Pricing is the only element in the marketing mix that produces revenue; the other elements produce costs. – Philip Kotler
How Apple Saved the Music Industry
2001 was a milestone year for several reasons. Not only did the world come out of the dotcom bust, but it was also the year in which the iPod was launched.
At the turn of the millennium, buying music legally was prohibitively expensive. The options were to either buy an entire music CD for nearly USD20 to USD40 or shell out USD10 a month for subscription services where they could access any song they liked, as long as the artist and the song were part of the music studio’s contract. There was one more legal option – wait for your favorite song to be released as a single to buy it. Naturally people turned towards piracy sites like Napster and other peer-to-peer file sharing websites. And even as music studios and artists cried out loud, and appealed to their fans, there was nothing much that they could do.
Apple was not a music store, and they did not have any experience in the music industry when it launched iTunes in 2001. But it set the stage for one of the greatest pricing innovations that the music industry has seen – the ability to buy just a single song, for a fraction of the cost than was previously possible. In fact, the price of a single song dropped from USD5 to just 99 cents after the launch of iTunes. It led to an entirely new business model of buying and selling digital content and led to the birth of digital streaming. [1], [2]
All of this happened because Apple saw pricing as a strategic lever. They understood that the existent pricing model in the music industry was not aligned with customer expectations, and hence was ripe for disruption. They also understood that they could leverage the power of pricing to create a new market and dominate it by shaping customer perceptions by offering a significantly strong value proposition.
The Most Important Opportunity
There are three fundamental constraints for any project – price, quality, and cost. An organization also has three opportunities– price, quality, and features, which present it with different options and challenges.
Many people consider quality as a very important factor, and even go to the extent of calling it more important than price. But it is important to understand that price will provide an indication of the other two factors (remember the fact that price is not just a number). It also is easier to scale up or scale down compared to the other two factors. In fact, BCG termed price the only option that could save European banks after they faced a period of degrowth and losses in the mid-2010s.[3]
Price has a strong power to create an immediate impact in the market. A large reduction in prices along with the right marketing strategy indicates that an organization is selling off its products. And a new higher priced product can indicate that the product may be of better quality. An increase in prices can also indicate that the product is in demand, and it may soon run out of stock. But because prices are so easy to change, competitors can respond very quickly to neutralize any advantages you stand to gain from a price move. Unless you have an unbeatable cost advantage, which prevents your competitors from responding in kind, it is almost impossible to establish a sustainable competitive advantage through lowering prices.’[4]
It is important to think pricing from a strategic point of view. It can drive profitability, ensure customer satisfaction, lead to greater market penetration, and even be a source of competitive advantage. And it is safe to say that quality and a strong set of features and functionalities cannot substitute pricing in its importance.
Pricing Is a Strategic Game
Many organizations consider pricing as a tactical game, and do not invest time and effort to make it a point of differentiation. They price in the same way the markets do yet expect results that are far ahead of the market. It is time that organizations consider pricing as a strategic game where innovation and persistence will be the key.
Let us take the example of Root Insurance, a U.S. based car insurance company. Launched in 2015, the insurance company was pitted against established insurance players. Having studied the market, they understood that every company was pricing its products in the same way, making it a commodity. Pushed by a need to innovate, Root Insurance launched their own telematics-based pricing model and mobile app in 2016. Car insurance premiums were calculated based on the number of miles the car was driven and a score that was based on the policyholder’s driving habits and behaviors. Safe drivers with low-risk behaviors were offered lower premiums whereas high-risk drivers were asked to cough up more. Through this, Root Insurance made sure that its pricing strategy was more transparent, innovative, and fair.[5] Today, Root Insurance is one of the leading car insurance providers in the U.S. They were able to make a mark because of their willingness to accept pricing as a strategic lever, and not trying to do what everyone else was doing.
The right pricing and revenue management strategy can increase the revenue nearly by 10%.[6] But very few organizations invest in pricing and revenue management. Fewer than 5% of Fortune 500 companies have a full-time function dedicated to pricing; fewer than 15% of companies do systematic research on pricing; and fewer than 10% of businesses schools teach pricing. But times are changing, and organizations are waking up to the power of strategic pricing. They are realizing the myriad benefits that will come once they look at pricing from a comprehensive perspective than think of it as another operational item.
Where Can Organizations Start?
As a start, organizations can get back to the drawing board to create a pricing strategy blueprint for the organization or revisit their existing blueprint if they already have one. And when they do this, here is a five-step process to ensure maximum success.
Step 1: Define the pricing opportunities
Price can be changed easily. And they can be set across a range of values – offering an entire spectrum of opportunities.
