“Building the business case to implement a value based pricing strategy”

Pricing Insight has released a white paper report entitled “Building the business case to implement a value based pricing strategy”. This report identifies the key areas you need to focus on to generate gross margin expansion and realise the maximum value for the products and service solutions provided to each customer segment. To order your copy of the report please email news@pricinginsight.com.au or call +61 2 9973 4099

Extract from report.

Pricing Strategy

Pricing strategy refers to the direction, resourcing and infrastructure used to drive sales. Marketing textbooks mistakenly describe pricing strategy in terms such as skim pricing, penetration pricing, loss leader and a range of other terms. These approaches are all present in today’s business environment, they are however pricing tactics. They are not strategy. A simple way to explain this view is to understand the difference between software and hardware. Hardware is the “strategic” software is the “tactical”.

Breaking this concept down further, pricing strategy refers to the long-term investments made to support pricing capability.  Your pricing strategy checklist includes:

• Centralisation vs. decentralisation of pricing
• Resources to manage pricing decisions – pricing management team and place at the lead team table
  
• Training and education of all sales and marketing staff to understand the pricing strategy or issue of simple rules of racing only
  
• Pricing methodology – Cost Plus, Mark to market, Market Compete or Value Based
  
• Customer & Product Segmentation strategies linked to pricing mechanics
  
• Industry Price leadership and follow strategies
  
• Financial Returns on Assets and Industry Cost Position
  

The above list of strategic consideration must be evaluated and addressed by your business to ensure resulting tactical plays and contractual pricing decisions generate the optimal gross margin outcomes reflective the value your provide your customer.

A starting point for any strategic pricing improvement program in your business should involve lead team discussion of these strategic questions. It is an ever present risk in a meeting on pricing to try to solve tactical or burning customer issues. These tactical discussions are important but must be noted and parked while the strategic pricing questions are identified and addressed. Any strategic meeting on pricing will be a pre cursor to follow up meetings and workshops.

The most effective way to generate progress is to identify 2-3 key areas for improvement, develop PILOT pricing projects for test, and spin evaluations. Allow at least 3 months to develop the pricing conversation in the business and then a further 3 months to implement and evelaute a PILOT project.

Two types of Pricing Strategies

Lets discuss two types of pricing which are fundamentally opposed in viewpoint and find out which one offers the most opportunity to generate margin growth. These two types of pricing methods are the well known.

They are: COST PLUS and VALUE BASED PRICING.

COST PLUS

COST PLUS mark up where you buy in or make an item for say $1,000 and you want to make 30% GP. Many get caught out by simply performing the calculation 1.30 X $1,000 to derive a sell price of $1,300. This calculation is in fact MARKUP not a Margin on Sell. Margin on Sell is the only way to evaluate gross margins.

The correct way to derive a margin on sell is to take your cost price of $1,000 and divide this cost by 1- the % margin required. In this case $1,000 / 0.70 which equals $1,429. The margin percentage is calculated by taking the $ gross margin of $429 and dividing by $1,429. If cost plus a margin is the approach used and the general belief is that we need to make 30% to make money, then all staff must understand the difference between COST PLUS markup and Margin on Sell Price.

The real problem with COST PLUS approach to price setting comes with the fact that is drives pricing behaviour that in many cases will mean your offer to a selected market segment is too expensive or too low in value. Overall, your average margin appears to be around 30% as required by the budget but the inconsistencies and variation in margins, prices and volumes for the same product to different customers is fails to capture a significant earnings opportunity across your customer base and product portfolio.
Cost Plus is used almost exclusively because it is tangible, feels less risky and can be “defended” against negotiation tactics employed by procurement managers or powerful customers.

Is Cost Plus a bad way to price? It is a great way to ensure you sell your product for more than what you pay for it so the answer is no. Cost Plus has been used for 100’s of years to build global empires. The question today regarding pricing is all about adaptation in the face of market evolution. Customer segments are increasingly disaggregated. There mass market as identified by Proctor and Gamble in the 1950’s which allowed television to become the medium of choice to market has given way dozens of smaller market niches and each one with a differing set of need states, capacity to pay and willingness to pay for features that deliver benefits that in turn provide value for the customer.

One technique you can employ to understand this concept of market disaggregation is to segment your top 100 customers by size firstly and then think about your customer’s attitude towards your business.

Place your customers into three categories based on how they perceive your product and or service offer.

These three categories are:

• vendor 
• supplier
  
• partner

If you are a vendor, your offer is easily substitutable and considered to be commodity. Features based selling often drives this commoditisation.
If you have a supplier status you have some interrelationship backed by a well constructed, benefits driven Service Level Agreement or contract. But even this arrangement leaves you exposed to opportunistic competitors.

A partnership is a deep, interrelationship that often has shared intellectual property and Joint Venture arrangements in place for R&D, factory space, knowledge bank and long standing commitment supported by regular and meaningful dialogue across the management layers. This relationship is the future state for most companies but a reality for a great many companies today. Partnership status is characterised by value based selling.

How do you develop and economic value for all of the above partnership benefits? The answer is not simple or straightforward but the concept is easy to understand. No longer do we compete and charge for the physical product or discrete service purchased, we evaluate the total value generated to the customer by our offer. The value of our supply chain with its DIFOT of 92%+,our industry research that brings new ideas to market every 12 months, our technical support and the high quality account management are all valuable.

Our customers have it in their interest to tell us that these things are irrelevant and that they do not care about the value of these additional features.  For selected customer segments these features are extremely valuable. They may generate value for the customer in 4 ways:

• Lowering Cost of Doing Business
• Allowing the customer to charge a higher price for a better quality product or service.
  
• Lowering the COGs purchased through more effective trade agreements
  
• Lowering the risk of supply or product failure – an insurance value.

This last value driver is the most powerful value driver available to us to derive additional income. We must understand the Value of Risk to develop our pricing strategy and tactics. This is the concept of Value Based Pricing.

For more information and business case presentation pack
Email: news@pricinginsight.com.au
Phone:+61 2 9973 4099