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An Overly Simplistic Approach to Pricing Strategy

November 2015 Corporate, Pricing

A number of recently graduated MBAs have been hitting me recently with an overly simplistic concept of pricing strategy.  The conversation goes like this:

 

Recent MBA Aside: I just landed this great gig and now I have to prove myself.  They told me to work on this company’s pricing strategy.  I took finance.  I know profits go up faster when price go up than anything else.  Let’s just raise prices.
Recent MBA: OMG!  I totally have an awesome idea.  Let’s raise all the prices and see what happens! Right!  That would be awesome!  We will keep selling things and make a higher profit. And, if it doesn’t work out, we can just go back a little on prices and it will be like nothing ever happened.  That’s pricing strategy, right?
Wiglaf: I can’t quite recommend that.
Recent MBA: But it worked for Starbucks and their profit went up.
Wiglaf: Yes, sort of.  It was a bit more complex than that.
Recent MBA: What do you mean? They raised prices.  People complained.  But they still bought coffee. Some store traffic went up. They were totally in the inelastic part of the demand curve.  It simple.  Why can’t we do that?
Wiglaf: If you study the Starbucks case more carefully, you will see that they raised some prices and lowered others.  It was more complex than simply raising prices across the board until the customers stopped buying.
Recent MBA: How is pricing strategy more complex?  We have supplier power.  We can raise prices.  Why make it complex.  Keep it simple, Right!?
Wiglaf: You can do that if you like, but it doesn’t always work out so great.
Recent MBA: What do you mean?  Don’t you know the 1% Windfall rule?
Wiglaf:

Yes, I know that a 1% improvement in prices will, on average, increase profits by 10-13%, depending on the reporting year.  But that doesn’t mean every strategic pricing effort should result in higher prices across the board.

 

Take a look at Netflix. They raised prices and their subscription growth declined precipitously.  They choose to back track and issue a huge apology.  Prices were stuck at a low point for a few years after that fiasco.  No, I encourage you to think a little deeper.

Recent MBA: Whatever.

 

Pricing strategy is not executed by simply raising prices.  If that’s all it took, then every fool would do pricing strategy, and every business owner would have a clear pricing plan.

No, pricing is far more complex.

True, in some cases, prices can increase without impacting sales volume.  But in many cases, for many product or specific selling situations, a higher price will kill sales.

Pricing strategy is about systematically charging the right price to the right customer at the right time.  This means understanding the customer, their willingness to pay, and how it varies across products, buying situations, and competitive markets.  It is about understanding how a firm’s prices should stand in relation to its competitors and how to respond to a competitive price action in the most productive manner.  It is about choosing a price structure that enables the firm to profit, and appropriately addresses the market segmentation strategy.  It is even about defining the organizational capabilities required to execute the firm’s pricing goals.

Systematically charging the right customer, at the right time, the right price is difficult.  To get it right, firms must understand their customers – deeply. That means market research and pricing analytics.

Adding to this complexity of setting an informed pricing strategy is that there isn’t just one form of market research or pricing analytics that solves every pricing challenge.  At times, Voice of Customer research is needed to inform models of the Exchange Value to Customer.  At other times, surveys using Conjoint analysis or MaxDiff reveal the variation in customer’s willingness to pay.  And at other times, pricing analytics can meaningfully provide insights on expected product list prices, variations of prices by customer segments, target deal prices, and deal floor prices to guide salespeople in their negotiations with customers.

It isn’t that the recent MBA’s strategy is completely flawed.  I know of cases where it worked out for the good of the company, the shareholders, and the customers.  But I also know of far more cases where that would have killed the business.  It is that the recent MBA’s strategy is incompletely thought out.

Not all recently graduated MBA’s sound like this.  Most understand that business is complex and difficult. Most practice greater humility than described in the story.  But for those few that are overly attracted to simplistic ideas, I encourage you to remember a quote from Thomas J. Watson, Sr., the late CEO of IBM: THINK.

 

Watson  Think



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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