Defining pricing opportunities is about identifying and evaluating different market areas across different price points where different pricing strategies can be employed. It involves creating a deep understanding of market needs, customer expectations, and the competitive landscape across different price points which can be used as an input for creating the optimum pricing strategy.
For example, a smartphone can be set across multiple price points by following a good-better-best pricing strategy, or the price points can be varied across a set of values by offering buy-back guarantees for different models of the smartphone’s earlier versions. Each of these price points are different pricing opportunities – with each offering a different set of options, competitors, and requiring a different mix of communication, channel, and product availability strategy.
For any product, organizations must define the pricing opportunities that are possible. This is the first input for any pricing strategy document and will dictate all other allied aspects of the product including the remaining 3Ps in the famous 4P approach (price, place, product, and promotion).
This will also ensure strategic alignment across business and other priorities and ensure that it is in line with the organization and product’s overall competitive advantage. It will also enable organizations to think from multiple perspectives across different zones of value and ensure that there is no value erosion. Defining pricing upfront will also ensure flexibility and adaptability in pricing strategies and ensure that organizations have frameworks and processes in place to accommodate sudden changes in market conditions, or customer expectations. Evaluating pricing opportunities early on will help organizations to craft clear communication strategies based on customer perceptions and may even help shape customer perceptions to a large extent. A clear definition of the different pricing opportunities will help the organization allocate resources more efficiently.
Step 2: Assess the strengths and gaps
Organizations must understand their strengths and weaknesses to prioritize the pricing opportunities that they want to leverage. Some opportunities may seem financially viable, and offer a great prospect for growth, but the organization may not have the strength to capitalize on the same. And then there may be opportunities that seem innocuous, but it offers the greatest strategic alignment to the organization’s strength and business priorities.
Through this approach, organizations can clearly identify their competitive advantage and prepare plans that can maximize them. And they can also address weaknesses and gaps in relevant areas. This assessment will also help organizations allocate resources efficiently.
Step 3: Identify the value drivers
Value drivers are features, such as price, availability, and service that an organization believes will create value for the customer at the time of purchase and after it. Post assessment of strengths and gaps, it is imperative that organizations take time and effort to identify the value drivers that will be important in the long run.
By applying a strategic perspective to identify the right value drivers, organizations can formulate the right pricing strategy, adopt the right pricing models, and create the right pricing for the right customer. It will also help organizations differentiate their product from the competition, and help the customers identify with the product or the service. Moreover, this will also help minimize revenue leakage and optimize the revenue from each customer vis-à-vis the value provided to the customer. It will also help in allocating the right resources to further grow the product.
Step 4: Craft out the execution plan
Buoyed with the prospect of a great market, and armed with the power of superb value drivers, organizations tend to be aggressive. Or they tend to chalk out a plan that is too regressive, and cautious. Very rarely do organizations achieve the balance in creating the right execution plan that balances practicality, risk, aspirations, and is agile enough to accommodate market changes.
Crafting out the right execution plan, that is aligned with the vision and the organization strategy requires expertise, and the ability to think out of the box on a consistent basis. These plans will require the right balance between being innovative enough to cater to the changing world and being consistent enough to make sure all the stakeholders of the organizations do not resist a drastic change. It also needs to consider the availability of resources, the practicality of implementation over a period, and potential risks. Moreover, the execution plan needs to include the right performance metrics and feedback loops to consistently improve the plan.
Execution plans to achieve the pricing strategy need not be great, they need to be right. And a right execution plan goes a long way in helping organizations realize the price they have set for their products without relying too much on discounts or other forms of price reductions. It also increases the likelihood of the customer buying the product.
Step 5: Communicate, educate, and execute
Many organizations jump towards execution immediately after the plan is in place, only to sink in the myriad problems that the ocean of practicality and human emotions will throw up.
Before executing, organizations must communicate their pricing plan to different stakeholders including shareholders, employees, partners, and regulators. They need to dedicate enough time to make sure the communication is personalized and relevant to the stakeholder. For example, a reduction in price may be seen unfavorably by shareholders, but they may be well received by customers. To avoid this, the organization can communicate to the shareholders the rationale for the price reduction along with their approach to how they plan to achieve greater revenue or better profit. It is important that organizations also make efforts to educate the right stakeholders about their value drivers, and pricing strategy so that they can become their advocates in the long run.
After focusing on communication and education, organizations can focus on execution. They will need to build in the right framework, processes, and practices to make sure the execution is on track. They also need to ensure that if the execution goes off plan, the right measures and metrics are in place to bring it back on track. It is important that organizations do not forget that communication and execution are meant to be a continuous process.
Creating the Right Alignment
Organizations can focus on defining the right pricing opportunities and identifying the right value drivers. But organizations must also align their pricing strategy to their business priorities, the market conditions, the customer expectations, the product strategy, and the channel strategy.
