Author – Pankaj Mohanta | Download PDF: INSIDE THE ANATOMY OF STRATEGIC PRICING – PANKAJ MOHANTA
“Too many people overvalue what they are not and undervalue what they are ”
– Malcolm Forbes
Not too long ago, I was associated with a tech startup hooked with a consultative role. Among all the never ending things over the front of strategy formulation for growth & expanding market cap or machinating to orchestrate execution in marketing, one of them was pricing & from my personal experience, it turned out way more sophisticated than I thought it was. Talk about sophistication & people who keep chaining quotes every once a while about lines that flows something like, “Simplicity is the ultimate sophistication” actually stands a lot bit true when we think about determining a price. Behind these 3 platinum letters – M.R.P, lies the ultimate act of balancing where businesses wind up walking on a tight rope with a constant struggle which decides the outcome between falling on the will-sell or wont-sell sides. Undeniably, essentials like, product & service, business environment & value chain, branding, people, organizational culture, expertise/know-how [& luck] etc. are although factored in for a blockbuster streak of sales of a product or a service but a diverse powerhouse in a country like India, a right commodity pricing is almost an imperative to attract any segment that is, by any means today, spoilt with choices.
Startup founders & the likes of their top management folks are almost always swamped neck-deep about pricing, well, to say that would still be embarrassingly understated since their intrinsic entrepreneurial drive to solve customer pain points may not necessarily have a proven business model. That being mentioned, the product or service may not even be a minimum viable offering that could self-sustain, given how rapidly customers keep switching preferences until they find THE one. Even for the Managers from organizations that are more or less incumbent, this is that type of migraine that has got no pills.
Factually mentioning, gauging the potentially right pricing strip by the organizations even with the best finance & analytics team strapped with numbers & formulae can only go so far, if the moving parts on the ground & beneath aren’t grabbed with the data as its prime accompanying informational accessory to begin with. For what it’s worth, there are just too many items on the sheet to factor in. Indirect business situations in the grand economic scheme of global forces like, emerging markets, technological pace, ageing workforce, resource scarcity, decreasingly low barriers to market entry etc. are seen to be having underlying impact over countless number of things including commodity pricing of products & services in the liberalized markets that is moving the inflation bar. On another hand, consumers continually keep up with the crusade of demanding more for less, it is forcing organizations to forge inroads towards a rapid pricing transparency in this “new normal”. Much of the in-house efforts are heavily biased towards setting a competitive pricing to thwart new & nimble challengers that are now increasingly viewed as major threats as opposed to previously perceived incremental hiccups. This mind-set paves way for undercharging for a product or service as a sub strategy to dodge “disruption”. Right here, lies the cause for a pause!
As belittlingly audacious as it may seem or sound but undercharging a new product/service severely suppresses its market positioning by sharply edging out its premium-ish element from it. However in many situations where, sales, generating & retaining marquee customers is quite a business development priority, this may be what it takes to be an approach to stick to, by low balling prices of the new offering. Having done so, the next thing you know, not only you’re throwing overboard all your profits but also, bad yet, the revenues. And even worse yet, since the customers would have gotten used to such low prices, it runs a breathing risk of unleashing a systemic sales killing when the prices are jacked up. The capital investments that are thrown into the R&D in a lot of instances, the cost numbers have historically matched 8 to 9 figures for either acquiring or developing it. For example, take any typical smartphone from the current times that conveniently fits in a user’s pocket. They have capabilities that are strongly at levels with a super computer from a while back. The interesting thing here is, they have latest generation hardware which houses some of the best processors that provides superior computing power inside their ergonomically slim casings. Not to mention the additional app & device features they have in them complimenting each other that ensures an unmatched user experience & yet, they are sold at rock bottom prices that don’t seem logical in the first look. It is surely all great for buyers but given the extravagantly large customer acquisition costs [companies with culturally high Digital Quotient are exceptions though] for any new product/service, this paradoxical reality continues to be one of the compound fractures. Agreed, it takes a few bright minds & significantly higher innovation doses to strike that fine balance but the ever growing pressure for robust investor & shareholder returns, companies often rabidly end up chasing for higher market shares for a higher market cap for an even higher returns on investment. This is a monumental challenge given such large associated operational costs not the least of which is, how other competitor gradients keep affecting these every once a while.
