I am often asked ‘what is the right pricing for my product?’ What pricing Methodology should I use to get there? To these questions, I typically explain how we can strengthen our market leadership through our pricing strategy and decisions. These decisions should be broadly based on our foundational goal of building sustainable competitive advantage by having right product at the right price for the right reasons, for the right customer, each time enabling us to highly satisfy our customers (external) and meet our stakeholder expectations (internal).
Why do we review prices?
To enable us to be a market leader, we must invest in our chosen business sector, including vital research and development that brings new and transformational technologies to market, leading us a competitive edge. We need to ensure our capability to serve the current needs of our target customers, also for future improved outcomes of these customers and an ability to expand into any aligned opportunities.
Right Product, Right Price, Right Reasons, for the Right Customer, each time
To manage Price effectively, a check of external consistency helps us determine that the price-value proposition for a particular product is in line with (preferably superior to) the price-value proposition being offered by all other the competing firms (as the next best alternatives). Similarly, we also explore the relationship between value being delivered and our competitive position and its impact on our broader business strategy. (Eg; growth, market presence and cash flow).
Thecheck of internal consistency helps determine if all the products in our portfolio are priced to value, (i.e., a product delivering higher customer value is priced higher than a product delivering lower value). Another aspect of internal consistency is about cost-value-price consistency. We ask ourselves – are we able to price to recover the cost (and earn a reasonable margin) that we need for delivering the promised value?
Together, the external and internal consistencies also highlight the cause-effect relationships. For example, our ability to create and deliver value can help us realise better prices and more volume simultaneously. While investment combined with a cost for a value-based strategy would deliver greater than a volume-based strategy, our ability to get better prices should compensate for incremental costs and investments, thereby helping us earn better margins. An increase in volume would lower our unit costs, thereby creating a *virtuous cycle of value creation. (*as described in a previous paper discussing WTP).
Product Price Positioning
We discussed the need to ensure internal and external consistency in our pricing decisions. However, we may experience an increasing complexity in our product portfolio as we try to cover different customer segments through our additional products and brands. An increase in portfolio complexity would also imply an increase of complexity in our price management process.
To offset the complexity, we can highlight how pricing for value can simplify the pricing strategy choices. The higher value-adding products are priced higher. If we do not price a product to its value, we either lose customer or margin. A standard product (delivering limited value) gets priced lower than an innovative product or a service intensive product, while an overall better total solution should help us to better price realisation than the individual components of an innovative product or service offering.
The scenario diagram below shows variations in Cost to Value relationship performance for different customer segments.
A. The yellow segment on left highlights where the supplier has a cost-disadvantage, i.e., it costs more to produce limited value (High cost dominates the area representing value being created).
B. On the other hand, the grey area on the top right hand side shows the supplier has a cost advantage in creating value, i.e., less cost to create incremental value. (Value being created exceeds the contained cost).
C. The middle segment represents where we have the cost-equivalence, i.e., the cost increases remain in proportion to the value being created.
The result of a better product management will give the supplier a cost advantage (efficient operation- it costs little to produce significant value). Alternatively the result of poor product management will give the supplier a cost disadvantage (inefficient operation- it costs a lot to produce limited value)
Further we identify the expected price activity as we overlay the price line over the cost-value areas describing three different pricing situations.
Situation A: The supplier has a cost disadvantage, i.e., it costs a disproportionate amount of resources to create value. It is likely that the customer would keep negotiating prices down to the lower value being delivered and the supplier would not be able to recover cost, resulting in a loss or below normal margin. (Left side blue line segment).
Situation B:On the other hand (right side green line segment) illustrates a situation where the company has a cost advantage, i.e., it can produce additional value at disproportionately lower cost. In this situation, it is expected that the customer will be willing to pay a price that is closer to superior value and the supplier will be able to earn above normal returns.
Situation C: Describes a situation where the cost and value are equivalent, i.e., the costs and value rise in the same proportion. At this stage, if the customer recognises the value we are delivering, it is expected that the customer will have willingness to pay a price equal to our target levels – resulting in our realising a normal margin. (Middle Red line segment – Price Equivalency)
As it will help our understanding in this complex pricing environment, we should use the following model to describe the relationship of our pricing strategy with in-market consistency.
In the ideal world, we would expect the competitive position to become stronger as our company offers additional amount of value. Here we describe the market relationship with the help of the green arrow on the 45° line.
A position below the 45° arrow represents a market flooded with multiple undifferentiated products wherein a firm is not able to build a strong competitive position even when it is delivering high value. It is also possible that the firm in question is delivering value on misplaced priorities. In a situation characterised by weak competitive positioning, we would expect a firm to base its pricing strategy on the competition ‘market’ pricing levels – characterised as Market Follower Pricing Strategy.
A position (top left) above the 45° arrow represents a unique competitive position where the value delivered has little influence over a firm’s competitive position – a position that is not easily sustainable. It is a premium pricing situation wherein a firm is able to charge a premium pricing (over value and costs) as a result of its unmatched competitive position.
As we move to the best position (top right) above the 45° arrow we have a competitive situation which is consistent with the value being delivered – a position characterised as the Market Leadership pricing. In other words, we are able to identify customer needs, deliver to those needs and offer a superior price-value proposition that differentiates us from the competition.
Price Positioning and Market Dynamics
The above detailed discussion allowed us to present an entire value pricing framework together – linking Price-Value-Cost-Competitive position. Our objective, of course, is to build a sustainable market leadership by pricing our products to value with additional margin for being innovative and cost effective. Market follower would end up price to discount on value and the margin would depend on its cost performance. On the other hand, a commodity market is likely to be characterised by market-based pricing, with no clear leader.
Further to this discussion to better understand value based pricing methodologies, a good way to transition to a practical application of the Right Product, Right Price, Right Reasons, for the Right Customer, each time is the use of ‘Value Maps’. Value mapping is an easy method for quantifying our price position against the value we are offering and compare it against our competitors’ price-value position. A value map also allows us to build a hypothesis about how the competitors are likely to react to price changes initiated by any one of the players. However we will leave this topic of value maps for another discussion.
Thanks for staying with me to the end of this topical discussion ‘what is the right pricing for my product?’