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CEO Best Practice: Pricing Strategies

Executive Tools

  • Executive Summary
  • Self Assessment Checklist

Expert Practices Articles

  • Pricing in the 21st Century
  • Basic Pricing Strategies
  • Pricing for Long-Term Relationships
  • How to Win a Price War
  • Value Pricing in a Commodity World
  • Pricing Strategies for a New Economy
  • Making a Profit in a Commodity World
  • Staying Vendor-of-Choice in a Commodity World

Book List: Pricing Strategies

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CEO Best Practice: Pricing Strategies

Executive Summary

  • Pricing in the 21st Century
  • Basic Pricing Strategies
  • Pricing for Long-Term Relationships
  • How to Win a Price War
  • Value Pricing in a Commodity World
  • Pricing Strategies for a New Economy
  • Making a Profit in a Commodity World
  • Staying Vendor-of-Choice in a Commodity World

Pricing in the 21st Century

We turned to three experts on pricing issues -- Vistage speakers R. Sam Bowers and Douglas Gilliss and former Vistage speaker Eric Mitchell -- to get their take on this issue. Interestingly, while they tend to agree on the symptoms of the problem and the overall diagnosis, they do not agree on the cure. All three acknowledge that new technology, unlimited access to information and increasing global competition are conspiring to "commoditize" entire industries and force prices into a seemingly endless downward spiral. Their opinions diverge, however, when it comes to the response they believe CEOs and companies should take to counter those relentless market forces.

When faced with constant demands from customers to lower prices, Mitchell and Gilliss support a value-added approach. In essence, they feel that companies can overcome commodity pressures and maintain high margins by finding narrower market niches to compete in and then focusing on adding value to the customer in order to differentiate themselves from the competition. When customers understand the difference you bring to the table, they willingly pay a higher price.

Not so, counters Bowers. He believes that the value-added mindset is a relic of the old economy, that in the new economy the process of commoditization is inevitable and unstoppable. By fighting it, you only make matters worse by raising your costs higher, which makes it impossible for you to lower price and still make money. In a world where customers have many vendors they consider to be equals, says Bowers, the only way to make money is by continually lowering your cost structure so that you can compete on price. Companies that continue to employ a value-added approach will soon cost themselves right out of business.

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Basic Pricing Strategies

According to Mitchell, developing a comprehensive pricing strategy involves five essential factors:

  1. Competition
  2. Customers
  3. Financials
  4. Perceived value
  5. Marketing objectives

In addition, Mitchell also recommends giving due consideration to the following principles:

  • Set prices according to your market, customer and competitive needs.
  • Adopt a long-term pricing perspective.
  • Find creative ways to reward retention.
  • When in doubt, start high.
  • Collect information about major competitors.
  • When possible, set internal target prices.
  • Convey target prices to your salespeople.
  • Design and budget for promotional pricing.

What happens when a very large competitor decides to enter your niche? Instead of trying to compete on price with someone who can sell a product for less than it costs you to make it, Mitchell recommends a two-pronged approach:

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Pricing for Long-Term Relationships

Over the years, Mitchell has seen a lot of changes in pricing strategy. He identifies three major pricing challenges in the current environment:

  1. Justifying your price
  2. Proving your price is fair
  3. Pricing for a relationship

To justify your price, Mitchell recommends the following:

  • Create a buyer review checklist. Publish a pamphlet or tip sheet that educates customers about how to buy your product or service. For example, "How to Buy from an Ad Agency" or "Ten Tips for Purchasing Data Storage Services."
  • Make things real. Provide testimonials touting your product or service (especially true for service companies). Anything you can do to make your benefits more tangible will enhance your ability to maintain price.
  • Provide references. Ask your clients to write letters of recommendation. Provide prospects with a list of satisfied clients to call.
  • Provide an exceptional guarantee. One of the best ways to distinguish yourself from the competition is to offer a guarantee that far exceeds industry standards.
  • Shout your value. Never assume that customers know you and your reputation. The burden of proof rests on your shoulders.

To enhance the perception of fairness for your price:

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How to Win a Price War

Gilliss defines a price war as more than just trying to steal market share by offering a lower price. Instead, it consists of a long-term marketing/costing problem that requires looking at who you are, what business you are in and how you serve that marketplace. To win a price war, he recommends three strategies:

  1. Don't fight. Instead, pick your battles by narrowing your focus. Maximize your strengths by putting all of your resources in an area where you can absolutely win.
  2. Pick your battles and maximize your strengths. Narrow your niche until you can dominate it. Dig in where nobody can compete with you.
  3. Create alliances to eliminate enemies. Form an alliance with your sales team by helping them fully understand who they're dealing with and what they're delivering. Also, find ways to align with companies who use the same kind of product or service and can naturally refer customers to you.

