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Strategic Pricing
How to adjust pricing to strategy
Published in Hebrew in Status - Management
Thinking Magazine Issue 244,October
2011
By Ari Manor, CEO of
ZOOZ
Is pricing a tactical or strategic issue? Who should dictate the
pricing of your products and services? How do you know what the
right pricing is for your business and marketing strategy? What
pricing will allow you to grow and increase your revenues in your
market? This article will attempt to answer these questions, while
focusing on the strategic aspects, and on matching the pricing to
your strategy
A. Pricing – Tactic or Strategy?
Pricing has tactical aspects, especially if it is specific
pricing, such as negotiations with a large customer, a price quote
as part of a tender for service provision, or a sales promotion of a
shelf product. There are tactical pricing principles that you should
employ in these cases.
For example, prior to negotiations with a large customer, you
should determine in advance the lowest price (based on the minimal
cost and profit that will suit us), the highest price (based on
market prices, above which the customer will refuse to buy), and an
intermediate price that we can aspire to (based on the profit and
the positioning we wish to attain – as a company providing either
cheap, intermediate, or expensive solutions). During the actual
negotiations, you should start with the highest price, which is
above our target price in any case, and if necessary – lower the
price in increasingly smaller increments, to indicate to the
customer that we are reaching our lowest possible price.
There are also similar tactical principles for pricing quotes as
part of tenders, and to pricing sales promotions. For example – with
certain tenders, it is recommended to offer the customer a range of
discounts according to future purchase volumes. Details about
successful pricing for Gilat’s antennas using this method appear on
page 53 of the book Ekdah Bekrav Sakinim (Gun in a Knife Fight) by
Yoel Gat. With certain sales promotions, it is standard practice to
raise prices one month before the sale. For example – raising the
price of books one month before the annual Book Week sales.
Strategic pricing is
a key to profitability
So,
there are tactical aspects to pricing, and tactical principles for
specific pricing. However, on a macro-scale, pricing also has a
decisive strategic effect. Pricing is one of the 4P’s of the
marketing mix (product, price, position, promotion), and it is
therefore a cornerstone of the marketing strategy. Pricing
indicates to customers our positioning in the market relative to the
competitors (for example – basic, premium, super premium). The
pricing we choose must match our business strategy (in other
words – our market, and what products / services we will offer). For
example – a company that offers subcontracting services must offer
competitive prices to its customers, who will undoubtedly compare
with other suppliers.
Later
in the article, we will focus on the question of how to match
pricing to strategy. In other words, according to what strategic
principles must we price all the company’s products and services.
This is an important question. The CEO and the Marketing Director
are meant to have their say, to answer this question, and to dictate
to the entire organization the strategic principles for appropriate
pricing.
B. Strategic Pricing – What should those stuck in the middle
do?
In
any given market, there are generally three strategic pricing
options:
1.
Cheap prices – suited to a cost control strategy
2. Intermediate prices – for those who are “stuck in the middle”
3. Expensive prices – for those offering differentiation and added value
According to Michael Porter, an expert on Competitive Strategy, the
second option, those “stuck in the middle”, characterizes 80%
of the companies and suppliers in any given market: whether they
offer baby bottles, furniture, dental equipment, plastic piping,
education services, photography services, or any other solution. The
suppliers that are “stuck in the middle” are generally trying to
give a little bit more than the competitors (so that people will buy
from them), but cannot get a higher price in return.
There are many reasons why these suppliers give “a little bit
more for the same price”, or “the same thing for a little bit
less”. They either feel uncomfortable asking for more (compared
to the competitors and to the market standard), or the added value
that they provide is not important enough to customers (and
therefore the customers are not prepared to pay more for it).
Moreover, some of these suppliers would like to offer cheaper
prices, but cannot because they are not streamlined enough, or they
do not have a size advantage, and generally because their operating
costs are too high. Either way, those “stuck in the middle” all
suffer from low profitability. They are not unique enough to sell
expensive, and they are not streamlined enough to sell cheap. Their
profits from each sale are mediocre, as are their sales volumes.
