Eight Reasons It’s Hard to Get Higher Prices
1. Lack of Managerial Focus
Studies have shown that managers spend only about 10% of their time on pricing management – the rest of their time is spent on issues that drive business cost! One reason this may happen is because managers see pricing in a limited context – seeing pricing management strictly as the “set price” activity. But profitable pricing management starts well before prices are set; profitable pricing starts with selecting target customers and thoroughly understanding their businesses. Profitable pricing also involves developing value delivery in the offering design phase, creating communication messages and selling scripts that communicate value delivery, and negotiating in a way that forces customers to acknowledge and pay for value. Profitable pricing management involves much more than just setting price – it involves developing marketing processes that are focused on mobilizing the entire business in creating and delivering valuable offerings customers can just not get from any other supplier. This requires a broad, integrating view of pricing activities. And, it rightfully requires significant attention from the management team.
2. Power Procurement
The days of weak purchasing departments are long gone! Many companies have recognized the powerful effect procurement has on their costs, and they have built aggressive, powerful purchasing functions. These new purchasing groups have optimized the purchasing process and have trained their people to control the purchase event. Corporate wide purchasing information systems make it virtually impossible to hide price offers in specific geographies or divisions of larger companies. And, purchasing personnel have been trained to use negotiating practices that foster price concessions from their suppliers. Helping sales people improve their negotiating skills is dangerous if the negotiation fosters price negotiation! To profitably engage with these new purchasing practices, marketing teams must prepare offering options that shift the negotiation from price negotiation to offering negotiation. And sales people must be trained to correctly diagnose buying behavior patterns, communicate value delivery, and force customers to trade value delivery for lower prices. This implies the purchase negotiation is a strategic issue which must be prepared for well in advance of the actual negotiation.
3. Offering Design Challenges
Some companies encounter difficulty in managing their pricing process because they have inadequate offering designs. It’s not that they have bad products or services. Rather, the problem is these companies have not matched their offering design to their target customers’ businesses. Instead, these companies try to sell the same offerings to many customers segments (hoping to achieve “cost economies of scale” in producing uniform offerings). The starting point of profitable pricing processes is definition of target customers – identifying those customers for whom the supplier chooses to build specific offerings. Failing to tailor offerings for specific segments often results in some customers getting lots of value they are never asked to pay for. Other customers get too much value and insist on price concessions. The consequence is widely dispersed price points. This creates lots of hidden costs (see “Fixing Price” by George Cressman in the October, 2006 issue of Marketing Management) as the business tries to cope with a complex price array. And, because of all the hidden costs, profits suffer. A “one size fits all” offering holds up the potential of achieving cost economies, but these cost economies must be evaluated considering lost profit resulting from poor pricing management. Successful pricing management demands a concise definition of target customers and the design of appropriate offerings for target customers.
4. Uncontrolled Discounting
Many companies have not managed their price discounting practices. Discounts are often applied on an inconsistent, ad hoc basis. Think about your discounting. Do you offer customers volume based discounts? If so, if we plotted price versus volume, we should see a relatively consistent progression – as volume increases, we should see prices move down in an orderly progression. What we often observe, however, is a “scatter plot,” indicating there is no relationship between price and volume – or what we call “price anarchy.” What this shows is that price is not the result of supplier policy. Instead, discounts and realized price points are the result of customer bargaining power. Of particular concern are those customers who buy small volumes and have negotiated very low price points (these are often called “strategic” customers – there may be no reasonable explanation for these low prices!). Of equal concern are those customers who are paying higher prices – what happens when they find out their supplier is offering much lower prices to some customers? Setting price and determining discounts should be done by policy: discounts should only be offered to drive business volume a supplier would not otherwise achieve. And, all discounts must be regularly reviewed and discontinued when they are no longer working.
5. Poor Price Determination Methods
The most commonly used method for setting price is a cost basis; adding costs to a desired profit margin to give a target price. The problem with this approach is it assumes customers value a supplier for the supplier’s cost structure. The second most common approach for determining price is matching a competitor’s price. The problem with this approach is customers who understand a supplier’s drive to match competition often “game” their suppliers: competitors always have lower prices. And finally, some companies base their price determination on customer “willingness to pay” (for example, “What price do we have to have to be competitive?”). The difficulty with each of these approaches is they systematically undermine price and profit potential. Setting price points should be the culmination of a planned marketing process that starts with understanding how an offering delivers value – economic impact – to the target customer’s business. The price setting process then captures a portion of that delivered value while the negotiation process forces customers to give up value delivery if they insist on lower price.
6. Diffused Pricing Management
In many companies, in addition to a limited pricing focus, management teams have no clear process for managing pricing activities. Because the roots of profitable pricing practices are widely spread across the marketing function, there are often conflicting and confused perspectives on how pricing decisions should be taken. Consequently, there are multiple demands for managing pricing practices. These multiple demands pull pricing processes in many directions. The people making day-to-day pricing decisions are often forced to sub-optimize price points, driving down profit potential. An integrated process for managing the pricing process is required, pulling together all the marketing functions that contribute to profitable performance.
7. Short Term Competitive Perspective
Managers may take a short term competitive perspective, using price cuts to grow market share or load their manufacturing facilities. This often happens as economies cycle down, or as industries mature. The problem with the price cut approach is that it almost always drives competitive response – with in-kind price cuts. It has been shown that the majority of price wars are accidents; the company that started the price war was simply trying to take a piece of business from a competitor. But price cuts are readily visible (particularly because powerful purchasing practices make a supplier’s price move apparent to other suppliers), and faced with the threat of losing a valuable customer, a supplier will often match a competitor’s price move. Competitors then move back to their original share positions, but at lower price points. And the result is long lived; the average price war lasts just over five years. Operating in a highly competitive arena requires careful planning: understanding who the real competition is, what their strategic intent and capabilities are, and how those will impact your firm and the industry. Tools like scenario based planning, “thinking in time,” and contingency planning are critical to the profitable management of a market position.
8. Reactive Price Decisions
The objective of all pricing management processes is to increase the business’s profitability. The challenge is that the profit optimizing decision changes as a consequence of the business’s underlying cost structure – the split between fixed and variable costs. Since many businesses offer products and services with different cost structure, it is critical the marketing and sales team understand each offering’s cost structure – so the right pricing moves are made consistently. Some business’s hide these costs, making it difficult for the marketing and sales teams to know the appropriate price move. And, the marketing and sales teams do not always conduct the appropriate analysis to understand the profit implications of a proposed pricing move. Not every proposed pricing move will increase profits, and not every competitor price move should be countered. Profitable pricing management requires marketing and sales teams to understand the volume implications of proposed price moves, and judge whether the volume implications can be achieved. This requires a thorough understanding of underlying cost structure as well as detailed understanding of market and customer conditions.