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 knew of his slingshot capabilities and likely also of Goliath’s weakness. Therefore, it was good strategy to take the risk of the challenge and to reject the protection that was offered to him and would only have made him slower.

Unfortunately, good strategy is rare, and most of the time, the adjective “strategic” has no meaning when added to any business function such as strategic marketing, strategic finance – or strategic pricing. Yet, strategy workshops and the practice of defining a pricing strategy are well-established rituals in the corporate world that frequently result in a conclusion that is a variation of this: “We aim for profitable growth!” It is not clear what that means but it is flexible enough to justify any pricing goal including both profit and revenue maximization – depending on who you talk to. Upper management and marketing typically prefer profit, while sales favors revenue.

Because bad pricing strategy is so common, most pricing professionals have never experienced how powerful a good pricing strategy is. So, let’s see if we can change that. In the following, we first explain what pricing strategy is all about, then we outline a concept of how to develop a good pricing strategy, and finally we look at some examples.

Strategy in general and pricing strategy in particular are all about choice – that is, deciding to do one thing and not the other. If a company decides it is fully committed to profit, it must accept that it will lose customers. If it aims for revenue, it will keep more customers, but stockholders tend to be less happy and bonusses slimmer. There is no escape from such fundamental trade-offs in deciding on the right pricing strategy. They need to be addressed, discussed, and then 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 the pricing strategy needs to focus on how to extract the largest possible share of the value the company creates. A good pricing strategy does this very effectively.

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 strategy examples, the book also provides a useful framework for developing a good strategy. Here, we apply the three steps of the framework – diagnosis, guiding policy, and coherent action – to pricing strategy.

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?

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.

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).

Let’s look at some examples of good strategy to see how this plays out. We start with David’s assessment in the above tale.

David and Goliath

  • 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 no one knows about this (Strength). Also, I’ve detected a spot in Goliath’s armor, where he is unprotected – right between his eyes (Opportunity). A 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.

  • Result: Known!

There are two take-aways from this example, that are common for good strategy: (1) Good strategy is very clear and straight-forward. (2) Don’t expect others to understand it before they have seen its success. Here are two examples that highlight good pricing strategy:

AOL

AOL was the internet giant of the 1990s that introduced the internet via dial-up to the public and merged as the larger partner with Time Warner in 2001. With the advent of broadband internet, it became clear, that AOL’s dial-up business was dead.

  • 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 some money to be made.

  • Guiding policy: There was no benefit in pricing on value and substantially reducing prices to compete directly. Therefore, all focus should 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: As of 2015, AOL had still more than 2 million paying customers and was sold to Verizon Communications for $4.4 billion.

Oil lamps

Oil lamps are a classical example of 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, as many people saw the high cost of lamps rather than the benefit of having easy access to light all day and night.

  • Guiding policy: Take away the initial high barrier of having to buy an expensive lamp to make it easy for people to get used to consuming oil. The many recurring payments for the oil are small steps for the customers but add to a mayor improvement 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.

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. In the traditional automotive business model, many manufacturers sold their vehicles with close to zero margins and then earned their living by later selling spare parts and services at a better margin. Electric vehicles are also sold at cost or below, but later on they do not require many service parts such as oil filters. If then autonomous driving also takes away a large share of accident related parts, then it is very unclear how to ever make money with e-mobility. The industry is clearly lacking a good pricing strategy.

A final note: Pricing strategy matters! Don’t expect that you can avoid it by handing over price decisions to some dynamic pricing AI 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 employed correctly, it can be a very capable enabler.

 

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