Your ability to get the price you want depends to a large extent on how your customers perceive your product and service offering. To enhance your customer's perception of value, says Gilliss:

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Value Pricing in a Commodity World

One way to combat the seemingly relentless pressures on pricing, suggests Gilliss, is to base your pricing structure on the value you deliver to customers, not on the cost of goods and services you sell. To help customers understand your unique value:

  1. Differentiate, differentiate, differentiate. Ask, "What do we do that is better, faster, easier, etc., than our competition?" Then create a profile of the ideal customer for those benefits and focus all of your resources on serving that customer.
  2. Provide real value. Solve the customer's problems and meet their specific needs by understanding the four principles of value:
    • Value, not price, is always the issue.
    • The customer (not you) defines the value.
    • Value and service are your only real product; it's difficult to differentiate on the product itself.
    • It's not what you sell; it's how you sell it.
  3. Focus on the customer's customer. It's your job to educate the customer about how to make money with the goods and services you sell. Don't expect them to figure it out on their own.

According to Gilliss, customers make buying decisions based on the "components of value" you offer. Examples include time, expertise, information, convenience, quality, guarantees and payment terms. The challenge is that each customer values different components. To avoid commoditization, identify the specific items of value for each customer, set them up in order of importance, and then reduce your value to quantifiable terms. Remember that value, not price, is always the issue.

The ultimate goal, says Gilliss, is to climb out of the commodity box so that you can engage in value pricing. With value pricing:

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Pricing Strategies for a New Economy

Bowers believes that the defining element of the new economy is a fundamental shift in the way goods and services get exchanged. He also believes that we have moved from a world where products and services are sold to a world where they are bought -- a subtle but very important difference. When customers are buying (as opposed to being sold) three critical factors exist:

  • Customers have already researched the product or service, either through the Internet or their engineering or purchasing department.
  • They have already found at least two or three alternative vendors, any of which they feel comfortable buying from.
  • They know exactly what they want and how much they are willing to pay for it.

Once these factors exist, any hope of selling the customer on your value-added flies right out the window, never to return. The only thing left to dicker about is price. You can't fight the trend of commoditization and you can't beat it. What you can do is learn to manage the process so that you still turn a healthy profit. In order to do so, however, you must come to grips with the realities of the new economy:

  • Old economy thinking: You can increase profits by raising price.
    New economy reality: The only way to increase profits is by lowering costs.
  • Old economy thinking: You can raise price (or at least maintain margins) by adding value and convincing customers you are "special."
    New economy reality: The only way to compete is to improve your quality and productivity so you can lower your price.
  • Old economy thinking: When asked to lower price, the best strategy is to do more for the customer.
    New economy reality: When customers demand lower prices, do less, not more.
  • Old economy thinking: A great relationship with the customer allows you to charge more.
    New economy reality: Customer loyalty is dead.

Does this mean you should completely forget about trying to differentiate yourself or stop trying to stand out from the crowd? "Not at all," says Bowers. "You still need a quality product or service or you won't even get into the game. And you still need to constantly look for new and innovative ways to solve customer problems and serve their needs. But once the customer makes the decision to buy, you must stop playing the value-added game and stop selling. All that does is increase your costs and lower your ability to make a profit."
To many, this sounds like a bleak -- rather than a brave -- new world. However, Bowers believes you can make money in the new economy by adopting these strategies:

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Making a Profit in a Commodity World

The secret to making money in a commodity world, suggests Bowers, is to proactively manage the process of commoditization. Specifically:

  1. Stop selling and let the customer buy.
  2. Focus on reducing costs.
  3. Manage your "Kenny Rogers" line.

When customers are ready to buy, most companies send in their highly trained (and very expensive!) salesperson to try to convince the customer how special they are. Instead, says Bowers:

  • Acknowledge the customer has already made the decision to buy.
  • Stop trying to prove you are "special."
  • Send in a negotiator, not a salesperson.
  • Focus on meeting specs at the lowest price.

To reduce costs, says Bowers:

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Staying Vendor-of-Choice in a Commodity World

When you're the vendor in place and one of your competitors suddenly offers a much lower price, don't automatically assume they are willing to lose money on the deal. And don't assume they're offering an inferior product or service. The competitor may have found a way to lower their cost structure, which means they can now make money at a level you can't afford to go. Or, their price doesn't include the same level of service as yours, which means your current offering may include things the customer doesn't want or need.

Either way, advises Bowers, don't rush back in and try to convince the customer how special you are. Instead focus on lowering costs and moving your Kenny Rogers line to the left.

If you're vendor-in-line number two or three and you want to dethrone vendor #1, you can't just match their price, you have to beat it. That requires purposefully and deliberately moving your Kenny Rogers line to the left so you can offer a lower price and still make money. Overall, the ideal strategy is to become the vendor in place and then continue moving your Kenny Rogers line to the left faster than your competitors and your customers. When you reach that position, you then have two equally good choices:

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