A Winning Tool to Manage Price: The Pricing Checklist

Sean D. Jasso, MBA; Peter L. Louie, MBA, PhD

2006 Volume 9 Issue 1

A Winning Tool to Manage Price: The Pricing Checklist

Have you reviewed your pricing strategies lately?

By Sean D. Jasso, MBA and Peter L. Louie, MBA, PhD

Photo: Michal Koralewski

Companies lacking a pricing culture often succumb to cost-based as well as reactive pricing methods. These methods serve neither the best interests of the company nor the customer. Creating a pricing strategy will proactively improve the company’s ability to make a profit and the customers’ ability to receive better value.[1]

Strategy

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Marketing is not the art of finding clever ways to dispose of what you make.
It is the art of creating genuine customer value.
-Philip Kotler

Scrabble board with words business, profits, success — Photo: Michal Koralewski

The pricing function of the marketing mix is often met with uncertainty, risk, and consternation. No doubt you may scratch your head regarding the following questions:

Can you authoritatively explain the methods used in the pricing of your products and services?
Do you simply price to cover your costs?
How often do you measure your pricing results?
Do you price to maximize profit for the company in conjunction with pricing to maximize value for your customers?
Why is effective pricing strategy so complex?

Price is actually not the problem. Instead it is the ineffective management of price that confuses customers, turns them away from your brand, diminishes your profitability, and eventually puts your business at risk.

This article provides managers with a set of winning pricing approaches that help the marketing department make pricing decisions that are proactive, strategic, and grounded in results. If you performed a literature review on the subject of pricing, you would find thousands of articles on a full range of pricing topics-many steeped in normative theoretical concepts that may serve the academician (or not), but that provide little value to the industry practitioner who needs to put a price tag today on goods or services.

Our experience working with clients that develop brilliant products, exhibit powerful entrepreneurship, invest in strong R&D, and have developed a solid customer base reveals that when it comes to strategic marketing, the traditional areas that get the most attention are product, promotion, and distribution. With regard to pricing, there is usually infrequent and little managerial oversight of this sensitive yet essential issue of price. This article offers the manager an organized Pricing Checklist for approaching price confidently, intelligently, and strategically. The article focuses on two areas of discussion: 1) the benefits of proactive pricing and models that have provided results for clients who have suffered from pricing myopia; 2) provision of a toolkit-a managerial checklist-to achieve competitive, profitable, and intelligent pricing.

The Virtue of Proactive Pricing

The best outcome is one that has been planned. Perhaps there is an element of excitement and risk associated with acting on a whim, but in reality, planning-a simple word for strategy-yields lower opportunity costs (tradeoffs) and hence higher returns, less stress, and more control of your assets. Remember that your brand is your most important asset, and price is your ultimate statement of worth and value to your customer.

Thinking strategically means operating proactively, that is, asserting your intellectual capital and all associated attributes to maximize a goal or objective. The title of this article asks a simple, question: “Have you reviewed your pricing strategies lately?” Frequently CEOs and marketing departments have no formal pricing policies. However, you must remember that the price is where all of the marketing investment meets the moment of truth between you (the brand) and the customer. By understanding the virtue of proactive pricing, you can build equity with your product, service, and brand.

Innovating Price Thinking: Cost or Value?

The literature on pricing reaches far and wide. At the heart of effective pricing is the theme of profit. The Big Question before you produce, launch, and distribute your product or service is, “How much money do you need or want to make?” Do you ask that question before you apply for a job, sell your widget, or design your service? What is your profit objective? With such questions, you are actually revealing your entrepreneurial vision, and price is the economic tool to achieve your profit goal.

The problems immediately associated with holding a mindset grounded in profit are the notions that a business is out for itself and that profiting comes before building relationships with customers. To refute these misunderstandings, we recommend the insight of Thomas Nagle and Reed Holden’s The Strategy and Tactics of Pricing: A Guide to Profitable Decision Making, 3rd Ed.[2] The authors maintain that with regard to price, managers have been poorly educated, misled, or have not learned about the concept of price integrity. An example of this educational void is the common use of cost-based or customer-based pricing as opposed to the proactive and strategic method of value-based pricing.