Typically, companies try playing safe by implementing either a step up or step down approach in pricing, somewhat leaning over the pre-existing similar products along the relevant offering types as their point of reference which is regardless, a natural instinct. Setting the price relatively lower or higher than the existing offering[s] by their competitors sure sounds just about right & makes even more strategic sense to have them felt competitively priced. That right there & proportionately levying R&D, production & marketing costs included into the pricing slab which is almost a standard protocol could potentially backfire in the wake of unpredictability about consumer adoption. A calculated risk never entirely mitigates the dangers posed by the variable value it delivers to its target customers despite all the homework.
One of the no-chances-taken attitude can help in dilemmatic pricing situations like this one. I call it benefit gauging. I would argue that this approach is very crucial now more than ever in the wake of the readily visible disruptions that have become a norm much lately. The reason being, anything that looks too good to happen currently, is just only a matter of time away. We no more have the luxury to assume about who are disrupting now, the prime concern should be rather, who will be disrupting later & everyone knows that these innovatively disruptive practices are going to keep coming to which there is no stopping. Embracing an approach that counts in the widest amplitude of stakeholder & competitive factors is the key to set aside expenditure differences that arises from the normally rigid cost engineering of internal processes. In my opinion, since a great quality pricing number shouldn’t be determined from a few logical derivations based on what some Cost Benefit Analysis [CBA] has to say, it should actually be looked from the possibilities of delivering the longest term profitability prospects. Sure, the component of financial logic is a definite rationale that has to be tightly integrated but it shouldn’t be the only prominent brick type laying the floor groundwork since the operating models of experiential logic now outmatches on the mosaic pattern of consumer behaviors. This has fundamentally & permanently changed the business models uncovering a slew of options once uncommon & unheard, for instance, pay-per-use pricing models. This demands the pricing itself to be broken down into functional factors of all its fundamental logic that accounts for benefits for every hierarchy that are related in some or another ways for the producers, the sellers & the end users. As obvious as it is with this appropriate setting, the benefit landscaping should always be one of the first things to be implemented in the development cycle. Favorably as early as, even when the idea is being conceptually drilled & markets are canvassed for having being surveyed about product & service attributes the customers are most willing to pay for.
This categorically prevents a contact binary problem of gaining new & retaining the core user base by altering the customer’s behavior on preference switching & delivering superior value for the asked price. Obviously, there is lot of economics to this. Compactly laying out real quick, it includes the combination of, floor price [the lowest feasible price], ceiling price [the highest feasible price], the competition [substitute offerings that gives customers the bargaining power], marginal profits [for the beneficiaries involved in trade channels – distributors, vendors etc.] & price elasticity over the supply & demand axes [higher price & even higher demand drop –Elastic product indication | higher price but relatively lower demand drop – Inelastic product indication]. But from purely a strategy perspective, it’s not something like setting a ceiling price for any given commodity & focalizing much efforts towards starting from lower end of the pricing bar but instead, approaching a regressive style surely helps. This regressive & dynamic pricing approach leaves less accommodating space for the competitors because for newly launched products, there either may not be enough existing market because it’s too niche or the target segment’s willingness to pay puts them in a position to ask for a greater value that would affect the optimum pricing levels. So, establishing standing analysis for landscaping the uncertainties by benefit gauging ascertains every nodal price points being considered before hitting the go line on any one of them. This brings us to the next step which has the prime objective of establishing the comfortable average from whereon a certain flexibility in standard deviations may be allowed. This phase requires an intricate understanding of how much the new offering might mean to a typical customer from the target segment & the degree of emotional binding customers may attach it with. Because if that means what you think it means, customers almost always pay the price if it means what they think it means. Not to make it seem like some bargaining chip but this is just to say that, the decision makers from the producer’s viewpoint initially do have an extensive spectrum of viable options to choose from while inclusively delivering the desired value a typical customer from the target segment expects.