Let us look at each of these in detail.
Aligning with business priorities
Have you heard about MoviePass? Its initial pricing offered unlimited movies for a flat monthly fee leading to a rapid growth in its customer base and popularity. While they expected a customer to watch only two or three movies a month, they never considered the super-user who may end up watching more than ten movies a month. And as a result, they struggled financially as they had to pay for the movie halls each time their subscriber visited them. Faced with mounting losses, MoviePass tried to change its pricing model. They experimented with limited selection of movies, surge pricing for popular movies, and even reduced the number of movies that the customers could watch as part of the subscription plan. But customers started ditching the platform because of their frequent changes in pricing. And eventually they filed for bankruptcy.[7]
The fundamental reason why MoviePass failed was because of the misalignment of its pricing strategy with its business priorities. For any business to continue, it needs to generate money, and not bleed money with every transaction. While the proponents of hyper-growth may argue that even Uber loses money in most of their rides, the case with MoviePass was different – their pricing strategy was not promising a financially viable model – not then, and not anytime in the future.
Aligning the pricing with the business priorities of the organization is important. For example, if an organization is prioritizing exponential growth at the cost of profit, a discounted pricing strategy may be appropriate. If the organization is prioritizing profit overgrowth, then the right price which covers the cost and achieves the profitability targets may be the right way forward. If the priority of an organization is to achieve market share and cost leadership, a lower price may be justified.
Aligning with market expectations
Juiceroo was great company, with a fantastic idea. They made awesome juicers with proprietary juice packs that offered customers the option of having restaurant like juice at home. But the juicer was initially priced at USD699. And the juice packs were only available as part of a subscription service which was also exorbitantly expensive compared to other options available in the market. This led to the product being perceived as extremely expensive with respect to the value it offered, and within no time, the product failed.
Clearly, Juiceroo was not priced as per market expectations, which clearly wanted a more affordable juicer with no proprietary subscriptions. Aligning pricing strategy to market expectations is important as it helps with faster and continued adoption and creates a strong value proposition for the customer. And these market expectations are not just about the customer. These are defined by the existing competition and impacted by the thoughts of industry experts and influencers. This will help in driving the overall adoption of the product or the service and help the product or service stay relevant in the market, in the short term as well as the long run.
Aligning with customer expectations
The pricing strategy must be in line with what the customer wants. For example, Vertu was known for its extremely costly phones which were positioned as limited availability luxury items. Initially, Vertu was able to hold its fort against competitors such as Nokia or Motorola. But eventually advanced technological features became the key selling point for the category. Customers, who earlier preferred luxury brands, became unwilling to shell out big bucks for phones like Vertu as brands like Apple and Samsung offered the latest features at high price points. Eventually Vertu had to shut shop by 2017, but only after demonstrating that pricing, even for luxury products, must align with customer expectations.
A pricing strategy that is not in line with customer expectations will prevent customer adoption, create negative value proposition, reduce willingness to pay, and push customers to alternative products. Hence, it is important that organizations align their pricing strategy with the customer expectations and be ready to realign their pricing strategies with evolving and changing customer expectations.
Aligning with an updated product strategy
It is also important to note that the pricing strategy must be in line with the product strategy, even if it is continuously changing.
Let us take the example of Blackberry to understand this further. Towards the end of 2000s, there was no better phone for a professional than BlackBerry. BlackBerry was known for its premium phones that prioritized security and productivity and came with physical keypads. But new brands like Apple and Samsung entered the market with sleek models that did not have any physical keypads, and customer expectations began to evolve. Moreover, security and productivity became necessary features rather competitive differences. But BlackBerry took time to adjust to the evolving market expectations. For a long time, the product strategy of BlackBerry focused on security and productivity, and the resultant pricing strategy was high compared to the competitors. All of these meant that customers started moving away from BlackBerry and started using alternate phones. As a result, BlackBerry struggled to maintain its market share and gradually it was pushed out from the smartphone market. On the other hand, Apple’s premium pricing was in line with its strategy of offering high-quality, user-friendly, and technologically advanced products. And so, even with high price points, Apple captured the lion’s share in the profit generated by the smartphone industry.
By creating a pricing strategy that is in line with an updated product strategy, organizations can not just stay relevant, but also expand the market. It also helps in creating the right differentiation and offers the right degree of customer value proposition.
Aligning with channel strategy
In 2012, the retailer JC Penney decided to revamp their pricing strategy. With an aim to simplify pricing, they decided to abandon its promotional pricing strategy and discounting approach in favor of an everyday low pricing strategy. And they also decided to follow the same pricing approach in its physical stores and their online stores. While it was launched amid high expectations, it received a major backlash from its customers. JC Penney forgot that each channel had its own cost structure, requirements, and catered to different sets of customers. And the new single pricing strategy did not consider these channel-specific requirements. As a result, JC Penney lost a lot of customers. They quickly reverted to their channel specific strategy and the CEO who was responsible was replaced. Several stores were closed, and a strong financial restructuring ensued. JC Penney had learnt their lesson.
