Despite its vital role in firm profitability, sustainability and survival, pricing has not been considered an executive management task.
According to data from the Professional Pricing Society, the world’s largest organization dedicated to pricing, fewer than 5% of Fortune 500 companies have a full-time function dedicated to pricing. At the same time, McKinsey & Company has estimated that fewer than 15% of companies do systematic research on this subject. And only about 9% of business schools teach pricing, according to the Association to Advance Collegiate Schools of Business.
This neglect of seeing pricing as a company strategy is however a bit puzzling considering that pricing has an immediate and substantial effect of company profitability. Studies have shown that small variations in price tactics can raise or lower profitability by as much as 20% or 50%. 1
The JC Penney story
Not only studies support these findings, but also real cases, where companies failed to take notice of the importance of strategic pricing. An illustrative and well known example is the unsuccessful reinvention story of the famous US retailer JC Penney; the company has been extensively in the media spotlight after their strategic misjudgment.
JC Penny took the misguided decision of replacing its sales through coupons with everyday low prices. In early 2012, the company announced a major overhaul of the way JC Penney does business, with a new “fair and square” everyday low pricing scheme to replace the “fake prices” used commonly in the past. The idea sounded great, in theory. Didn’t everyone hate those “fake prices,” which were inflated only so that the inevitable discounts would seem tempting?
Well, no. Shoppers are often drawn to stores not by the promise of fair pricing, but by the lure of hunting for deals via coupons and price markdowns. It’s all a game, and a contrived one at that. But it’s a game that shoppers are accustomed to playing, and that many, consciously or not, like playing, with the “How Much You Saved” line at the bottom of the receipt serving as a score. It didn’t take long for people to note that the no-coupons, no-sales experiment was failing to attract customers. Sales collapsed through early 2012, denoting a misguided strategic step for the retailer. 2
The examples of faulty pricing strategies can be expanded to other industries as well. When Bank of America announced in September 2011 that it would start charging a $5 monthly debit card fee, the public outcry was so intense that the bank soon rescinded the plan. But the damage was done: Account closings in the final months of 2011 increased 20% compared with the same period in 2010.
When Netflix implemented a 60% price increase in July 2011 for customers who both rented DVDs and streamed video, 800,000 users cancelled their service and the company’s market cap plummeted by more than 70%. 3
Corporations worldwide tend to use “rules of thumb” to establish prices for their offerings. By using multiples of estimated costs to set prices and then reacting to competition with discount tactics, firms often price reactively resulting in the draining of profits (and therefore, corporate resources) in the industry.
What does differentiate successful pricing from failing strategies?
Although companies that sell services to individual end-customers may be radically different from companies that sell jet engines to sophisticated purchasing centers, and although pricing approaches in India may differ considerably from pricing approaches in Finland, pricing approaches across industries, countries and companies usually fall into one of three buckets: cost-based pricing, competition-based pricing or customer value-based pricing. 1
Companies that benefit from a high pricing power have proven to share some common traits: culture dedicated to pricing, sophisticated tools to quantify customer willingness to pay and customer price elasticities and robust pricing processes.
These companies typically have high confidence in their ability to implement list price increases and to defend their price levels vis-à-vis customers. They also have dedicated senior personnel responsible for pricing. These senior positions are responsible for implementing robust organizational processes to ensure discipline in price setting and price getting. This means that pricing decisions are embedded in robust structures and processes, rather than being left to the discretion of sales personnel in the field. Executives in companies with strong pricing power are actively engaged in improving pricing capabilities and in improving overall system effectiveness.
References
- A. Hinterhuber and S. Liozu, “Is It Time to Rethink Your Pricing Strategy?”, MIT Sloan Management Review 53, no.4, 2012
- B. Tuttle, “The 5 Big Mistakes That Led to Ron Johnson’s Ouster at JC Penney”, April 09, 2013, www.business.time.com
- M. Bertini and J. T. Gourville, “Pricing to Create Shared Value”, June 2012, Harvard Business Review, www.hbr.org