Price Management Process

The price management process encompasses various elements beyond mere price setting. A comprehensive price management process consists of several key phases: pricing strategy, price definition, execution, and monitoring, all supported by robust data analysis. (Fig 1).

Pricing Strategy

The pricing strategy outlines the methods to achieve the financial objectives pursued by the business. Common financial goals encompass aspects such as price, volume, market share, revenue, gross margin, EBITDA, and more. These variables directly influence price management, and certain goals can be at odds with each other. For instance, goals related to profitability may contradict with objectives focused on volume or market share.

A successful pricing strategy clearly outlines a balance between price, volume, and margin percentage to achieve the desired absolute margin, considering the trade-off between lower volume and market share levels on one hand, and higher profitability on the other. Depending on the business's maturity, one variable may take precedence over another. For instance, if a company aims to enter the market with a new product, it might sacrifice margin percentage to gain market share. Conversely, an established company seeking to increase EBITDA may focus on maximizing absolute margin, even if it means sacrificing volume to achieve higher percentage margins.

The pricing strategy must be in harmony with the revenue growth roadmap, outlining goals by channel, product, and region. Ultimately, companies should concentrate their growth efforts on specific regions and product lines, considering factors like profitability, market potential for growth, and their competitive advantage. Brand equity plays a critical role in defining this advantage, as a strong brand perception allows for easier establishment of premium pricing compared to competitors. Price positioning is another vital component of the pricing strategy, linking value delivery and value extraction.

Price Definition

The pricing strategy provides guidelines for price definition, utilizing three main methodologies: cost-plus, competitor-based, and value-based pricing.

Cost-plus pricing, the simplest and most used technique, derives prices primarily from the company's costs. While it's straightforward, relying on readily available internal data and ensuring the desired margin, it has drawbacks. This method doesn't fully consider customer willingness to pay, suggests price reductions with cost efficiencies, and, when fixed costs are factored in, can lead to a cycle of continuous price increases. For a cost-plus approach, managers must conduct a break-even analysis, determining how much sales loss or gain is acceptable to profit from a price adjustment.

Competitor-based pricing is another cost-effective and straightforward method, but it carries several drawbacks. It relies on the assumption that competitors have the right price positioning strategy, overlooking customer willingness to pay. It also often educates customers to expect discounts.

Instead of solely focusing on determining a price that helps achieve market share objectives, managers should shift their perspective. They should inquire about the market shares they can serve most profitably.

Value-based pricing, in contrast, determines prices based on customer willingness to pay and incorporates various techniques to understand and quantify the value perceived by customers. While it compensates for limitations posed by other pricing methodologies, value-based pricing brings some challenges. It assumes customers are honest when expressing how much they are willing to pay and that they fully comprehend the value of the product.

In addition, instead of asking what price the customer is willing to pay, managers should focus on identifying what customers with higher willingness to pay do they wish to serve. In other words, they need to better segment the market to reflect the differences in value to different type of customers.?

In conclusion, the three methodologies for price setting come with their own set of advantages and disadvantages. Companies can benefit from utilizing all three methods to determine prices, finding a balance among them based on factors such as budget constraints, time-to-market considerations, and the criticality of the pricing decision. The more critical and vital a pricing decision is, the more sophisticated the techniques for price setting should be.

In addition to the methodologies for price setting, a crucial factor in defining prices is a comprehensive understanding of price elasticities. Profitability is a multifaceted function, influenced by prices, competitor pricing strategies, volume, and costs. Grasping price elasticities is essential as it enables businesses to estimate the volume response resulting from price changes, consequently affecting revenue and profit.

The key to determining the optimal price that maximizes revenue or margin lies in understanding the volume response function, or in other words, comprehending product elasticities. In the case of inelastic products, revenue and margin can be maximized by increasing prices. However, for elastic products, finding the price sweet spot is crucial, as price increases can either boost or decrease revenue, depending on the elasticity and the level of price increment.

After establishing their priorities and business goals through the pricing strategy, companies need to articulate the price definition phase ideally in a granular level of customer and SKU. This step demands robust analysis to determine optimal prices that maximize the specific variable the company aims to prioritize. It's essential to recognize that each variable is maximized at a distinct price level (Fig 2).

There are various methods to identify the price response function, including analyzing transactional data, conducting price change experiments, relying on expert judgment, and utilizing customer surveys. The choice of method depends on the specific budget or time constraints of the situation; one technique may be more suitable than another based on these factors.

Pricing Execution and Monitoring

After defining the price, successful price management depends on effective implementation. A nimble price execution relies on a well-defined price management process, where tasks are clearly outlined with assigned responsibilities. The entire process should be based on a governance model that strikes a balance between sales force autonomy and control. Top management's involvement in the process should be driven by the strategic significance and financial impact of the pricing decision.

In addition to governance, price execution encompasses various other aspects, including discount policy formulation, setting target prices, and effectively communicating price/value propositions.

The salesperson plays a pivotal role in the success of price execution and must be empowered with responsibility, comprehensive training, and appropriate incentives. If the sales team has pricing authority, their compensation structure should be tied to contribution margin rather than revenue. The incentive system should emphasize how effectively salespeople implement prices, specifically how closely their actual prices align with the target prices.

Setting target prices should be systematic and tailored based on measurable variables such as region, customer size, and customer channel. In addition to target price setting, the discount policy should provide clear guidelines for managing the commercial relationship with customers. This policy must establish discount rules to incentivize desired customer behavior. Table 1 below illustrates some examples of discounts associated with specific incentives that companies typically want from their clients.

A robust discount policy operates on a 'give-get' logic, meaning that if a company offers a discount, it should receive something of value in return. This could include higher-margin product sales, reduced cost-to-serve, or more favorable payment terms, among other benefits. Table 2 illustrates various examples of give-get scenarios.

Companies often empower their sales teams to apply discretionary discounts in response to competitive attacks, preventing volume reduction or customer loss. However, these discounts must be managed carefully to prevent excessive margin erosion. It's crucial to find a balance, ensuring that while accommodating competition, the company doesn't sacrifice too much margin percentage in exchange for volume. Clear guidelines outlining the conditions for applying discretionary discounts are essential to preserve the absolute margin and prevent margin erosion.

Another important aspect of pricing implementation involves sales force training to effectively communicate product value and defend product prices. Also, sales incentives must be aligned to balance volume and margin. During times of inflation, discussions about price increases with customers become more frequent. Therefore, sales teams need appropriate methodologies and tools to conduct these conversations smoothly. They must be prepared to justify price increases, counter customer arguments, and execute in alignment with the company's strategy and goals.

Monitoring represents the final step in the price management process. To facilitate effective pricing monitoring, companies should establish clear Key Performance Indicators (KPIs) for price realization. They should be capable of addressing key questions, such as:

●???? Were target prices and volume achieved? If not, where are located the main deviations and why?

●???? Was the price increase well executed? Did the implementation of price increase succeed?

●???? Did the discounts achieve their objectives?

●???? Is the incentive structure effective?

●???? Etc.

Price execution and monitoring are crucial steps in the price management process. A well-defined pricing strategy is effective only when executed efficiently. It is imperative for top management to enable effective execution and monitoring by investing in a dedicated pricing organizational structure, ensuring alignment of price decisions with the overall strategy, designing appropriate incentives, and implementing modern methods for price monitoring.