Posted: 07 Oct. 2014 10 min. read

Is Your Price Right?

How does your organisation think about pricing?

There are two simple approaches to pricing – “price leading” and “price following”. Since price is a sub-component of many functions (e.g. marketing & branding, sales, product design, finance, growth strategy, risk management) and rarely a dedicated function, organisations tend to price follow themselves, or competitors.

‘This year’s price is 4% higher than last year’s, because it “feels right”. Increased competition in our market means we need to discount more than normal.’

Anecdotes are often used instead of facts, leading to a lack of direct accountability for pricing decisions. This results in the inflation of the organisation’s risk profile. In a competitive market like Australia, this will ultimately result in unacceptably low margins and large numbers of unprofitable customers or services, offloaded onto you by your competitors (who may have perfected their pricing strategy).

Similarly, in light of the growing discrepancies in labour costs and disposable income across geographies, businesses are missing out on opportunities to increase their prices in regions with higher labour cost growth.

Does your pricing structure incentivise what is in the mutual interests of you and your customer?

In the past five years, we have experienced significant shifts in our economy across multiple domains

  • industry (e.g. the mining boom);
  • geography (e.g. growth of the regions); and
  • external influences (e.g. iron ore and coal price changes, AUD variation).

These factors directly affect the fundamental cost drivers of most businesses (e.g. labour, imported product costs, etc.). Consequently, businesses should either “price-in” the cost of risk of these factors changing, or alternatively, “set price” in a way that distributes the risk between the business and its clients.

As an example, jet engine manufacturers have adopted performance-based “power by the hour” pricing models, whereby the owner of the engine only pays for available engine hours. This approach to pricing has many implications:

  • Product reliability is directly linked to revenue, incentivising valuable behaviour throughout the organisation.
  • Customers are paying for the outcome they want (a flying plane), rather than the mechanisms to achieve their outcome (e.g. an engine, spare parts and an engineer).
  • Competition by low cost aftermarket parts manufacturers is lessened, which safeguards significant research and development investment, and increases “trailing revenues”.

So who is responsible for ensuring that your price is appropriately competitive and representative of your value proposition?

A dedicated pricing function is critical to balance the competing interests of CFO’s, CMO’s, CEO’s and the Head of Sales. Likewise, it drives accountability and ownership via a clear governance mechanism and supports adherence to pricing policies across the business.

And why is an agile, flexible pricing strategy more important now than ever before?

Aggregators are comparing products as commodities, separated only by price. Online shopping makes it quicker and easier to shop around and review the competition in a larger market than ever before. Some businesses are using this to target high margin services offered by large incumbents. We have seen several industries undergo disruption from small, nimble competitors who take the market by surprise, often using low cost imports and smart pricing strategies to grow quickly, at low risk.

Consequently, it’s never been more critical to know:

1) The value of your products: Does your marketing, branding and sales team align to the value proposition? Does pricing reinforce the proposition?

2) The profitable core of your business, across customers, services, channels and geography: Are any customers taking you for a free ride? Are you doing all you should do, to take care of your highest-value customers? If you face “big customer risk”, is your pricing structure managing that risk?

3) How your pricing strategy aligns to the business’ objectives: Does pricing target margin, or revenue? Are the goals understood by decisions makers throughout the business, including those in front of the customer?

By working through these questions and identifying the price leader in your business, you can shift pricing from being a threat, to a competitive advantage.

Alon Ellis is an experienced Director, having developed bespoke analytical solutions for business problems, in a range of industries, across the US, UK and Australia. Alon’s focus area is the integration of Analytics into Strategy & Operations methodologies, with the purpose of creating granular, actionable insights, across a complex, and often disparate fact base.

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