The pricing for any new offering largely depends on its type. To have a relatively better understanding of the new offerings which is the current issue of my focus in this very paragraph, I would like you readers to see it through the periscope of Ideation. As we all know, ideas, frugal or otherwise could even crop during a throwaway conversation after all it’s a refined thought that could change things for the better & anyone could think [& brainstorm]. Talk about ideas, it effectively could have 3 main tiers:
- An idea that is just like everyone else’s. [Think: Generic]
- An idea that is better than everyone else’s. [Think: Innovative]
- An idea that is like no one else’s. [Think: Inventive]
Here at this point, take some time to picture those 3 tiers by overlapping on the product or service offering as differentiation stripes. So correspondingly, for the types of available offerings sold or served, we now have:
- Clones: Just like any other products or services that are available for the target segments with strikingly similar brand messaging & the going gets tough with a minimally flexible pricing scope.
- Evolutionary: These improved offerings provide better than before features than their predecessors for the same target segment brought to them with refreshingly new tweaks. This is one of the reasons for the fight among companies, particularly those that operate & share identical or similar sectors for largest market cap & retaining the previously scored ones.
- Revolutionary: A potentially game changing offering that target segments never knew could exist yet effectively capable of serving their needs that they never knew was required. Since they are often only theoretically validated, these are inherently risky & it is usually already too late by the time companies realize they have produced something which the customers don’t want. Thus requiring both, time-resources & slick marketing to communicate smartly about its USP to ensure business viability to reach & get past the break-even point.
According to Accenture Strategy, an increase by 1% in the average price yields an approximate scale of operating profits in the range of 7-15% which rightfully goes onto suggest that having done so, it saves a lot of trouble from having to push too hard on the salesforce & or aggressively acting on cost cutting initiatives. Sounds convenient? Well, not quite. The thing about industry threats from the competitors is that they are ambiguously visible to monitor or decide conclusively & have become tactically undercover these days almost to an extent of a time something like today’s corporate cold war era that we have been living in. To which, organizations need broader interior evaluation which has some fair chances of providing practical insights into pricing strategies that suit the above 3 tiers with respect to offering’s market positioning.
Since we are more plugging towards marketing mojo capabilities to zero in on some of the most suitable pricing ranges, the two methodologies that helps businesses shine a torch towards getting more refined data capacitors for potentially right numbers are perceptual mapping & conjoint analysis profiling. Sort of an afterthought right here; in a startup or in a company that has a startup like environment/culture and as is the case anywhere with tight deadlines, those techniques however may not be the ideal go-to analytical schemes. Top reasons are, it is entirely a data dependent process that requires statistically high quality of crude back-end information right from the very beginning, to fairly get close to reasonable operating assumptions beforehand about estimates for quants like willingness to pay based on perceived value to customers [by the marketers]. Besides, numbers related to competitor’s business volumes & market cap is another must have thing handy to even start grading a map based on perception. However on a bit of a downside to all of this, these marketing-centric tools act as nothing more than just facilitators and enablers rather a conclusive resting block for an ultimate decision making for pricing.
Nothing is a sure game anymore because perceived value of a product or a service strangely floats along the trends & fast fads these days. The more the offering gets viral, the better the attention; the better the attention, better the chances of it being mass absorbed; the better the mass absorption, better the lead conversions & commercial realization. Now let’s get back to pricing again with such facts in the backdrop, inputs about product & marketing mix, cross-channel exposures & optimization of the customer experience management can be a distinct way to numerically slash down user attrition. By all means, techniques such as those can evaluate more or less as to what is the potential unique value perceived or how much emotional attachment customers will have behaviorally. But in practice, this is often widely relied on guessing by technical teams which entirely undermines the data mining & market researches. Although those that do, they tend to be boxed in within their prism biases towards an offering’s attribute that solely rests on very few prominent features, thereby jeopardizing entire efforts & foregoing potential profits in the longer run.
