Value pricing – You can’t get there from “Cost-plus”

Do we ever really get pricing right?  Sometimes we do, and some of those times are actually on purpose, but it takes a lot of upstream activities to go right in order for pricing to be optimal as well.  Too often pricing is that last variable at our disposal when all else fails.  Discounts and two-for-one specials – the universal emergency fallback remedy for poor design, poor quality, late-to-market, out-of-stock, too much stock, poor service, poor forecasting and overall poor planning.

What to do?

  1. For starters, fix all those operational excellence items mentioned above.  Easier said than done, of course, but there is no time like the present to get started, and no better place to start than inventory optimization and demand synchronization of the supply chain.
  2. Improve the forecasting, improve the forecast accuracy.  Get that random component down to a manageable size.
  3. Back to basics – Part 1: VALUE PRICING.  Remember why you went into this business in the first place.  You are creating value – get paid for that value.  To support and reinforce a Value-oriented culture, add a Return on Assets, Return on Equity, Return on Capital Employed (my favorite,) or Economic Value Add metric to your management dashboard if it's not there already.
  4. Back to basics – Part 2:  Stop it with the COST-PLUS pricing!  When you catch yourself pricing with nothing but a spreadsheet formula that divides direct cost by (1-the overhead rates for SG&A and R&D and whatever), go back and remind yourself about Part 1 – Value pricing.  If your finance staff is doing most of the pricing with little or no input from marketing and sales and product management, you are doing it wrong.
  5. Which leads straight to a proper PRICING PROCESS that incorporates the insights of sales, marketing and product management into a formal recognition of the perceived value by type of customer and/or distribution channel.  If you do not work from a formal price book that incorporates these insights, there is no way you can come anywhere close to value pricing using just a spreadsheet and some cost data.
  6. Customer intelligence.  Much of that marketing insight is going to come from judgment and experience, but don’t forget the treasure trove of customer data you have available to be mined and analyzed in support of better pricing decisions.  There are undoubtedly several actionable customer attributes linked to your pricing/margin history that can serve as a solid, fact-based approach to value pricing.
  7. Activity-based costing. WAIT!  Didn’t I just entreat against a cost-based approach?  Still, you do need an accurate picture of your true costs – they set the floor and prevent a lot of unnecessarily bad pricing, marketing and production decisions.  Accurate costs are one VERY important piece to the pricing puzzle.
  8. Lifecycle pricing.  Once you’ve decided on your pricing strategy for your early adopters (i.e. premium, or market penetration), analytics can uncover the patterns in pricing and margins from your history of similar products.  Don’t miss the peak of the majority adopters, or wait too late for clearance pricing for the laggards by not understanding the pricing behavior of your product lifecycle.
  9. Price optimization.  When you hear the term “optimization” think – “constraint”.  And while price optimization most often applies (with great ROI, I might add) to non-inventoriable offerings, such as hotel rooms and airline seats, any process that has regular constraints in production capacity, supply chain, inventory, or distribution can benefit from an approach that includes optimization.

Just a few weeks ago in this post (“The Beatings will Continue …”) I concluded with what really is the heart of the matter: once you have forecasted your business as well as you can, using all the analytical tools at your disposal, there still remains that random component. The art and science of running a profitable business lies in developing and deploying better options for dealing with the inevitable variability in your business and markets, which includes inventory management, marketing programs and pricing among other things.  It is when you neglect to develop a comprehensive response plan to business variability that you end up stuck with cost-plus pricing at the point of sales negotiation as your option of last resort.  Pricing ends up being the overworked workhorse to atone for sins committed upstream.  Value pricing - it's why they call it a “value discipline”.

tags: activity-based costing, analytics, customer intelligence, forecasting, price optimization, Pricing, supply chain, supply chain analytics, Value Pricing

3 Comments

  1. Posted June 11, 2013 at 4:14 pm | Permalink

    Nice post . . .

  2. Hieu Nguyen
    Posted June 12, 2013 at 11:06 pm | Permalink

    Very nice and clear post with summary of sharing on costing and pricing.
    However, I believe it always exists a need for a corporate owner to have simple calculation on price and know how much profit earned in producing products, especially for SMEs with wide range of products.

    I always appreciate balance between costs and benefits of increasing time for pricing and its inputs from markets

  3. Posted June 13, 2013 at 7:41 pm | Permalink

    We discuss value based pricing all the time in our CEO Roundtable discussions but knowing how to do it right seems more art than science. It is hard and you need to invest time, money and effort to do it -- and then redo it. It is especially hard for small business to avoid the simplicity of cost plus pricing.
    Loren Carlson
    Chairman
    CEO Roundtable

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