Pricing: Marketing's Nuclear Weapon

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.