Aligning the pricing strategy with the channel strategy will help create a strong customer experience that is relevant to the channel that the customer is using to interact with the organization. It will also improve the operational effectiveness of each channel and create synergy between channels. It will also help streamline each channel and help increase customer satisfaction. Moreover, it will also optimize the revenue generated from each channel and avoid situations in which one may cannibalize the sales of another.
So, What Can Organizations Do?
To make pricing a strategic lever, organizations can do the following four things – create the right organization structure, invest in people, leverage the right technology, and focus on implementing the right pricing process across the organization.
Create the right organization structure
Let us take the example of Booking.com, a booking portal for hotels that competes with other travel portals like hotels.com and Experida.com. The travel industry is highly agile, which requires quick pricing changes. Even a 1% difference can make the customer switch to a competing portal. To cater to these needs, Booking.com has created a strong organization structure that helps with agile pricing. It has cross-functional teams that include pricing analysts, data scientists, product managers, and software engineers who consistently manage the prices through automated approaches thus reducing the price differential with competitors. This structure also helps drive seamless collaboration and knowledge sharing across the teams. Booking.com also has a strong data team that promotes a data-centric culture across the organization. It also follows an agile methodology with rapid releases to implement pricing changes, some of which may change every minute. It has also invested in and implemented a strong centralized pricing infrastructure that helps in achieving consistency and scalability across its different regional portals while allowing regional teams to offer customized pricing based on specific market needs.
As evident from the case of Booking.com, organizations need to invest in a great organization structure that is agile, focuses on data, and promotes knowledge sharing and collaboration across multiple roles.
Invest in people
People make or break a company, and people make or break a company’s prices. And one company that knows this very well is GE. GE, as part of its learning and capability building efforts, focuses extensively on enhancing the pricing knowledge across the organization. Its training focuses on pricing strategy, value-based pricing, pricing analytics, and pricing technologies. Moreover, it has established a dedicated Pricing Centre of Excellence (CoE) that acts as a hub for pricing expertise across the organization.
A well-trained and knowledgeable workforce in pricing is important for any organization – not just to make pricing a strategic lever but also in making sure the pricing strategy is executed in line with the organization priorities.
Leverage technology
It is also important that organizations leverage the right technology to define and execute the pricing strategy.
In a world where data is available in troves, having the right technology that can point organizations towards effective measures is paramount in defining the right pricing strategy. The right technology can help weed out the important metrics from the not-so important ones and make the pricing process simple and easy to use across the organization.
Uber is in fact a great example of an organization which leverages technology to make the right pricing decisions. Uber was one of the first organizations that implemented machine learning in its pricing decisions as they used the data about driver availability and customer demand to create price points that were acceptable for both the customer and the driver. They also used concepts such as geo-fencing, real-time heat maps and real-time data processing to create multiple price points that were updated on a real-time basis. They also were able to leverage technology to ensure transparency for their customers.
Today’s customers need real-time pricing that is personalized to their needs. Organizations must leverage technology to make sense of the data that is available to them and create the right pricing strategy for each customer segment.
Implement processes
The above three facets are important, but they may fall flat without a great internal pricing process with clear-cut responsibilities and measures in place supported by deep market research, continuous improvement, and strong governance.
P&G is a great example of this. They have a strong market research team that digs into pricing dynamics forming the foundation for their pricing decisions. They also emphasize cross-functional collaboration for each of their pricing decisions. They have clearly defined processes, accountabilities, and governance mechanisms along with a strong process to collect feedback. They also regularly review their pricing decisions to continuously improve. P&G stresses having a robust governance process that ensures consistency and compliance across markets. They also have frameworks and rules that act as guiderails for their entire pricing process.
A strong pricing process is not just a capability that is possible for large organizations but is a vital point of differentiation for small and medium size organizations. It can help create the right pricing strategy that is aligned with market expectations, organization priorities, and support long-term business growth.
The Final Word
It is high time that organizations gave pricing the importance it deserves. The benefits are numerous. Not only will it optimize the balance between revenue, cost, and value, but also ensure a competitive advantage for the organization and provide a strong platform for better long-term value creation. And if done in the right way, with the right people, treating pricing as a strategic lever will ensure increased profitability and customer satisfaction.
Organizations are beginning to realize the strategic importance of price as a fundamental lever in influencing how their stakeholders will react and interact. But they can do a lot more, and the ones who act will succeed in the coming days.