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Principal Pricing Methods & Approaches – Part II

Strategic Pricing, preferred approach for creating long-term value

In follow-up to the description in Part I of Value-Based Pricing and other pricing approaches prevalent in the market, we’ll present in Part II an overview of what Strategic Pricing is all about and the advantages it brings to companies seeking to implement a profitable, sustainable approach to pricing across their portfolio of products and services.

WhiteHeron Software has developed a software suite, WhiteHeron Pricing™, based upon this approach which is more broadly applicable in B2B markets and particularly adapted to the turbulent times in which we live. It is designed to align a company’s pricing strategy to its longer-term business objectives while also taking advantage, when possible, of the best elements of other methods such as Value-Based Pricing.

Strategic Pricing applies the business objectives of the company to its pricing strategy. As such, it provides an overall framework aimed at maximizing the company’s total mass margin over the long term. For a limited number of customer x product segments, Value-Based Pricing can be rolled into Strategic Pricing when dealing with innovative products for which sufficient knowledge of the company’s processes and cost structure have been ascertained via prototype testing. Price Elasticity may also come into play when comparable pricing data are available.

Convinced of the benefits of Strategic Pricing,we have molded this pricing approach into more of a holistic pricing process guided by four precepts:

  1. A company’s Pricing Strategy must align with its Business Strategy (objectives for growth, profitability and/or market share per business segment).
  2. EBIT-level cost and margin transparency are essential in defining a robust pricing strategy.
  3. Strategic Target Pricing needs to be derived from Target Margins by business segment and at the same time take in account the competitive context of each transaction.
  4. Management needs to continually monitor compliance in the execution of the pricing strategy by the sales force or, alternatively, adjust the pricing strategy when needed.

Let’s drill down into each of these four pricing precepts:

Precept N° 1. Translate the company’s business strategy into the pricing strategy The Business Strategy defines top-level objectives – at the business segment level – for growth, profitability and market-share. This, in return, requires a clear definition of customer x product business segments. Segments can be summed up as the homogeneous competitive territories in which the company operates. Typical business objectives might include maximizing production capacity by protecting the volume of big runners with low margins, quickly penetrating a new market through aggressive pricing vis-à-vis the competition, leveraging value-based pricing for innovative products, milking mature business segments with high margins where the company is dominant, etc. Surprisingly, many companies have established these types of well-defined commercial objectives leveraging real business segmentation but have failed to take the additional step of translating them into their pricing strategies.

Precept N° 2. Develop in-depth intelligence on margins and costs In order to define their business strategy by business segment and to get a handle on the competitive situation, companies must achieve full cost and margin transparency. Frequently, they are able to assess their gross profitability at a high level; however, Strategic Pricing requires a granular view of costs, including capital and fixed costs including those tied to investments. It is not always easy to identify the principal cost drivers nor to model their impact on cost behaviors at each step in the value chain (cost laws). It is only in understanding the impact of product specifications and customer service on the company’s resource consumption that it is truly possible to correctly allocate complexity costs and thus avoid cross-subsidization within the company’s product portfolio. They also help in getting a relevant and reliable view of product and customer margins while keeping costing simple and manageable. Even large companies with sophisticated controlling processes often face challenges in this area.

Precept N° 3. Determine the target price adapted to each sales transaction Strategic Pricing helps set the right Target Price for each sales transaction, i.e., for a given product to a given customer in a given competitive context. The Target Price thus takes into account the strategic objectives applicable to the concerned product x customer segment as well as other factors capable of influencing the price (price drivers) in the specific context of a given sales transaction. By way of example, typical price drivers include the strength of the local competition, the size of the customer or the level of urgency of the sales order.  

Precept N° 4. Continually monitor price performance in a self-learning way The analyses of Variance to Target Prices and Win Rates are two key metrics for determining sales force compliance with pricing guidance and for deciding when and how to adjust the current pricing strategy. A full-fledged pricing performance system helps track the different sources of price leakage and supports a virtuous improvement cycle based on a continuous feedback loop from actual sales prices to Target Prices at the transaction level.

Having written an article during the height of the Covid-19 epidemic, Laurent Dumarest1 saw the resulting economic crisis as having unprecedented consequences for businesses. With limited to no visibility on future market conditions, business leaders are struggling to decide which pricing approach to adopt: Set lower prices and sacrifice margins to maintain a minimum level of activity and absorb some portion of their fixed costs? Set higher prices to benefit from market shortages? Match price moves of the competitors at the risk of setting off dangerous price wars?  Index sales prices on changes in raw material costs to protect margins? As explained in his article2 published in August of 2020, “In a situation where everything can change very quickly, companies should not engage in guesswork or be content to follow market prices. Rather, it is essential that they set a course, that is to say a robust pricing strategy, while being extremely flexible and responsive to market signals”. Strategic Pricing is his preferred pricing approach, especially during turbulent periods like the one in which we are living.   

With its modular architecture, WhiteHeron Pricing integrates all the components needed to fully enable Strategic Pricing: pricing analytics, granular cost modeling and margin transparency at the customer and product level, strategic price setting, list price and discount structure management, price quotations and price performance tracking while delivering the most effective pricing methodology for creating long-term customer value.

Notes:

  1. Following 25 years as a Partner at Kearney, founder of Dumarest Strategies, a consultancy firm focusing on top line growth, margin optimization and Pricing.
  2. Article published on August 5, 2020: What is the right B2B pricing strategy during the crisis? 
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