PM Process: Pricing
The marketing mix is composed of product, price, promotion, and place (Philip Kotler). While the product is clearly a Product Management function, most PMs get tired of discussing pricing. And more so discussing discounting, bundling, unbundling, creating suites, etc, special pricing options — looks familiar? No PM is immune to such demands in any organization. Many call these pricing strategies, for some they are outright winning formulas. Practically, there are only three components when deciding to price. They are absolutely driven by 3 principles stated in the book Business Market Management, by Anderson, Narus, Narayandas, and Seshadri. Lucky to be taught the principles by Prof Seshadri himself a decade and a half back. Why talk about such basic concepts in today’s market? Because the fundamentals are so significant that even today in B2B marketing they are the easiest benchmarks to compare against. Use them, you will not be disappointed.
Economics of Pricing
All of you who had formal education in microeconomics would know, there is a demand curve and a supply curve, and where Harry meets Sally, they match and live happily ever after. Ever thought about how those curves are arrived at? First of all, economics is about commodities. Commodities have no differentiation. If there is a common marketplace like an APMC mandi where daily auctioning takes place you have a fair idea of the price curve where typical negotiations take place (not the extremes). Real pricing curves are range-bound or discontinuous. Again they are wholesale price but not retail. How do retailers like Amazon or Flipkarts know about prices? Remember discounts? Discounts are not just a tool to attract customers but they are excellent tools to know customer interest in the varying categories of products at varying price points. Even when the products are branded or not commodities. By varying discounts, these e-retailers know a complete profile of customer buying behavior that is measurable which is almost impossible for the Kirana store owner to match. Great, we have a bit of insight into the retail sector but what about B2B markets?
The Economics of Marketing
The fundamentals of marketing are to do away with the concept of the commodity. Create enough barriers that no two products are comparable. Even if there is apple juice they are: Appy vs Sunkist. There is sweetened water from Coke vs Pepsi. They are all different they do not compare to one another. At least that is what every marketer would like to create a perception in a customer's mind. How do you create comparisons or even talk about common pricing concepts?
Enough of preliminaries, let's get to the brass tacks. The pricing principles are designed as proxies to be able to effectively come to a number in the presence of non-comparables. They are:
- The Firm Cost
- Replacement Price
- Customer’s Value Perception
They are also considered as pricing strategies and named: Cost-based Pricing, Competitor Pricing, and Value-Based Pricing. Call whatever you are comfortable with, these are simple benchmarks. Every pricing scheme must be tested against each of them. The only reason I do not like calling them strategies as, if I choose a strategy I will not consider the other two and miss out on the insights.
The Firm Cost
A sustainable business must meet the cost of operations. Even if you want to write off the sunk costs, the cost of operations should always be supported effectively. Good cost-based pricing should be:
Minimum Sale Price: Marginal Operations Cost + Marginal Overheads + Huddle Rate
Always remember to add overheads and huddle rate to such calculations to justify at least your salary (for some companies Product Management expense are overheads :-) ) and without the huddle rate included in the prices, your next product planning will be challenged by the CFO organization for additional investments when you do discounted cash flows (DCF). Sounds familiar? We will discuss these in detail in the strategy discussion. In one of my previous employments, before my boss went on a vacation for the first time, he shared a spreadsheet with exactly the above. That helped me deal with deal desk discounting effectively. At what volumes, what prices make economic viability at our cost structure. Do you have it for your org? If not build it ASAP. Believe me, it is not easy as you open pandora’s box, particularly all the customers you have sold off pricelist special products!!!
I do not want to call it competitor pricing to be a purist marketing mindset where the differentiation is so perfect that only your product shall meet the needs of the market. But we very well know if your toiletries are short of a liquid handwash your bath soap will serve the purpose. In short, a competing product is anything that will meet the customer's needs when your solution is not around. This comes in very handy or rather the only one which is very quantifiable both for new sales and renewals. Displacement of the incumbent with a replacement has a cost associated and if you are the incumbent that will act as a favor. If you are the new entrant, the cost of the migration or pricing of the same can be justified by new business obtained from such deals.
Value-Based Pricing (Consultative Selling)
This is ideal but very few product managers actually get to understand the customer's real business needs. Where there is a strong consultancy or professional services engagement, there is a good opportunity to discover the customer business value and price the product matching to the customer needs. Here are some guidelines, when power discounts just came up from various utility companies many IT Asset Management solutions developed power management solutions and analytics and reporting to showcase customer direct value saving in their power consumption. If you ever engage with an IT analyst on pricing insights, they will provide you an understanding of what is an indicative price range of deal closing in the market. A large variation in deal closing prices in a specific sector is a great indicator of good asymmetric market information to be exploited by product managers. Have you analyzed your own pricing information based on sectors, customer sizes, and geo-locations? What do you see? How do you explain the substantial variation of one customer over the other? Asymmetry of information is the key to selling in the VBP. Why do IT security products sell in the Banking sector? Because their IT risk insurers demand due diligence from their customers. And IT downtime may cost them more with RBI scrutinies that may follow. Compliance is a great driver and often puts a hard number on value estimates.
If you look at the sales of goods or any such act, the price you agree is the consideration for the contract of sale. And they drive an open market economy where the price arrives at a bargain among equals. Here are some guidelines that governments would like to believe in terms of pricing:
- Parties to a contract have similar circumstances in contract.
- They have agreed on the contract on equitable terms on the free and fair agreement without any undue influence.
- The consideration is adequate and is not due to any kind of pressure etc.
- There is no activity involved that shall stifle competition in any manner. In short, seller colluding is not permitted but buyers can come together and create a consortium to price. Particularly, in sectors like insurance.
In reality, some businesses are cost-based. Like the power sector. There is only one electric utility distributor in a region. In such cases, cost auditing becomes mandatory and cost-based pricing with economic profits included is the only valid pricing strategy.
Towards the end, I felt probably we sprinkled over a lot of concepts on pricing. But guess as long as you keep every of your pricing decisions benchmarked against the three basic principles, you are good. There are some interesting pricing strategies described in the book: Co-opetition — Barry J Nalebuff and Adam Brandenburger (2004). Give me your thoughts, pricing challenges, and how you have managed to overcome or win over them.