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Why the right pricing strategy is important?

As against with other predictions, pricing is not that easy. 

In this blog, we talk about

  • Importance of the pricing strategy
  • The pricing strategy framework
  • The David-Goliath Tale
  • Real-life examples
Published on 26 Oct 2022 by
Paul Hanke Head of Growth
Blog Pricing strategy Revenue Growth Management

 

Why is getting the pricing strategy so important?

“Good strategy is like great art. It’s difficult to define what it is, but you immediately recognize it, when you see it.”

Here is a classic example: In the tale of David and Goliath, David was certain of his slingshot capabilities and likely also well aware of Goliath’s weakness. Therefore, to take the risk to challenge, and reject the protection offered to him which would ultimately have made him slower, was a very good strategy.

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Unfortunately, good strategy is rare, and more often than not, the adjective “strategic” hardly has any significant meaning  when added to  a business function such as strategic marketing, strategic finance — or strategic pricing.

Yet, well-established rituals such as pricing-strategy definitions only translate to - “We aim for profitable growth.”

Surprisingly, this vague definition somehow is is flexible enough to justify any pricing goal including both profit and revenue maximization — depending on who you talk to for the reason that upper management and marketing typically prefer profit, while sales favor revenue. Bad pricing strategy is so common that most pricing professionals have never experienced the power of a good pricing strategy. So, let’s see if we can change that by discussing what a pricing strategy is all about, outline a concept on how to develop a good pricing strategy, and finally look at some examples.

Strategy in general is all about the choice, especially pricing strategy — deciding to do one thing and not the other. 

If a company decides it is fully committed to profit, it will risk losing customers. If it aims for revenue, it can keep more customers, but may upset stockholders resulting in slim bonuses.

On the road to choosing the right pricing strategy, there is no escape from such fundamental trade-offs.

They inevitably need to be addressed, discussed, and decided.

The key objective of pricing is to support the overall strategy of the company.

The pricing strategy is the pricing manager’s theory of how to best achieve this. If the company’s objective is immediate profit maximization, then an effective pricing strategy would be focused on leveraging maximum value of the company. 

The Pricing Strategy Framework

One of the most useful practical books on strategy of this decade is certainly Richard Rumelt’s (2001) “Good Strategy, Bad Strategy”. In addition to the many entertaining examples, the book also describes a three-step framework for developing a good strategy— diagnosis, guiding policy, and coherent action.


Pricing strategy framework

1. Diagnosis: Based on the understanding of the overall strategy and how pricing can support it, the diagnosis needs to provide an explanation of the nature of the pricing challenge. A good diagnosis simplifies the complexity of reality by identifying those aspects of the situation that are critical for pricing success. For example:
  • Does it make sense to simply follow the pricing of key competitors with an established product?
  • Should you price an innovation at a low price to keep competitors out of the market or at a high price to skim off the high willingness-to-pay of early adopters?
2. Guiding policy: This is the overall approach to master the pricing challenges identified in the diagnosis. The guiding policy needs to specify the core pricing objectives, the KPIs to measure success, and guidelines on pricing methods, tools, and processes to achieve it. A good guiding policy can be summarized on one page.

3. Coherent action: This includes the coordinated implementation of the guiding policy in the pricing methods, tools, and processes. The complexity of this task depends on the industry’s pricing requirements (e.g., number of products, differentiation between customers) and the role of the company (e.g., price leader or follower).

 

The Tale of David and Goliath

Let’s examine the tale by equating it with ‘The Pricing Strategy Framework’ and describe diagnosis, guiding policy, and coherent action through David's point of view. 

  • Diagnosis: Goliath is the strongest man in the world and considered undefeatable (Threat). I’m weak (Weakness), but I’m pretty good with the slingshot — and it is a secret (Strength). Also, I’ve detected a spot in Goliath’s armor, where he is unprotected — right between his eyes (Opportunity). A clever case of classical SWOT analysis!

  • Guiding policy: I can beat him if I can hit him with my slingshot before he comes too close. Therefore, I need to be agile to get one good shot at him. That is my only chance.

  • Coherent action: Reject armor that was offered to me. It would only make me slower and doesn’t offer protection if Goliath hits me. Focus all attention on my first — and probably only — shot.

There are two take-aways from this example that are common for good strategy: First, a good strategy is very clear and straight-forward. Second, don’t expect others to comprehend or appreciate it before they have seen its success.


Let’s dive into more examples highlight a good pricing strategy.

The Company that got America on the Internet

AOL was the internet giant of the 1990s. AOL is the name that introduced the dial-up internet to the people. Later on, they merged as the larger partner with Time Warner in 2001. However, with the advent of broadband internet, it became clear that AOL’s dial-up business was dying down.

  • Diagnosis: With its 56 kilobits per second, AOL had a much inferior technology compared to broadband’s 16+ megabits per second. But, with a multi-million user base and slow churn in many segments, there was still hope. 

  • Guiding policy: There was no benefit in pricing on value and substantially reducing prices to compete directly. Therefore, the focus needed to be on reducing churn.

  • Coherent action: Maintain prices at $20 per month and fight to win back each lost customer by offering free months or reduced rates.

  • Result: AOL had still more than 2 million paying customers and was sold to Verizon Communications for $4.4 billion in 2015.

From Farm Boy to Business Visionary

Oil lamps are a classical example of a good pricing strategy. Oil producers gave away lamps for free, so people soon had a need to buy oil to fuel their lamps.

  • Diagnosis: When oil became readily available, there wasn’t enough demand for it. The high cost of lamps was a problem to most people even if it came with the advantage of having access to light all day and night. 

  • Guiding policy: Take away the initial high barrier of having to buy an expensive lamp. Make it easy for people to get used to consuming oil. The recurring payments for the oil are small steps for the customers, but add to major profits for the seller. 

  • Coherent action: Give away the lamps for free and then sell the oil.

  • Result: The oil baron John D. Rockefeller became the first $ billionaire and controlled about 90% of the oil industry by the 1890s.

This model has been widely adapted by manufacturers of a variety of products ranging from razor blades to coffee tabs. In modern times, manufacturers of electric vehicles are attempting a variation of this model but it seems like there is a long way to go.

As opposed to the traditional automotive business model, where many manufacturers sold their vehicles with close to zero margins and earned their living by selling spare parts and services at a better margin, today. Electric vehicles are also sold at a lower cost. However, after using the vehicle, they wouldn’t need many service parts such as oil filters. Eventually, autonomous driving will also take away a large share of accident related parts. For now, it is very unclear how to ever make money with e-mobility. The industry is clearly lacking a good pricing strategy.

Pricing strategy matters! It would be a poor decision to hand over price decisions to dynamic pricing AI systems in the hope that it will change prices so frequently that you will occasionally hit the right one.

Despite all their marketing, most of these pricing tools are much less advanced than you may expect. For the near future, technology will not be a substitute for strategy, but if implemented correctly, it can be a very capable enabler.

 

 

 

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