Viewpoint Hermann SimonPricing becomes a science
How a company prices its products and services in increasingly
seen as an important strategic tool linked to shareholder value
Pricing has traditionally played a tactical rather than a strategic role. Most companies base prices on cost-plus considerations or competitive comparisons, not concrete strategic goals. But the role of pricing is changing.
The internet, growing emphasis on shareholder value and more sophisticated methods of measuring the effects of value and price on performance have put pricing at the forefront of strategic thinking.
Chief executives and managers would be well advised to consider the following steps when deciding pricing strategies.
First, linking pricing more closely to shareholder value. Most chief executives and top managers say shareholder value and market capitalisation are at the top of their list of concerns. Pricing hardly features, although it is one of three profit drivers, along with cost and volume.
Compaq provides an example of how inconsistent pricing can put a drag on a company's share price. In a recent interview Michael Capellas, chief executive of Compaq, said the company made "a conscious trade-off between profitability and market share. For a certain time it will be more important for us to be profitable. Later, we will take back market share."
Only a few years ago, Compaq declared exactly the opposite. In March 1996, the US business press reported that the company had set the stage for a bruising
price war, saying it would sacrifice profit in an aggressive move to build market share. That does not sound like a long-term, consistent and convincing price strategy. Compaq's stock price has strongly lagged behind other companies in the sector.
The second step for managers is to understand that pricing must become more directly aligned to shareholder value goals.
Price changes affect every function of the organisation, including finance, controlling, sales, marketing, production and logistics.
Pricing and its effects require a holistic view, which is achieved only if the pricing manager holds a senior position in the corporate company.
General Electric is leading the way in upgrading its pricing manager's role. The group has launched an initiative in which a pricing manager in each of its 40-odd divisions reports directly to the chief executive. A chief pricing officer who reports to Jack Welch then co-ordinates the initiative across the divisions.
GE's initiative represents a substantial upgrading of the pricing function, a shift that many other companies will no doubt emulate. It should also make the pricing function more attractive to high achievers.
The next step is to avoid aggressive pricing. Achieving an attractive profit on low and aggressive prices is difficult. When I recently discussed the prospects for pricing with Peter Drucker, the management guru, he said "low prices and high profits rarely come together".
The disproportionate attention heaped on successful low-price companies, such as Southwest Airlines, Wal-Mart, Ryanair and Japan's Watami chain of restaurants, overshadows the fact that legions of firms with aggressive pricing strategies are now long-forgotten failures.
Aggressive pricing works only within a corporate culture of extreme frugality. But it is very difficult for people to work for long in such conditions. A value strategy is a much better way. I agree with Jack Welch that we are now in the "value decade".
The aggressive pricing syndrome looks poised to prey on some internet companies because the high price transparency of the internet will make it more difficult for companies to succeed on low prices alone.
This leads to the fourth step: the recognition that internet pricing favours the buyer, not the seller. Most industrial companies expect more from the internet on the purchasing rather than the selling side. Auctions, customer-driven pricing and shopping robots tend to lead to lower prices.
However, this situation reverses if capacity is scarce. The internet may even generate higher prices because buyers bid against each other for limited resources. But that is the exception rather than the rule in developed industries.
Dynamic pricing - which adjusts prices according to the current demand-supply
situation - is also likely to lead to lower prices.
The internet also tends to drive down prices for the simple reason that price is much easier to communicate than value. On the internet, price is just a number.
Value is a much more complex construct. It requires extra information, such as trust and confidence - things the media convey much less effectively than people.
Finally, pricing should be treated as a "science". In the last two decades, the finance function in companies has become highly quantitative and theory-driven. Pricing is experiencing a similar development. Masses of data exist and the internet will lead to even more data. With the notable exception of the airline industry, these data are hardly used effectively to manage and control price decisions.
Profit and growth are the essential drivers of shareholder value and both are ultimately related to how competently a company prices its products and services. Pricing will make a quantum leap towards higher professionalism as companies recognise just how powerful pricing can be in helping them resolve the strategic dilemma between profit and sales growth.
The author is chairman of Simon, Kucher & Partners, a consulting firm with offices in Bonn, Germany and Cambridge, Massachusetts, US.
www.simon-kucher.com
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