Great article, Richard, gave me some insight of pricing for big companies. Would be very intriguing to see your take on pricing for small service businesses, like consulting. I'll check your article archive.
Pricing: Marketing's Nuclear Weapon
Pricing is a dangerous weapon. With good analysis and proper implementation, it can win the war. It can also trigger a very undesirable competitive response and that is what we call mutually assured destruction.
I’ve seen a lot ways in which people have priced products and services. Some are incredibly well thought out and others leave something to be desired. Here’s a short list of pricing techniques commonly employed today:
Price to market
Price to closest competitor
Price to achieve a specific margin
Price to achieve a certain personal or corporate net income
Price at an X% premium or discount to market
Price at the same level as last year and where that price came from, who knows
Price X% over last year
Price to win
Price to lose
All of them can be legitimate methods for setting prices. All of them are fraught with peril. Without getting too technical, here are some factors that need to be considered when using those methods:
Your cost structure compared to your competition
Price sensitivity of the market
Do you have the sales and marketing ability to convert lower prices into increased volume?
How much additional unit volume will be realized from a price reduction?
What value does the market place on your differentiation?
How much additional volume will it take to achieve economies of scale in your supply chain?
What is the market price?
And the list can go on and on. The point is that playing with price is complex subject requiring the need to understand the financial dynamics of your business, your organizational capacity to implement a new price effectively, your competition and the market. Not easy, but the rewards are potentially enormous for those who dare tread the thorny path.
One of the truly great successes in my career was largely the product of using price as a marketing weapon. I had just moved into a $100 million factory automation business with responsibility for marketing and strategic planning. The company was losing $1 million a month and corporate wanted me to go stick my finger in the dike or die trying.
Pricing had been the responsibility of the controller. I guess the thinking was that if the company was losing money, they were pricing too low. That was a hard conclusion to follow as they were losing market share faster than they were losing money.
The result was that what work was won was the work no one else wanted. Complex projects with high risk that often resulted in delivered margins far below what was expected.
I lowered our pricing dramatically. I asked sales what price needed to be to win the work. While I don’t recommend using the price that sales wants as a good strategy, asking the question is always good policy. Based on our cost workups, I tried to get as close to the “winning” number as possible. We started winning good projects and avoiding bad projects. In two years, we had doubled our market share and were producing margins at record levels.
This succeeded because:
Price sensitivity of the market – highly sensitive, our projects would run $20 to $50 million, a 10% decrease in price was serious money.
Do you have the sales and marketing ability to convert lower prices into increased volume – we had a dedicated sales force and our company had a quality reputation.
How much additional unit volume will be realized from a price reduction – one additional win a year would have paid for the lost margin, but we won far more than that.
A not so positive outcome came when running another business in the B2B world. Sales and marketing were centralized so sometimes things happened outside of your control. We sold a significant quantity of a branded product that made an essential contribution to our bottom line. It was not the best product on the market and it was expensive. It did, however, have committed customers that liked it enough to pay the premium.
The division marketing manager decided the best way to energize sales of the product was to slash the price and price to market. Ordinarily, this would not have been an unreasonable thing to do. Pricing to market is one of those no-brainers, all other things being equal. He and I both knew they weren’t, so why he did it, I’ll never know.
What hadn’t been calculated into the equation was:
Your cost structure compared to your competition – we were a $30 million business competing in an industry dominated by $1 billion plus competitors.
Do you have the sales and marketing ability to convert lower prices into increased volume – we had a centralized sales force that had no interest in selling the product.
How much additional volume will be realized from a price reduction – we needed to increase volume 500% to breakeven, volume didn’t move.
The moral of the story is pricing is a dangerous weapon. With good analysis and proper implementation, it can win the war. Done incorrectly, it can trigger a very undesirable competitive response and that is what we call mutually assured destruction.
Don’t use the nuclear option without being very sure of yourself.
Learn more about the author, Richard Gabel.
Comment on this article
Posted by Nick Webb, Seattle, Washington |
Jun 19, 2011
Posted by Richard Gabel, Issaquah, Washington |
Jun 20, 2011
Thank you Nick. I believe most of the points apply to small businesses and professionals. In consulting, price can convey the quality of your service. With a higher price, you can also offer discounts to close a deal and have your clients feel they are getting superior consulting for a lower price.
I think the big issue is that if the market doesn't know you exist, your price doesn't matter. You also need to have a good feel for what the market rate for consulting is in order to establish your pricing strategy.
Posted by Johnson Smith, London, London United Kingdom |
Jun 30, 2011
Great post! I found your read very informative and nicely compiled. Thanks for sharing the insight of pricing for services and products. Instant cash
Posted by Richard Gabel, Issaquah, Washington |
Jun 30, 2011
Thanks Johnson. I appreciate the comment.
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