VideoIn times of double-digit profit growth, companies seldom challenge a conventional approach to pricing. Apart from weighing costs and the importance of retaining favored customers, what else counts? But good times do not last forever. As companies grope for ways to sustain revenues through less bountiful economic times, some are emphasizing a more elusive factor in the pricing equation: the value that goods and services represent to customers.
It stands to reason that if the cost of goods and services exceeds the value to customers, then a company is probably in the wrong business. But if the value exceeds the cost, as it should, why let costs govern prices? Instead, say experts, value to customers should determine the prices they pay.
"The primary input into your pricing process should be the value that people place on your product," says Robert J. Dolan, professor of business administration at Harvard Business School, in Cambridge, Massachusetts. "Cost-based pricing never worked very well," agrees George Cressman, a consultant in the marketing development group at DuPont, the Wilmington, Delaware-based chemical, energy, and life science company. "Customers buy because you deliver value to them, not because of your cost structure. If anyone is going to succeed with a good pricing scheme, it has to be value-based. Clearly, various customers see the offering differently. So you can charge preferential prices based on the value you deliver to that customer," he says.
In some industries, the trend is more advanced. Airlines pioneered so-called yield management by charging different prices for passengers according to when they fly and how long they stay over, irrespective of costs. It's not uncommon these days for passengers seated next to each other to have paid vastly different fares. Hotels and car-rental companies have followed suit. In other areas with low margin, such as durable goods, companies turn to preferential pricing out of necessity. "Those companies in narrow-margin businesses feel the pain of bad pricing and the benefits of good pricing," says Sameer Dholakia, director of pricing solutions for Austin, Texas-based Trilogy. "Where it's hard to differentiate products, as in the tire industry, companies are leveraging pricing to the hilt."
Whatever label a company uses, charging customers different prices appears to make good sense. Each customer is unique. Each has a different set of needs, costs, and values that affect its price sensitivity and, ultimately, a supplier's bottom line. The U.S. power generation division of Asea Brown Bovari Ltd. (ABB) develops different pricing structures based on customers' needs and then works with those customers to address their needs. "We look at which customers will survive and prosper," says Jeff Fischer, the division's director of business development.
Fischer's division has established alliances and partnerships with customers that are utilities and municipalities. "The best way [to determine a price] is to look at their costs in the market and where they fit in the basic supply and demand scenario of a commodity market," he says. ABB then "looks at those customers to find ways of increasing their profitability. We let them reach into our organization without the cost of overhead and strip out S&A, contingency, and warranty costs."
ANOTHER TRICK Trim companies can cut costs only so far. "Everyone has driven costs out of their business. We've grown profitability through that trick; now we've got to come up with another trick. CFOs should view pricing as a major pillar of growing revenues as we move toward the millennium," says Marty Mayer of Mayer Associates, a consulting firm in Dedham, Massachusetts, that advises corporate clients about pricing.
A climate that favors preferential pricing completely reverses conventional approaches to pricing. "Ten years ago, 80 percent of customers bought at the standard price that fit a universal price program," says Michael V. Marn, director of pricing services at McKinsey & Co. in Cleveland. "Twenty percent of the volume was on an exception basis--very big or special customers were cut a special deal. Now the balance has shifted exactly the other way. Twenty percent of the volume is off the standard price list and 80 percent is sold on some special deal. It's an important trend," Marn notes.
Three overarching factors are fueling the trend:
- * Increased customer demand. "There has been a lot of pressure from the customer to be treated differently--from the ultimate customer to intermediaries, such as distributors," notes Gene Zelek, partner in the marketing law group at Chicago-based Sachnoff & Weaver.
- * Consolidation of distribution channels. Downsizing, outsourcing, and activity-based cost accounting have made corporations look more closely at distribution channels. "You've got a handful of big customers accounting for a higher percentage of total sales," says McKinsey's Marn. "Powerful mass merchandisers are demanding things from suppliers," agrees Zelek.
- * Availability of sophisticated systems. Software is now more adaptable and permits tracking of all the permutations of differential pricing. Suppose a company with 100 products offers volume discounts in certain regions for a specified period of time. This could mean thousands of specialized prices that would be impossible to track without sophisticated software in place.
Companies that are most successful with preferential pricing set discrete price ranges within which their salespeople can negotiate, but they also make sure their incentive system follows the logic of the pricing decisions. A good example is Xerox, the Rochester, New York-based document services company, which has been a leader in what they call "range pricing." "There has been flexibility at Xerox for a long time," comments Alan Pariser, vice president of U.S. customer operations pricing. "Over the past 10 years, it has been mechanized and combined with the order-entry process."
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