Sunday, April 13, 2014

Who’s Responsible for Pricing?

Who has responsibility for Pricing in your organisation?

Many readers will probably answer "the Marketing Department". After all, Pricing is one of the "4P's" of Marketing, albeit the 'forgotten P'. In Leading Companies, there will often be dedicated pricing resources in the Marketing team, and in other organisation's, Product Managers will probably devote about 10% of their time to this business-critical function.

In many other companies, particularly those that practice cost-plus pricing, the people who are responsible for pricing are typically found in the Finance area. After all, that's where the cost data, on which they base their pricing decisions, resides.

Believe it or not, some companies will see Pricing as a "Sales" function. This oxymoron has given rise to the view that, particularly when Sales are heavily dependent on discounts to close a deal, Sales is the "un-pricing department", while Pricing is the "sales prevention department"

The fact is that pricing is everyone responsibility! Here's why.

In the last month, I have had to call the same insurance company on two separate occasions. The first occasion was to correct the address my policy renewal notice was sent to. A system upgrade meant that my renewal notice was sent to the wrong address, and by the time the letter was correctly readdressed, the policy had expired.

In the process of updating my records, and taking out a new insurance policy, the very courteous call centre staffer gave me a 50% (~$300) discount on the policy, vis-à-vis the one that had just expired. Thank you very much!

The second time I called them a couple of weeks later, was to get a different policy changed from joint names to a single name (I have no idea how or why this change occurred: probably that system upgrade again). Once again, a different call centre staffer offered me a discount (21%, or $80) on my policy renewal.

On neither of these two calls did I enquire about the price of the policy, or ask for a discount. I was given the discounts without even asking! Small discounts to compensate for the inconvenience experienced may have been warranted, but certainly not of the magnitude of the discounts given. Money has been left on the table.

Let's answer the opening question in a bit more detail: price setting could be anyone's responsibility: Marketing, Finance or Sales. But getting those prices is the responsibility of everyone in the organisation.

There is a Law of Discounting…

Ever had a conversation like this in your house? Your partner comes home with a bag of expensive-looking shopping.

You:                 Hey, what did you buy?

Partner:           I picked up this fantastic dress / suit (insert product of your own choice here).

You:                 Looks great. How much was it? 

Partner:           It was 50% off

You:                 Great! (No major damage to the credit card balance then, you think to yourself)

There is no doubt that we now live in a discount world. In his book "Bargain Fever" Mark Ellwood finds that the average discount offered in the USA 10 years ago was around 15% - 20%. Today, that average is closer to 45% which, being an average, means there are discounts much higher than 45% included in that figure. Anecdotally, the same trend is occurring here in Australia. But one thing is for certain: many companies can no longer be guaranteed that customers will pay full price.

Although Pricing is part art, part science, the (very common) conversation above breaches what is known as the Weber-Fechner law. Adapted to Pricing (and Behavioural Economics) from psychophysics research conducted by Ernst Heinrich Weber (1795 - 1878) and later Gustavo Theodor Fechner (1801 - 1887), the law states that the difference between two physical stimuli is proportional to the magnitude of the stimuli. So by not providing one stimuli (i.e., full price), the attractiveness of the discounted price, or the magnitude of the discount, cannot be properly evaluated and assessed.

In the above conversation, because we don't know the full or list price of the dress or suit, the partner doesn't know whether the purchase is a good deal or not. The same applies to the actual purchase by the customer. After all, there is a difference between 50% off a $2,000 dress or suit, versus 50% of the price off a $200 dress or suit.

Sounds perfectly logical doesn't it? And yet, I still see many companies still ignore this simple law.

A couple of years ago, while walking down Oxford Street in London, I picked up a brochure from a basket outside a telco’s store, which simply read "£20 Off". Once again, £20 off may be a great deal, but it didn’t say what the full price was and whether it was off a call plan, a handset or something else. The brochure didn't assist in evaluating the attractiveness of the offer.

More recently, there were two enormous billboards, side by side, on Platform One. At North Melbourne station. The first billboard read "Energy Bill Confusing?" Well of course they are, as anyone who has looked at a utility bill, or contemplated switching providers, will attest to. Ask someone what price they pay for energy, whether it's gas or electricity, and they won't be able to tell you. They will be able to tell you what their average bill is though.

The next billboard read "Ours is simple. Pay on Time and get 10% off". Feeling less confused? Hardly! The Weber-Fechner law has once again been ignored. Ten percent off what? Well that depends on what plan you are on, so while 10% off may reward you for good behaviour, it doesn't remove the confusion.

So what are the key lessons or take-always from this discussion? In many industries today, and particularly in B2C markets, a discounting strategy needs to be an integral part of any pricing strategy. The "base" or full price will come from your pricing strategy, but the price the customer pays, and your revenue maximisation opportunities, will increasingly be found in your discounting strategy.

Two Simple Pricing Rules That Will Help Every SME...

Over the years, I've conducted close to 80 public or in-house pricing workshops, all over the world. The general, consensus from attendees at the end of the program, whether it ran for three hours or three days, is usually something along the lines of "Wow, I didn't realise there was so much involved in Pricing!"

It should come as no surprise therefore, that being asked to write only 350 - 500 words for Small and Medium -sized Enterprises (SME's) on "the basics of pricing" is a formidable task, but one I will attempt to do by sharing just two simple rules of Pricing.

Rule Number One: Value is Subjective
Ask one person why they have private health insurance and she might tell you "...for piece of mind". Another might tell you " get out of the public health system", and a third might say something like " get back to work or home quicker".

These responses illustrate that all value is subjective. Yes, you can talk to them about features and benefits, but ultimately, value is in the eyes of the customer. So what are the implications of this for your pricing strategy?

Firstly, value is what customers are buying. They don't care about your costs. So the best way to increase prices is to increase value (and vice versa for decreasing prices), and not try to defend your price increase on the basis of the latest CPI figures.

Secondly, because value differs, between customers, so can (and should) your pricing. While one-on-one pricing may be "marketing nirvana", at a minimum there will be groupings of customers who see similar or identical sources of value in your product. They are called "customer segments", and rather than just giving them a warm and fuzzy name, develop actionable strategies towards these segments, whether it be targeted mail-outs or segment-specific pricing.

Rule Number Two: All Pricing is Contextual
If you're feeling downhearted after reading Rule #1, and learning you're not in control of this concept of value, the good news is that Rule #2 provides a solution, or at least some good assistance. You can shape perceptions of value by adjusting the context in which your pricing occurs. Let's look at some specific examples of this, which may be easily applied to your pricing strategy.

Why do customers pay more for an ice cold beer purchased from a five star hotel at one end of a beach, and less when the identical beer is purchased from a run down grocery store at the other end of the beach? Because the context in which the price is paid is different. Sure, the hotel can compete on price with the grocery store. But they will be leaving money on the table, and if you can win a customer on price, you can also loose a customer on price.

The $800 bottle of wine on a restaurant wine list also provides context: it's there to make the $80 bottle of wine look like really good value for money, and the one the restaurant really wants you to buy.

But don't stop there. Always try to offer customers three choices, the technical pricing term for which is "goldilocks pricing". Give the customer one choice, and you've got a 50:50 chance of winning the business. Give them two choices, and you are forcing them to make a price-based decision. But give a customer three choices, then firstly, the question they ask themselves is "which one do I buy?", not "should I buy from this vendor?" and secondly, you are forcing them to make a value-based decision (not a price-based one).

Many SME's are reluctant to exploit pricing to its full potential. But it is the most powerful profit improvement lever any company has, regardless of their size.