The
only thing that those “stuck in the middle” have going for them is
their relatively low level of risk. Michael Reiner, an esteemed
Innovation expert, used data from the Canadian Small Business
Authority and found that new companies that offered intermediate
pricing (neither cheap nor expensive) survived longer on average
than new suppliers that offered cheap or expensive prices.
So
what can businesses “stuck in the middle” that offer intermediate
pricing do? They can lower expectations (knowing that they won’t
earn huge profits, but that their risk level is low), or change.
One
option for change is to offer low prices. They can streamline,
improve the automation production processes, conduct mergers and
acquisitions, grow and acquire a size advantage, purchase higher
volumes of raw materials and at lower prices, and gradually offer
increasingly lower prices. This is a complex process that can last
decades, and is not suited to a market that already has gigantic
cheap and streamlined corporations.
Alternatively, companies “stuck in the middle” can try to raise
prices while investing in R&D, innovation, and branding, and offer
customers real added value, that they will be truly willing to pay
more for. If you are “stuck in the middle”, like 80% of the readers
of this article, this may be the direction you will choose to
improve your profitability. The key point here is to understand
what the actual customers define as added value. Or, in other
words, what will customers be willing to pay more for?
C. Competitive Pricing – The Cheapest Possible
In
a competitive market, the main marketing strategies are cost
control strategy (offering the most competitive and cheapest
prices), or differentiation and added value strategy
(offering relatively expensive prices).
In
order to offer the cheapest prices in your market, you must
be more streamlined than the competition (using automation
production processes, low employment costs, geographical proximity
to the market, aggressive procurement, etc.), and concurrently be
larger than the competition. A significant size advantage will
enable you to acquire raw materials and marketing avenues at lower
costs than the competitors, and accordingly further lower the price
of the solutions you offer. As stated, this is a complex and
long-term strategy, requiring non-organic rapid growth by means of a
long line of mergers and acquisitions of other companies.
Teva’s Acamol – The cheapest in
the world
Since two thirds of the mergers and acquisitions in the world fail,
an organization that wants to get ahead this way must be aware of
the risks and specialize in optimal execution of mergers and
acquisitions. Even when such an organization grows and develops, it
must continue to advertise “low prices” to its customers and
employees, and to maintain a modest organizational culture. Teva and
Keter Plastic are two Israeli manufacturers that managed to do this,
but hardly any other Israeli manufacturers took this route. In the
retail domain, the Rami Levi chain in Israel and Walmart in the
U.S., and the “dollar store” chains worldwide, are excellent
examples of streamlining and competitive purchasing, which made it
possible to offer customers the cheapest prices.
D. Differentiation and Added Value – Expensive but Worth It
There is a third option if you don’t want to be “stuck in the
middle” and cost control does not appeal to you: you have to offer
your customers differentiation and true added value that they will
want to pay more for.
One
option is to provide more expensive products and services, once you
have understood what benefits your customers are willing to pay more
for, and you have focused on positioning and differentiation around
one such benefit. If you have invested in R&D, design, innovation,
and branding that support an important benefit to customers, you may
be able to charge higher prices and earn more.
Apple products, for example, provide a higher quality user
experience: meticulous design and branding, a more user-friendly and
intuitive interface, and a somewhat cult following. Teva Naot’s
shoes are more comfortable thanks to a cushioned insole that you
feel as soon as you try on the shoe. HighQ, a psychometric exam
preparatory institute, invested in the learning materials, including
interactive presentations and computerized questionnaires, and used
pricing as an important method of highlighting its advantage. For
years, whenever the competition raised their prices, HighQ raised
theirs even more. Thus, their message to customers was that
the “most expensive = the best = HighQ”.
E. Premium Pricing – Pricy but
Prestigious
When it comes to luxury products, the high price is an important
part of the strategy. Customers pay much more for premium products,
partly because they are a status symbol.