There is a good chance that the questionnaire for the customers during its experimental phase prior to product prototyping may be localized to limited dimensions of potential issues which only corroborates the set of already known usefulness by the R&D team & anecdotal data presented by the in-house sales or business development team. Thus, it is very helpful to have a detailed brainstorming about the few or many possible value aggregates the offering could bring onto the deck that draws the line in the sand for customers from the intended target segment. In short, the teams should focus on the values for the customer not their product offering itself. For instance, consider these 2 question types post trial, for a premium luxury clothing line for men:
Question #1 – Did the meeting pinstripes on the peak lapel looked too old school when you had our latest flagship designer 3 piece suit on?
Question #2 – Wasn’t that a confident looking suit for a naturally confident you?
Decoding the message behind the two questions. When the given instance targeted towards a focused group of segment that is being analysed which primarily includes business executives, quite possibly some of the top personal attributes that are sought or at least expected to be amplified by the new suit [product offering] could be:
- Class & gentleman’s finesse
- Power & authority
- Successful & accomplished
The whole point of this example was that customers generally aren’t responsive towards trade-offs & putting too many gates in questionnaires that is exclusively meant for understanding the target segment itself is quite a degrading idea. Plus, from a customer’s point of view, they can’t brainstorm about the fine intricacies which an offering might have to offer. Simply because they might not be aware that its affecting their decision making without having them realized about any of that and not necessarily every respondent is capable of an abstract thinking. On the same page of product mix & marketing, take a look what’s happening with iPhone SE launch in India on April 8th, 2016. Exclusively from a pricing viewpoint, it costs about $600/ Rs. 39,000 which is too high a price in a typical Indian market that is being currently bombarded with several low cost smartphone manufacturers. Without a shred of doubt, it is a risky move considering, Apple offers iPhone 6s at about $640 / Rs. 43,000 which comes hot and steaming with competitive features thereby potentially cannibalizing their iPhone SE sales. Logically, there is a good chance of them eventually cutting down on iPhone SE’s prices for Indian markets as was done with its iPhone 5s, bringing it down to one of the lowest pricing anywhere in this world for its unlocked units. It’s true that they are making way for their next generation offerings while enabling more mainstream absorption of the previous models but they are extensively based on behavioral sciences. Apple very well leverages the perception of its brand as a premium one in the minds that maintains the status quo by keeping that price range for quite some time. The personal attributes they target are all geared towards the esteem needs of the customers. And when they finally do drop down their prices, word gets out quickly on the streets to the huge chunk of late adopters & laggard customers in India. They tap into this segment as if they are incentivizing which is strongly suggestive of the new price offering aimed towards firing up the pleasure-reward pathways of already curious prospective users who are NOW willing to pay. But once again, this is all to say that the customer’s play by the economics for any company in this decade & well beyond, is going to be shaped by the experiences & value perception. To many robust extents, this will present a long-view for a more accurate pricing picture for the end users that hold a given ceiling price to be justified for a new offering.
PRICING PROBLEMS & A FEW GETTING AROUNDS
Any form of penetration pricing [the lowest introduced price of them all] for a singular or multiple adjacent markets sure seems like a quantum leap for companies whose top priority is market capture. Having said some of that, it puts the companies on a clock. One of the two major downsides to it is, this is an impending flashpoint for a high excitement generation in an extremely short span & suppliers may not be able to keep up with such excessive demand. This excitement has taken its toll in interesting ways though. Remember the Indian e-commerce giant, Flipkart’s Big Billion Day 2015? That time when it was offering products with upto 90% flat offs & how it’s landing website kept crashing due to overwhelming internet traffic during anticipated peak load times? Regardless, this leads to scores of dissatisfied customers due to such unmet demand & fault ridden fulfillment management & a direct consequence is a black hole in the brand’s equity & overall goodwill. The second downside, going full throttle to scale rapidly by tactics of aggressively low balling retail prices almost always ends with a price war & there are no winners. As there are very little or no profits in a competitive market condition like that, every entity involved in such price wars quickly start showing early signs of financial distress & if not addressed sooner than later, it can implode organizations. If such a case involves a first of its kind or one of a kind offering connected to launches in underdeveloped markets, customers are normally price sensitive. Assuming that the supplier is the only standalone provider of such unique offering where customers perceive some value, it can rapidly build a formidable presence with its penetration pricing & can slip through cracks to reach out latent pockets of isolated demand opportunities. Considering all this buzz, competitors will soon enough dive in with clone offerings competitively priced or with jaw dropping discounts & with all kinds of customer loyalty schemes with an intent to outmatch. Unfortunately, this has been happening for quite some time in the Indian food tech sector where the margins have been historically thin in an industry where customer’s qualitative expectations were/are already too high. The end result, disappointing balance sheets & several shutdowns which also made quite a few runs in the national media.
