Pricing Strategy

Successfully implementing a Pricing Programme relies upon many moving parts moving in harmony. These are described in a separate article on "The Virtuous Circle of Pricing". One of the key elements is the Pricing Strategy adopted by the business, which needs to be clear, coherent and capable of execution.

For several years I led a Pricing Programme across several countries for a European wholesale distribution business. Overall, the programme was successful in improving the gross margin while improving sales, but along the way there were numerous setbacks and pitfalls. There are lots of things that can and do go wrong. Resolving these as soon as they arise, or better still, avoiding them in the first place, can make a huge difference to the success of the programme and the speed at which benefits are delivered.

Implementing a pricing programme effectively requires a recognition that it is in fact a comprehensive change management programme which touches every part of the business. I like to talk about a “Virtuous Circle of Pricing” model, which helps the business to think about all the areas which need to be addressed to make the pricing programme work. This paper is focused specifically on the Strategy component, which should be the starting point for all the other areas of activity.

Why do improved margins matter?

Let us imagine two companies in the same market with a similar level of sales, but with markedly different levels of profit:

 Both businesses have similar balance sheets, with a similar amount of debt.

All other things being equal, for a given level of sales, companies with a higher percentage return on sales will usually have proportionately higher market valuations. Why? Well, because Company B has a number of significant advantages over Company A, including:

• Higher generation of cash, which can be used either to pay higher dividends to shareholders, to reduce debt, or to re-invest in the business,
•  More cash to invest in the growth drivers of the business. In this example Company B is spending the same on overheads as A, despite having lower volumes. The business might be able to support a bigger sales force, or a stronger digital presence, for example,
•  More choices over how to allocate the cash generated by the business,
• More resilience in times of crisis: a 20% fall in sales would drop Company A into the red, while Company B stays positive (assuming overheads remain unchanged).

Importantly, Company A and Company B don’t have to be different businesses. Company A can evolve into Company B over a period of time and become a more profitable business, even accepting a small decline in volumes. There are numerous real examples of companies who have achieved this to great effect.

Of course, achieving the improved level of profitability can be done in several ways. Reducing the cost of goods sold through supplier negotiation can help enormously. Similarly, seeking efficiencies in fixed and variable overheads can also make a difference. But an increase in some selling prices applied in the right way can deliver the biggest benefit to the P&L with least pain.

The need for a clear strategy

Any increase in prices does require acceptance from customers, and indeed from employees, and therefore positioning is important. To achieve this, the business needs a pricing strategy which is clear, simple, coherent and consistent, based on an understanding of the market. It must be supported by a deep knowledge - both commercial and analytical - of where prices can be increased – or in some cases decreased – to optimise both revenue and the pricing opportunity.

It is very easy for a Management Team to say “Let’s put 2% on all our prices. If half of it sticks, we have a 1% net uplift in sales, which will go all the way to the bottom line”. This doesn’t work! Instead, a nuanced approach is needed which takes into account:

• The competitive position of the business and its market positioning,
• The value added that a business can offer, and how through its products and services portfolio it can show differentiation from the competition in a way that means something to customers,
• A segmentation of customers, and an understanding of their needs,
• A segmentation of the product range, and an understanding of the business’s strengths and weaknesses across the portfolio,
• Analytical input which provides empirical evidence of price elasticity across multiple pricing segments.

At the same time, the strategic approach should not be over-complicated. It needs to start with the principles of how the business wants to price its products and services. This must be comprehensible to everybody in the organisation, and it has to be perceived as appropriate and fair by employees and customers alike. For example, a wholesale distributor might say:

• “We have a "Core Range" of high-demand products, stocked across all branches and available through our web shops, where our prices will be absolutely aligned with the market;
•  We have an "Extended Range" of lower-demand products from our core brands, which we will stock and have available with rapid delivery, supported by technical expertise and advice, and where our pricing will reflect the additional service component we provide;
• We have a “Service Range” of complementary products which will not normally be stocked, but will be sourced on demand for our important customers, supported by our technical knowledge and expertise, and where our prices will reflect the high level of service we are offering”.

In parallel with these product pricing principles, there may be a customer angle which says:

• “In general, we will offer higher levels of discount to loyal customers with higher levels of spend, and
•  Our pricing will be uniform across our various sales channels”.

 Articulating these principles is helpful both for supporting and embedding internal acceptance by employees, and as a backdrop to the positioning of the business in the marketplace by the sales and marketing teams.

 Application of the Strategy

All of the strategic pricing principles above should be supported by a tangible Commercial Framework or matrix – ideally a visually clear single-page document - which articulates the rules of how pricing will be determined and set for different ranges of product and type of customer, consistent with the overriding principles. This matrix should not be too complex: in my example above, it would be three types of product grouping by perhaps three levels of customer.

As long as the strategic principles are clear and understood, the execution of price setting and discounting can and will carry considerably more granularity and detail, supported by the businesses’ tools, data, processes, and people. So for example, there may be hundreds of different product sets, each with their own pricing calculations - but all falling within the three product types described - in this case "Core", "Extended Range" or "Service Range" to which the strategic pricing principles are applied.

As with all sets of rules, there should be some scope for exceptions. The business may have defined very clearly what the pricing principles and rules are which we wish to apply, but in the real world there will often be a need for some flexibility to accommodate specific circumstances. Buying decisions are usually made by humans, whose behaviours and choices are driven by many different factors. In order to secure a sale, there are likely to be occasions when tactical discounting will be required - regardless of the skill and training of the sales person. To accommodate this, the Pricing Strategy needs to be clear about the extent to which tactical discounting will be allowed, and the Commercial Framework needs to set out clearly what the rules are in each segment for tactical discounting – whether it is allowed, how it will be managed and controlled, and who in the organisation will have ownership of the pricing decision.

 Review of the Strategy

The Virtuous Circle of Pricing describes a series of elements which need to be managed effectively, and which will be covered in more detail in other articles. One of the key points is that to become a virtuous circle, there has to be a continuous process of feedback, evaluation and improvement across all elements. The Pricing Strategy should be reviewed regularly and refined as necessary to ensure it is delivering the benefits to the business that an effective Pricing Strategy can unlock.

Nigel Trend is a consultant specialising in helping companies to implement pricing programmes, having led successful and less successful programmes himself. He is interested in how technical and data science-driven solutions can be converted into successful execution of pricing strategies by people on the ground.