The Lacoste emblem on a shirt –
for premium prices
The
shape of the Absolut vodka bottle, the Lacoste alligator on the
shirt, the Mercedes logo on the hood of the car – all symbolize
premium products, and the affluence of the buyer. Because price
symbolizes quality – when a perfume’s price is decreased
dramatically, its sales actually go down (who wants to buy a $4
perfume?).
This trend is further reinforced when it comes to super-premium
products. Prices here can really go through the roof, and soar
way above the standard market prices. A round-trip ticket from
Israel to New York in El Al’s First Class (Super-Premium) costs
$8,209, double or more than Business Class (Premium) – where you
will “only” pay about $4000, and 6 times or more than Economy Class,
where you will pay $1,400 and less. Beluga Gold vodka (super-super
premium) is sold in Israel for about 1,400 NIS a bottle, compared to
premium vodka (Grey Goose, for example), sold for about 200 NIS, and
“regular” vodka sold for around 50 NIS a bottle.
F. Pricing and Expertise –
Expensive Because We Know You
Another option for providing an added benefit is to specialize in a
particular population, such as people over the age of fifty, urban
women, children, cats. You can specialize in one or more specific
customers (mutual dependency strategy) – especially when it comes to
large customers that have thousands of employees and large
procurement budgets: the I.D.F., Shufersal, Boeing, Petroleum of
Venezuela.
The
more specialized we become in a particular niche (fifty year olds),
and the better acquainted we are with a specific customer
(Shufersal, for example), and the closer our relationship with these
customers are, the greater the temptation to lower our prices for
them. Doing so is a serious strategic mistake!
When you specialize in a particular target audience, you get to know
these customers better than your competitors do. You give them
better service, you know their needs well, and are familiar with how
they like to receive products and services. Therefore, you are worth
more to them! And since you only focus on a portion of the market (a
specific segment of the market or certain large customers), your
risk increases. For example, if a large customer leaves you, it may
jeopardize your entire business.
That is why you have to price your expertise, and your risk – and
get more money from those that you do more business with.
Think about all the profit that you could lose if you accustom your
loyal customers to pay you less. Instead of doing that, make sure
you sell them products and services at relatively higher prices,
maintain these prices, and even raise them over the years.
G.
Maintaining Prices in a Blue Ocean
There
is also an alternative option to the various options for strategic
pricing in a competitive market. You can move away from the
competition in a crowded “red ocean”, where competitors are drawing
blood eating each other alive, to a competition-free “blue ocean”.
According to the Blue Ocean strategy, to do this you must first
identify a central benefit that most customers want more than
anything else. Then, develop a new marketing mix while improving
and adding components to a product or service that support this
benefit, while concurrently reducing or obliterating other
components that are not associated with this benefit. This
way, the pricing does not change and the prices remain as
they were, since the costs involved in reinforcing the desired
benefit were offset by the savings from the other components.
The IKEA Catalog – Attainable
Design
For
example – IKEA offers stylish furniture, and invests in designers
and furniture design innovations, but saves costs on raw materials,
and also puts the onus of the furniture delivery and assembly on the
customers. Thus, IKEA’s furniture is competitively priced despite
its high level of design.
With regards to pricing, the important point here is not to raise
prices, even though you provide a greater added value. You give
more in an area that is important to customers, and save on what’s
not important. Companies that work this way benefit from greater
sales volumes, and profit nicely from each sale, even though they
generally offer very competitive prices. Studies have shown that
companies that adopt the Blue Ocean strategy, that avoid direct
competition, earn on average ten times more than companies
that do not adopt this strategy, and that operate according to what
the competitive market dictates.
H. Summary
Pricing
has several tactical aspects as well as fundamental strategic
aspects and implications. It is therefore important that your
company’s CEO, Marketing Director, and senior management determine
the pricing policy according to your business and marketing
strategy, and subsequently dictate the pricing principles to the
rest of the organization. This is how you will be able to maintain
the positioning you wanted to attain in your market, and you will
also be able to grow and develop according to your strategic
planning.
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The article was written by Ari Manor, CEO of ZOOZ Marketing & Organizational Consulting. ZOOZ conducts training for managers and employees. Send your comments to
[email protected].
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