Cost-Based Pricing

Nagle and Holden argue that historically, “…cost-based pricing has been the most common procedure because it carries an aura of financial prudence [whereby] pricing every product or service to yield a fair return over costs is sensible and effective.” On the contrary, cost-based pricing “…in practice is a blueprint for mediocre financial performance”[3] mainly because the manager is managing expenses rather than managing profits. The authors provide a simple, yet powerful model that illustrates how managers must alter their focus on pricing to cover costs to pricing to maximize value for their customer and the company.

Common Practice

Cost-Based Pricing: Product→Cost→Price→Value→Customers

Proactive, Winning Practice

Value-Based Pricing: Customers→Value→Price→Cost→Product[4]

What Is Meant by Value?

Value is the “golden nugget” that entrepreneurs realize is the ultimate solution that their product or service can deliver for a customer. The essence is to put a price on this value and then build your product and its corresponding costs around the value. We suggest adding to Nagle and Holden’s model that entrepreneurial pricing drives the marketing mix in which value first is defined and then strategically aligned with profit objectives, followed by presenting the price tag to the customer with confidence and integrity. Many of our insights are influenced by the term entrepreneur or entrepreneurial. What do these terms mean? The entrepreneur is the individual responsible for and capable of taking the risk necessary for establishing and driving a business. Consequently, entrepreneurial pricing requires marketing managers to think like entrepreneurs-understand the profit and capital objective, price with integrity, price the value, compete, and lead the market.

Nagle and Holden clarify the difference between simply setting price and pricing strategically, where price setting demonstrates a reactive tactic to the market, and the market thus leads you. Conversely, strategic pricing is the “coordination of interrelated marketing and competitive and financial decisions to maximize the ability to set prices profitably,”[5] which ultimately entails that you proactively lead the market. Proactive pricing is not easy, since it suggests higher risks by leading rather than following a given market. Ultimately, proactive pricing affirms stronger connectedness with your customer’s value demand, affirms that your product’s or service’s price can rest on a strategic backbone and not merely on competitive forces. Lastly, proactive pricing implies that a greater entrepreneurial compass is guiding an enterprise in which the priority of profit is synonymous with growth, innovation, and customer retention.

Putting Proactive Pricing into Practice: A Brief Case Study

Recently a small business client whose niche is in design and manufacturing of retail furnishings was educated in the science of proactive and strategic pricing and, moreover, in the art of pricing value as opposed to merely covering costs. The client’s business was started out of a garage, but over the course of five years, the business moved to a large business park to facilitate its growth. The business was the epitome of the small business icon: innovative product, solid customer base, and healthy referrals. All of these marketing elements translated into a busy manufacturing floor featuring a productive team of initially 5, then 10, and now 25 employees.

All of the elements of the marketing mix were paying off. The product was strong, public relations and word of mouth effectively drove promotion, and distribution was logistically sound. However, this seemingly healthy marketing activity began to collapse under pressure of growth and demand because the firm not only had a mediocre pricing policy, but more directly, also had no pricing integrity to serve the best interests of the company’s profitability. For example, the company was tied to a cost-based tactic primarily because the product lines were customized and made-to-order. In a typical selling situation, a sale was driven by the customer’s customized needs followed by a profound delay in pricing all of the materials, manufacturing labor, and distribution costs. The pricing delay was the key variable that began to undermine the profitability of the company primarily because in the end, sales lacked the value demand of the customer and were priced according to costs and competitive fear that the customer would take their business elsewhere. In essence, the company was pricing too low and losing valuable customer relations time.

