Pricing Strategy: THINK

A number of recently graduated MBAs (and some private equity managers) have been hitting me recently with an overly simplistic concept of pricing strategy. The conversation goes like this:

MBA Aside:
I just landed this great gig and now I have to prove myself. They told me to work on this company’s pricing strategy. I took finance. I know profits go up faster when price go up, than when I work on anything else. So I should just raise prices.

MBA:
OMG! I totally have an awesome idea. Let’s raise all the prices and see what happens! Right! That would be awesome! We will keep selling things and make a higher profit. And, if it doesn’t work out, we can just go back a little on prices and it will be like nothing ever happened. That’s pricing strategy, right?

Wiglaf:
I can’t recommend that.

MBA:
But it worked for Starbucks and their profit went up.

Wiglaf:
Yes, sort of. It was a bit more complex than that.

MBA:
What do you mean? They raised prices.   People complained. But they still bought coffee. Some store traffic went up. They were totally in the inelastic part of the demand curve. It simple. Why can’t we do that?

Wiglaf:
If you study the Starbucks case more carefully, you will see that they raised some prices, but they have also lowered prices on some products.   They raised prices selectively.  It is more complex than simply raising prices across the board until the customers stopped buying.

MBA:
How is pricing strategy more complex?   I think we have supplier power. We should test that and raise prices. Why make it complex. Keep it simple, Right?

Wiglaf:
You can do that if you like, but it doesn’t always work out so great.  And, are you sure you have supplier power?

MBA:
What do you mean? Don’t you know the 1% Windfall rule?

Wiglaf:
Yes, I know that a 1% improvement in prices will, on average, increase profits by 10-13%, depending on the reporting year. But that doesn’t mean every strategic pricing effort should result in higher prices across the board.

Take a look at Netflix. They raised prices and their subscription growth declined precipitously. They choose to back track and issue a huge apology.   Prices were stuck at a low point for a few years after that fiasco. No, I encourage you to think a little deeper.

MBA:
Whatever. (Meaning, Wiglaf won't be hired for the job.)

Pricing strategy is not simply raising prices. If that’s all it took, then every fool would ride horses, grade school-er would be a great pricing strategist, and business owner would have a clear pricing plan. (Plus, raising the minimum wage would have no negative effects.)

No, pricing is far more complex.

True, in some cases, prices can increase without impacting sales volume. Yet, in these few cases, we find that offerings were under-priced in the first place.  In most cases, for many offerings and specific selling situations, higher prices across the board will kill sales.

Pricing strategy is about systematically charging the right price to the right customer at the right time. This means understanding the customer, their willingness to pay, and how it varies across products, buying situations, and competitive markets. It is about understanding how a firm’s prices should stand in relation to its competitors and how to respond to a competitive price action in the most productive manner. It is about choosing a price structure that enables the firm to profit, and appropriately addresses the market segmentation strategy. It is even about defining the organizational capabilities required to execute the firm’s pricing goals.

Systematically charging the right customer, at the right time, the right price is difficult. To get it right, firms must understand their customers – deeply. That means market research and pricing analysis.

Adding to this complexity of setting an informed pricing strategy is that there isn’t just one form of market research or pricing analysis that solves every pricing challenge. At times, Voice of Customer research is needed to inform models of the Exchange Value to Customer. At other times, surveys using Conjoint analysis or MaxDiff reveal the variation in customer’s willingness to pay. And at other times, pricing analytics can meaningfully provide insights on expected product list prices, variations of prices by customer segments, target deal prices, and deal floor prices to guide salespeople in their negotiations with customers.

It isn’t that the recent MBA’s strategy is completely flawed.

I know of cases where an across the board price hike worked out for the good of the company, the shareholders, and the customers. But I also know of far more cases where that would have killed the business. Where some prices should have been raised while other prices lowered.  That is, where price alignment to market opportunities could be brought into better alignment to improve customer capture and profits.

It is that the recent MBA’s strategy is incompletely thought out.

Not all recently graduated MBA’s sound like this. Most understand that business is complex and difficult. Most practice greater humility than described in the story. But for those few that are overly attracted to simplistic ideas, I encourage you to remember a quote from Thomas J. Watson, Sr., the late CEO of IBM: THINK.