“In many companies, pricing is an area where the level of sophistication does not match the importance of the topic,” says Marco Bertini, Associate Professor and Head of the marketing department at ESADE.
There are only three real drivers for profit: price, costs, and sales volume. Of these, price has by far the strongest impact. While many companies recognize that pricing decisions have substantial impact on the bottom line, far too many do not exploit this opportunity and fail to design a thorough strategy.
“In many companies, pricing is an area where the level of sophistication does not match the importance of the topic,” says Marco Bertini, Associate Professor and Head of the marketing department at ESADE.
After obtaining his Ph.D. from Harvard Business School, Bertini has built his career researching, teaching and working with businesses on the question of monetization, especially the psychology of pricing decisions.
Companies that look at pricing decisions purely as questions of optimization can severely hurt what their company stands for.”
“Pricing is a communication tool just like advertising or all the other standard methods – and it should be consistent with these messages to customers,” Bertini points out. “Companies at the extreme ends of markets – luxury companies and so called ‘low cost’ companies – know that price and brand are intimately related. In between these extremes, things can get blurry: companies may not see that their pricing decisions impact the realization of their strategy.”
“Companies that look at pricing decisions purely as questions of optimization can severely hurt what their company stands for. Their pricing can be destructive,” Bertini cautions.
“Take for example a bank that attempts to extract everything it can from every transaction, seeking revenue streams with all kinds of fees and added costs – it does so without realizing that, before long, its approach will lead to disgruntled customers who have lost their trust in the company, or even the industry,” he emphasizes.
While this kind of aggressive approach may have worked in the past, it is detrimental in today’s market. Consumers are fast to notice if a company’s prices seem unfair, they actively share and compare pricing information on social media – and easily take their business elsewhere.
“Many companies still think of pricing as a mere technical issue. Although it certainly has technical elements, there is a significant strategic component to pricing. If there is one foolproof way to assure you fail in pricing, it is not realizing that there is a link between the pricing decisions you make and the strategy of the organization,” Bertini asserts.
The four key steps of strategic pricing
Bertini lists four key steps that should be addressed in developing a sound pricing strategy: designing the revenue model, establishing a process to set prices, agreeing on the arguments useful to defend prices, and setting rules to vary these prices.
Step 1: the revenue model
Designing a revenue model is about understanding what the company’s policy for making money should be. It often means challenging assumptions that the industry as a whole takes for granted.
“Think of a laptop for example. Should the company put a price on the laptop itself, or perhaps the use of the laptop, or the performance of the laptop?” Bertini questions. “Your revenue model should track the value delivered, making sure money is not left on the table and customers are not burdened with inefficiencies.”
There is a clear trend going on: industries are now moving towards a ‘pay for performance’ method.”
Bertini reminds that technology gives us tremendous opportunity to identify and measure the value created for customers: “IoT, micropayments – technology is radically changing everything we do and how we are able to appraise value.”
While technology has made it a far easier task to understand what customers value, it has also enabled customers to easily gain extensive information on prices offered.
“We are in an information race, where readily available information is helping both customers and companies,” Bertini adds. He underlines that it is important to note that companies are not pricing to their customers but with their customers.
“There is a clear trend going on: industries are now moving towards a ‘pay for performance’ method,” Bertini affirms.
Step 2: setting prices
After designing a revenue model, step two is establishing a process to prices.
“How much? This question cannot be answered simply looking at costs,” Bertini remarks. “One of the key reasons why companies fail in pricing is being too internally focused, with pricing decisions driven mainly by cost structure or the desire to outdo competitors.”
Bertini explains that at this stage, the company wants to complement internal information on (the right) costs with external information on what competitors are doing and, importantly, their best assessment of what the customer actually values the product or service at.
Step 3: defending prices
With a revenue model and a process to prices established, step three is finding the right arguments to defend the value of a product or service with confidence.
When the value of an offering is clearly understood by both firm and customer, price is seldom a problem.”
“Customers want to get the same product or service cheaper and competitors may look to undercut you. There is truth to the saying: ’When the value of an offering is clearly understood by both firm and customer, price is seldom a problem.’ Companies need to be able to quantify value, and give a sense of calibration and confidence that helps fight off the pressure imposed by clients. Moreover, companies need to be able to signal fairly and legally to competitors about their ability to lead a market,” Bertini says.
Step 4: varying prices
Bertini claims that, from a pricing standpoint, not all customers are equal. This takes us to the fourth step, varying price:
“Certain customers find more value in a product than others do. Using one price point across the market is thus bound to be wasteful – either underestimating the worth of the product and leaving good money in the customers’ pockets; or overestimating worth and hampering sales that would make financial sense, albeit at a lower level.”
“In price variation, companies must seek opportunities for price discrimination that are palatable to customers,” Bertini concludes.
Marco Bertini teaches monetization at Aalto EE’s Strategic Pricing program which looks at pricing from a strategic management perspective. The program proposes alternative approaches that lead to better pricing decisions with a direct impact on a company’s financial performance. Read more about the program