The key economically macro takeaway from this entire episode is that, it’s always better to put an elevated pressure via various offerings, new or old. So that it advances a reactively healthy pricing attitude across the industry which is not only ethical but also strategically critical, since such pricing could be used for taking deep swipes at the competition [highly situational though]. Keeping an eye open on the bigger picture, a penetration pricing is just isn’t the right thing to do every time. Such as now in the Indian food tech industry, across this subcontinent market which has statistically low switching costs along with which, one where it qualitatively lacks strong enough standards of product & service benchmarks in the said niche. Players in similar growing niches & sectors that are overcrowded can well adopt a strategy of gradually raising it. But with prevalent churn rates resulting from widespread disruption, new & unexpected competitors with slightly better offerings could bring landslides for incumbents if customers are exclusively bent towards value instead of price. Innovation or collaboration is most certainly a way out of this which is a discussion for another day. But talk about practices, such prices have to be re-established back from the drawing board to have a better handle on the accuracies on cost per unit. The arrived floor pricing after adding the minimum expected output of Returns on Investment [ROI], incurred expenditure per unit & an accepted margin usually gives the appropriate lowest reasonable price for the offering. If it still doesn’t sell among the targeted segments, the offering isn’t viable or isn’t being communicated good enough to generate excitement. The pitfalls don’t just stop here at the inappropriate floor pricing, there also exists chilling effects by way of tanked profits for offering types that are already being sold or served. There is a very little breathing room for clone offerings where customers have a supreme power to switch. Replicating the pricing model based on optimistic assumptions from competitors for similar offerings is most certainly isn’t a good idea as their varying sizes & operations comes with unique factors which might not necessarily be the similar case. This is catastrophic when entire revenues & operating profits rests solely on the expenditures saved due to a measure of an achieved economies of scale to afford some flexibility that are nothing but based on false estimates about market & segment size early on while calculating the floor price.
In emerging economies where there are typically less advanced market clusters with a scattered rural demographics, sweet spots right below the ceiling has to be figured out. In a market like that where we have a complicated mix of customer profiles which includes both, quality conscious & bargain trappers or the “switchers”, the common principles of supply & demand may not always work. Thus, there is a probability of a sales vacuum for offerings that lies halfway in the floor to ceiling runway which acts as a purchase repellent by being perceived as cheap by the skeptical-former & expensive by the hustler-latter in a demographics which has an economics-defying customer profile mix like that. One believable solution to this is the already rampant practice that has witnessed a surge in popularity among marketers which is seeing the daylight ever since is, freemium. Microsoft has been over-aggressively pushing Windows 10 OS for free like a badass despite drawing criticisms worldwide at an epidemic scale. This is a mega attempt not only to blanket cover as much existing older OS user base but also this is where they hope to rake in as many high profile influencers as they can in the process. Such sharewares, freemium, trial periods & the likes of those offerings greatly accelerate the rate of market penetration. For most part of it, they are necessary evils in the business as usual context because during the most crucial 1st year of the offering’s launch, these are qualitative determinants for value positioning in the target segment. During the initial 12-month timeline, flat discounts are a big no. As the saying goes, “first impression is the last impression”, no company would want their newly released offering to come across as cheap. Ascertaining the maximum possible profitability could only be obtained by a detailed cost analysis & a systematic market research which can greatly provide the strength & belief to dodge the initial chaos around the new offering to encash its actual value. However at the same time, to make matters a bit more challenging, there is definitely no second guessing over not undercutting the value proposition by shaky pricing while explaining the benefits to skeptical buyers. And since it’s hard to change customer perceptions & since you don’t get a second chance to make another first impression, it’s hence, radically important to communicate well as if ringing a bell. Having a Birdseye view over the total assessment regarding answers to pricing bracket for the new products & services is arguably called for during the very beginning of product development cycle.
