter abstractThis chapter discusses how top leaders in firms can strongly positively or negatively influence the success of a pricing transformation. Research shows that the role of the CEO and the C-suite is critical in supporting the troops and in leading by example. This chapter describes the difference between a CEO's involvement in pricing and a CEO's championing of a pricing transformation. It proposes specific behaviors that CEO and members of the C-suite can display to generate collective confidence and create buy-in across the entire organization.
4Center-led Pricing Management: A hybrid Organizational Architecture for Pricing chapter abstractThis chapter addresses the topic of organizational design for pricing. It reviews the various options to set up a pricing function within an organization: centralized, decentralized, center-supported, and center-led. This chapters offers the pluses and minuses of each option but focuses on the center-led management design and the specific roles of pricing teams. Finally this chapter proposes that the combination of a center-led pricing team and a pricing council structure is the optimal organizational architecture for pricing.
5Capabilities: Social and Technical Assets and Activities chapter abstractThis chapter covers critical concepts and definitions of what pricing capabilities are in practice. Drawing from various bodies of literature, the author makes a distinction between pricing dimensions, pricing resources, and pricing activities. Both tangible and intangible capabilities are necessary to make sure pricing changes are adopted and assimilated. Based on the work from pricing scholars, the author introduces the concept of socio-technical change related to pricing capabilities and how these positively influence firm performance.
6Change Capacity: A Progressive Internalization chapter abstract70% of project fails. And they fail because of a lack of focus on true change management science. This chapter review concepts of change management and organizational change capacity using the pricing lens. The results of a survey on change management in pricing are presented and discussed. Finally this chapter presents the key change factors that are important to any pricing transformation as well as introduces a transformational framework composed of ten dimensions of change in pricing.
7Confidence: the Fuel of the Organizational Transformation chapter abstractChanging requires courage and confidence. Transforming organizations requires self-esteem and confidence at the collective level. This chapter covers the concept of organizational confidence in pricing. Drawing from multiple research studies, it proposes a collection of programs that can used to build collective self-esteem and confidence in teams so that they can jump on board the change train. These programs can easily be deployed across the organization to create buy-in and solidarity among the various functions that might be impacted by the pricing transformation.
8Possible Roadblocks Along the Journey chapter abstractPricing transformation can take anywhere from 4 to 10 years. That is a long journey and many things can go wrong along the way. This chapter proposes the 12 most common roadblocks business and pricing teams can face when conducting transformational activities. It also offers some practical tips on how to handle and respond to each of these roadblocks.
9Pricing Myths at the Organizational Level chapter abstractThere are many myths affecting the organizational perceptions about pricing. Pricing professionals need to be aware of these myths and need to be able to combat them when they design and implement pricing programs. This chapter lists some of the most common pricing myths at the organizational level and offers some tips on how to change perceptions of pricing within their organization including with top leaders.
10Pricing Skills to Face Complexity and Dynamic Environments chapter abstractThe pricing discipline has come a long way over the past few decades. The science and discipline of pricing are also changing requiring pricing professionals to learn new skills. With the emergence of big data and pricing technologies, the role of pricers in the future will require a balance of technical and social skills. This chapter offers more details on how pricing skills are affected and how important it is for pricing professionals to define a learning agenda. It addresses the complexity of pricing and the dynamic nature of pricing science.
11Closing Thoughts chapter abstractThis last chapter proposes integrative findings from the entire book and how it affect the potential success of pricing transformations. A case study is presented on how the 5C model was used to successfully transform a mid-sized company's pricing orientation. This chapter makes the case for change and proposes a manifesto for change-driven pricing. Finally the chapter calls on the pricing profession to wake up and start their own transformational journey.