For many companies,
pricing is more art than science. A lack of precise data about customer
preferences leads many pricing managers to make decisions based on
"feel" rather than facts. Lately, sluggish demand, overcapacity, and
Web-enabled comparison shoppers all seem destined to drive prices down
to their lowest common denominator: what the competition charges, or
what the best customers get.
Yet pricing need not be
an economic endgame. In fact, pricing should be a powerful lever for
achieving specific business goals. Analytic frameworks supported by new
technologies are enabling some companies to develop pricing strategies
based on reliable predictors of customer behavior. Some are maximizing
margins by eliminating unwanted features. Others are increasing
penetration by tailoring products for more precisely defined segments or
expanding the market by adding new features. Taking a focused and
disciplined approach, managers can put
back into pricing by following six basic steps.
1. Know your strategic business objectives:
Developing your pricing strategy begins by asking: “What
are we trying to achieve?” Organizations need to be very specific about
this, because broad generalities such as “being the market leader” will
not provide the direction needed to make tough decisions. The pricing
strategy required to drive penetration often differs from the one needed
to gain market share, which in turn differs from the pricing strategy
that will grow revenues or maximize margins. Starting with a clear set
of strategic objectives will make pricing strategy decisions much easier
once you develop a good understanding of how customers respond to
2. Embrace the science of pricing:
Too many pricing and product feature decisions are made
using inconclusive or anecdotal evidence. Lacking concrete information,
managers are forced to make pricing decisions based on anecdotal
experience or personal hunches. This also exposes pricing strategy to
the influence of organizational politics, where value-destroying habits
can become entrenched as misaligned sales incentives or cost-focused
thinking rules pricing decisions.
Thinking strategically about pricing begins with the
willingness to adopt a disciplined, data-driven approach to pricing
This means using information to discover how price and other product
attributes affect customer behaviors, and applying this knowledge to
develop a pricing strategy that supports specific strategic objectives.
3. Think in terms of value, not cost:
Business strategy is about
value. What your organization does—the goods or services it provides,
and the activities it performs to provide them—largely determine how
is an entirely different discipline, and pricing is the primary
mechanism by which any organization realizes its own share of the value
Too many organizations
that take a “cost plus” view of pricing with little consideration of
business strategy and customer perception of value. Because cost data is
often the most readily available information to pricing managers, the
“default” approach is often to set prices according to cost.
Price and cost together
dictate profitability, and profitability is a good indicator of whether
or not your organization should be involved in a particular business.
But your own cost structure tells you nothing about your customers’
perception of value.
Effective pricing strategy is about understanding what the
customer is willing to pay—not
how much margin the
is hoping to earn, or willing to sacrifice to boost revenue.
4. Look for patterns of customer behavior:
Modeling customer preferences and predicting their willingness to pay
has challenged marketers for decades. While many segmentation techniques
have attempted to simplify patterns of customer preferences, evidence
suggests that the most reliable segmentation models are based on
purchase behaviors. Traditional psychographic and demographic data can
be very useful in targeting, but modeling customer preferences is often
best done through analyzing buying behaviors.
Behavior-based modeling is effective because it has
proven to be a good predictor of customer response.
The best pricing strategists are learning to use more sophisticated
research and analysis techniques to identify behavior patterns that are
likely to repeat themselves. These are quantitative models that predict
what happens at the margin: how incremental changes in the
offering—including price and non-price attributes—affect purchase
It is equally important
to understand how customers make trade-offs among product features. Many
managers overlook product configuration when assessing their pricing
strategy options. For example, a price drop on a competing product tends
to provoke a natural reaction to match the price decrease. Yet it is not
unusual to find untapped sources of value in new product features that
can provide the differentiation needed to sustain or even increase
prices. Or, there is opportunity to lower prices and drop unwanted
features that contribute unnecessarily to product costs.
5. Test your hypotheses:
Predictive models can give a sense of how customers will behave given
specific choices, but these models are only as good as the data used to
build them. The exploratory survey methods often used in new product
development or enhancements rely on customer responses to hypothetical
situations, not their actual behaviors. No technique can fully predict
what will happen in the real world, nor can any amount of modeling
overcome the absence of “real world” data.
Some organizations are
in the enviable position to use powerful software tools to test pricing
and identify relevant patterns using live data. Zilliant, a software
company, has received complimentary press coverage lately for its
exciting work in testing prices in “live” settings. Zilliant’s software
enabled DHL to experiment with different price points for phone-in
customers to determine revenue-maximizing prices in over 40 markets.
recently described how large retailers analyze millions of sales
transactions to alter the timing and extent of product markdowns to
improve revenues and margins.
Most organizations are
not in the position to develop and test pricing strategies using
real-time data. Configuring highly analytical software tools to analyze
purchasing patterns for hundreds of items across dozens of markets can
take months of effort. Thus,
ability to quickly develop hypotheses and rapidly test them in
controlled environments is a critical capability for fine-tuning pricing
This is especially important for consumer good companies that use highly
targeted promotions and other direct marketing tactics. The best
consumer marketing organizations have well-defined processes for quickly
developing and testing pricing strategies.
6. Take Action.
New analytic frameworks and software tools have made
pricing a more scientific discipline. More information has meant more
opportunity to study the effects of pricing changes, and some
organizations now employ small armies of analysts devoted to price
modeling. However, it is critical to maintain an organizational bias
toward action, rather than study.
Strategic pricing is as much about timely execution as it is about the
right information. Some organizations can develop, test, and execute a
promotion in as little as four weeks. In general,
organizations should be able to research, test, and
implement pricing strategy within 2 months.
Organizations can shorten their pricing strategy cycle times by taking a
more proactive approach to learning from customer behaviors. This starts
with accumulating relevant customer transaction data and frequently
analyzing it for relevant patterns.
Finally, organizations need to be pragmatic about pricing power. This is
especially true in multi-level relationships. One client, a small
supplier of a highly commoditized consumer good was thrilled to learn
that their product was priced in a high-volume retail channel at a lower
point on the inelastic part of the demand curve. They could raise the
supplier price a few cents, the retailer could pass it on to the
consumer, and everyone would be happy. The only catch was that the
retailer was Wal-Mart. Any pricing strategy needs to take into account
the reality of the company’s position within the value chain.