The Pricing Function: Simple Questions with Complex Answers

October 2015 Corporate, Pricing

The three most practical of practical questions in defining a pricing team are

  • Where should pricing report?
  • How large should the pricing team be?
  • How do I measure their performance?

On the face of it, these are reasonable questions. Yet, the answer to each is frustratingly complex.

No Standard Best Practices

Take the first question: Where should pricing sit? Companies have found that pricing works best for them under marketing, finance, sales, and other departments. Which is to say, there is no single best practice found across all industries. What a dissatisfactory answer!

Take the second question: How many people should I have in pricing and what is the right balance between people and technology? Some companies have hundreds of pricing professionals and others have only one.  Some companies have lots of pricing technology and others with almost none. Which drives us from asking about absolute numbers to asking about ratios, but there too we come up short.  Some companies have one pricing professional per $50 million in revenue, others have one per $10 billion—a factor of 200 difference. What a frustratingly imprecise standard!

We get to the third question: What are the key performance metrics of a pricing team? Examples and counter examples of performance metrics for pricing confound clarity. Most executives in pricing will report being measured by one of three, or some combination of these three performance metrics:  revenue, margin, and market share.  While these are good metrics (indeed, Wall Street should measure and pay CEOs on exactly these metrics), it is hard to state that pricing alone impacts each. The effectiveness of pricing as measured by margin, revenue, and market share cannot be disentangled from that of marketing communications, sales, product development, channel management, operations, and other functions.  Moreover, none of those metrics go to the heart of what a good pricing function delivers: better decision making regarding pricing through more accurately and efficiently identifying the market’s willingness to pay, and the impact of that specific pricing decision on the company’s performance. No clarity once again, but at least alignment with corporate goals.

So, if benchmarks aren’t meaningfully useful, where should we look for direction?

Ask Better Questions

It isn’t that the leaders in pricing lack answers to these questions, it is that we know that there is no singular answer. The best answer to these questions is the most frustrating answer and consultant-like answer of all. It is, “it depends.” Which means, “ask me a better question.”

As with other strategic challenges, the first step to addressing it, whatever it may be, is to properly define the challenge needing to be solved.  In doing so, we identify the questions which leads to the answer of the practical question at hand.

Performance Metrics Should Be Driven by Performance Goals

For instance, on the question of key performance indicators (KPI) of pricing teams, one should ask what the goal of the business unit.

  • For a few companies, the strategic goal is to dominate the market due to the value of network effects in driving disproportionate returns to the dominant competitor. (Uber, Amazon, Xiaomi all follow this strategy at the time of writing.) If the corporate strategy calls for market share and penetration pricing is used to support that strategy, then then pricing’s performance metrics should be dominated by market share with a heavy dose of revenue growth.
  • For most companies, the goal is to earn profits. (Emerson, Harley Davidson, Piaggio, Caterpillar, Cummins, Hertz, and many others all follow this strategy at the time of writing.) If earning profits are the corporate goal and neutral pricing is used to support that goal, then pricing’s performance metrics will be dominated by margin with a decent dose of revenue maintenance to modest growth.

All Metrics Will Be Dependent on Stage in the Pricing Excellence Adoption Cycle

Even the above reasonably good answers are, unfortunately, incomplete.  To get a more complete answer, we need to address the stage of the company in the pricing excellence adoption life cycle.

  • Companies that are just beginning to build a pricing team should initially focus on defining the first year’s problems the team must address. Is it a price execution, discounting, setting, or strategy challenge, which most needs to be addressed? In some cases, the performance metric should be something correlated to profits, revenue, and share. In other cases, the performance metric may be the reduction in errors, reduction managerial discussions regarding discounts, accuracy and confidence in making pricing decisions, or alignment of pricing to market segment strategy. Moreover, companies early in their pricing journey are often urged to start with small teams and build from there. Hence, many firms start with one to three resources and stay at that level until the small team can prove their worth.
  • Companies that have been doing pricing for a while tend to expand the scope of responsibility for the pricing team in both business units and business challenges. In expanding business units, pricing practices developed in one business unit are repeated in others, and turned from one-off efforts into standardized pricing routine. In expanding the business challenges, pricing teams may move from the issue of managing discount policy and execution towards defining prices and price structures themselves. Moreover, companies more mature in the pricing excellence adoption cycle may grow their team five- to tenfold in a single year when they turn their newly discovered sources of pricing power into a corporate core competency and standard operating procedure. They may also shift from a human resource intensive effort towards a more balanced effort, which includes pricing analytics and price management software.

Talent, Not Benchmarks

While the above roadmaps help in defining the direction, when push comes to shove and people are given mandates or pushed to the sidelines, we find the above answers fall short of complete clarity.  Perhaps we need to take a different angle.

Just as winning business strategies don’t flow from a standardized recipe, neither do organizational strategies for pricing teams. The problem isn’t the practical questions. Organizations need to know where pricing functions sit, how large they need to be, and what results or performance metrics they should expect from them. The problem lies in expecting to receive an accurate answer from someone who doesn’t know the specifics of your strategy, your needs, nor your level of preparation. That is, the simple and most practical of questions in pricing can only really be addressed by asking the many hosts of far more complex questions. So, instead of looking for a standardized recipe to copy, look for a chef who knows a variety of ingredients, techniques, and recipes and has the creativity to define a dish that is just right for you. Once the chef has defined the right recipe for your outlet, the sous chef can take over and repeat, perhaps with even greater efficiency.

About the author

Tim J. Smith, PhD is the Managing Principal of Wiglaf Pricing, and an Adjunct Professor at DePaul University of Marketing and Economics. His most recent book is Pricing Strategy: Setting Price Levels, Managing Price Discounts, & Establishing Price Structures.

Tim J. Smith, PhD
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