At this point our Pricing Checklist was implemented. With perseverance, training, and risk, the company began selling their product lines with a single price tag. Before the company’s use of the Pricing Checklist, customers had dictated the sales events because what they were looking for was a price up front that didn’t initially exist. For example, a typical customer order ranged from $35,000 to $120,000 for customized retail furnishings. Once the customer placed an order, the sales event was held up for days while design fees and materials costing were calculated, followed by a return call to the prospect with a price that was often negotiated down to the margin of minimal profitability. While the opportunity costs for a single sale were enormous, time lag between prospect and sales and reactive pricing metrics brought stress and mediocrity to the sales event. In essence, the company lacked pricing integrity, which is a willingness to adhere to the company’s strategic pricing intention, to price the value of an entire product system. Basically the sales department had no initial idea of how much to charge for its product.

The bold move of pricing a complete system valued in high dollar amounts is initially risky. Yet when value is sold to the customer-that is, the host of attributes that translate into value-added assets for the prospect-if the demand exists and the value is identified, sales will result. Of course putting your price out on the line is risky, yet it shows leadership, entrepreneurship, and that you are open for business.

Recently, the client realigned its pricing strategy to put the customer’s value demand first and to price its product based on this metric. The results attributed to proactive pricing have been positive: sales are increasing due to proactive pricing tactics, managerial stress is decreasing as well as the production time lag, more products are being made as bundled units-thus simplifying the sales event-and most importantly, profitability has been strengthened.

A Manager’s Proactive and Profitable Pricing Checklist

Graphing out the metrics — Photo: Alfonso Diaz

As you evaluate your current pricing strategy and consider the issues raised in this article, remember that the “difference between price setting and strategic pricing is the difference between reacting to market conditions and proactively managing them.”[6] In the following Pricing Checklist are six essential elements to help you design a proactive, strategic, and powerfully effective pricing policy for your company. Our hope is that at the very least, you consider using some of these elements (preferably all of them) regularly and that your pricing event is met with vigor, intelligence, and confidence.

PRICING CHECKLIST

1. Understand Your Business Model.

What are your revenue and cost drivers?
How do changes in these drivers affect your company’s financial benchmarks, e.g., sales, contribution, and net profit margins?
What pains are you solving for your future and current customers?

2. Establish Strategic Objective.

What are your pricing objectives with this product?
Are you maximizing market share by penetration pricing or current profits by price skimming?

3. Identify the Value of the Product or Service.

Who is your customer, and who is your competition’s customer?
What is the current marketing landscape, such as opportunity size, and what is your competition’s positioning?
What price do you think the customer would pay? Would the customer pay more?

4. Position Your Pricing Strategy.

Is the pricing strategy in alignment with the other elements in the marketing mix? For example, a high price skimming strategy will be incongruent with an undifferentiated commodity product distributed through mass channels.

5. Price with Integrity…but, Test as You Go.

Now, price your product.
Communicate the value of the product.
Measure sales, contribution, and net profit margins.
Adjust pricing strategy to maximize profit contribution of the product and reduce incremental and avoidable costs.
Should sales not reach your target, reevaluate your value proposition to the customer, re-examine the product offering, consult with your customer, and then make necessary adjustments to your price.

6. Make Pricing Part of the Culture.

Obtain regular pricing feedback from customers.
Evaluate pricing regularly (monthly or quarterly).
Develop standard pricing policies that promote proactive and strategic thinking among staff.
Don’t forget the value-for the customer and the company.

Conclusion

This article provides specific examples of a case in which companies traditionally lack a pricing culture and succumb to cost-based as well as reactive pricing methods in lieu of using more proactive and strategic approaches.

For the manager who is either remotely or directly related to the marketing function, especially senior leaders within the organization, we recommend addressing the questions we have raised today and determining if you can state with conviction your pricing methods, and moreover, whether your current pricing system leads or follows the market.

Finally, you will want to evaluate the important concept of value. Have you explored every aspect of value added benefits for your product offering, and is the value that you sell “a portion of the value created for [your] customers [and is it] recouped by the company?”[7] Our hope is that the Pricing Checklist approach will stimulate a pricing debate in your organization that will encourage your team to audit its pricing strategy and tactics to ensure that entrepreneurship, business strategy, and profit remain guiding principles for your company.