Another way out is starkly effective but are always hidden in the fine prints of the service level agreements & various related “paperwork”. From my personal experience, I can tell this with a great material degree of mercantile confidence that the legal gridlock happens to be one of the surest areas of focus if a company is actually serious about its pricing optimization. To put this in a general fashion minus the legal jargons, the way these paperwork works is by pushing a delivery vehicle deep into the regulatory & compliance territory with legal frameworks that either statutorily or contractually binds the parties. The immediate episode that awaits next is, liabilities arising out of either actions or omissions that leads to violation & term-sheet breach & a consequential revocation & in some cases litigation exposures too. This keeps a lot of CEOs awake at nights but it need not be this hard. This phase needs a bit of a solid attention for a constant eye out to work the details in the form of a legal due diligence to redline the unfavorable clauses that has a propensity to affect the costs which eventually goes onto proportionately affecting the offering’s retail price. Before dotting the i’s and crossing the t’s, the covenants must be reviewed by a qualified & experienced Attorney or a team of legal professionals to review and negotiate on behalf of the company with other parties. To those who might think that this is of little consequence, I should probably reassert that the financial terms, once agreed & signed goes under the head of fixed costs [not the variable costs] until it expires & almost always, there is no bypassing it due to its nature of specificity. It needs to be customized according to changeable conditions that tend to get very fluid once the market condition changes or other business specific issues. For instance, things like machinery and asset depreciation, labor, constantly changing oil & commodity prices onto which businesses are directly/indirectly dependent are a few of those many areas which are often ignored that further add to cost structures. The covenants that intricately revolve around some of these fluid issues are required to have them tailored so as to prevent companies from getting locked within channel agreements which restricts their pricing maneuverability. It is always a smart move by being upfront from the very early stages of contract negotiation by explicitly stating-mentioning the KPIs [Key Performance Indicators] that matters most for tracking & achieving milestones while dealing on acceptance criteria with any external contractors, vendors, dealers & 3rd parties who are planned to have them on-board in general.
Stepping a foot into the future from a business perspective over the powerplay of pricing, the pre-existing offerings that are currently in the market is affected by consumers overall. The risk takers & brand loyalists which sum up the early adopters all in all, will always be willing to pay the extra price to have a taste of experience that the new offering delivers. Banking on that, companies could still charge a premium overhead on their new & smashing products. But eventually even the big & mighty ones are seen dropping prices for the products or services whose time has come and gone so as to entice the late majority & the rest. This stage requires a good level of sales foresight for offerings, especially when they have product verticals which are brand extensions from the same company. Since the success of an offering after launch is also just as much important while not burning the sales runway of their existing line of portfolios that are doing well, they have to price it higher than those existing ones. So the new doesn’t end up hijacking the old by cannibalizing its sales. And if the predecessor offering is being gradually phased out, it’s a common tactic to give the release price of the successor offering a little less price booster so that the new offering hits the ground running with minimal attrition from existing customer base. A complete planning of such lifecycle also assists the suppliers to evaluate their capabilities for production capacity management till the phase of market maturity & planned exit.
On a far more long term road with a vision to lasting value creation for the target segment & handsome profitability, the lifecycle management over the issue of pricing new offerings by any company is probably the most consequentially significant series of steps which needs to be intelligently managed. The new & improved evolutionary type of products and services are one of the most vulnerable & so are the same ones which create ripples that paves way for a wave of others who try to catch up. At the end of the day, it all trickles down to end users. There needs to be a long term view of the pathway to profitability with a good stakeholder governance. Commercially viable products with a bulletproof pricing will only last so much & as long as we continue to live in times of chronic turbulence, the ever altering dynamics of the business ecosystem will continue affecting the prices, giving marketers & companies a run for their money. If there is anything more to learn from this article, then there is about, how a good understanding of where things are moving in terms of customer preferences & how the laws of economics in this overly complicated & digitized environment can mean the difference between will-sell or won’t-sell situations because the game of pricing is far from over.
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