For our February Webinar, Tim J. Smith, PhD, Founder and CEO at Wiglaf Pricing, explored the key actions a new Pricing VP or Director should undertake to deliver a positive impact from day one.. At the end of the session, he answered questions from the audience. In this blog, we share part two of his live answers.
Do you have any suggestions on ways to find out how much a customer is prepared to pay for your service?
I wrote a white paper about new product development and pricing, so you can find that on my website. It lays out the entire pathway. Start with creating that understanding of the economic value to customer Don’t create measurements first. Instead, create a hypothesis, build that value model, understand the benefits, convert them into business drivers, put the business drivers into a picture, segment it, and then develop a pricing structure [covered in Pricing Strategy – my textbook].
Now you have a hypothesis of what pricing should be. Given a hypothesis, the point of market research is to test that hypothesis before going to market. And if I’m going to work off Economic Value to Customer, I may think a farmer uses their combine six months a year, but I don’t actually know. But I can ask a farmer “how often are you using combine?” I may think Union Pacific uses a train 24 hours a day, but I don’t actually know. So why don’t I ask Union Pacific how often they use a train? How does it vary between long haul versus short haul? How much diesel are you forecasting that to be for the next 25 years? I can ask those input parameters that go into the value drivers to create a more informed Economic Value to the Customer from which I can estimate using heuristics, rules of thumb, and how much price I can capture.
I’ve done all of that without doing any of the fancy measurements. I can also add in a van Westendorp price sensitivity meter, or Gabor-Granger, neither of which I find to be good for price seeing, but good rather for price expectation understanding. Is the market expecting it down here, but is my value really up there? And if my value is really up there and they should be able to pay for it, given the heuristics, how do I close that gap? What’s missing in my communication? What do I misunderstand about my value? Or does the market misunderstand my value? Because I didn’t explain it right.
The problem with van Westendorp price sensitivity meters and Gabor-Granger is that they don’t simulate a real purchasing decision. They just kind of ask, would you buy this mouse at $20? Yes or no?
Well, you don’t get to choose just one mouse. There are thousands of mice. You get to choose what mouse you want, and you need to simulate trade-offs. That requires conjoint analysis, and conjoint analysis simulates real trade-offs. And that creates a much better idea of what the actual demand curve is, and what your price optimization is.
But, as I go from Economic Value to Customer to Voice of Customer feedback for the market, maybe even a price sensitivity meter (because they’re cheap, but I know that they’re not going to give me the right price), to the conjoint analysis, I’ve just gone from a two to six-week project to a six to 16-week project. I mean, it just got much more complex and more costly, and you have to make sure you have the built-in time to make that happen.
And is it worth it? Then you start to ask “how much is the product worth in terms of revenue and profit and is the 1% improvement in price accuracy worth that extra piece of research?”
Regarding the profit bridge, do you have advice on how to prove the value in businesses with more complex and configurable offers? Can more developed segmentation give rise to ambiguity between price/mix/volume effects?
Let’s talk about what the profit bridge does. It measures the impact of increased volume. It measures the impact of increased price (or decreased price), it measures the impact of changes in the mix, and it measures the impact of changes and variable costs. Now your hypothesis is “let’s change the price structure, I’ll make more money.”
The question is, are you going to make more money by attacking a segment that you couldn’t get before? This is the idea behind versioning. I take my best product, and I bank on cheaper version. Why? It’s going to cannibalize the sales of the best product, but it will also grow the volume down in this other segment. So you have to think, am I trying to grow the volume, or am I trying to go the price? How does your hypothesis of a change in price structure, feed in to improving mix, improving price, improving volume, or reducing variable costs? And then on the profit bridge, you can say, “my hypothesis said, I should expect this a year later. I got that. Was this good plan?” Study, repeat, constant improvement.
My competitor keeps cutting prices and offers lower price than my customer. What are some tips to retain market share?
You know, the old adage from the airlines – “you can only price as smart as your stupidest competitor,” made by the CEO of Continental (long before it became part of United). There’s a simulation that I use in class called “Universal Car Rental Simulation.” And as the professor, I get to set it up so my competitor always prices lower, competitor does tit for tat, the competitor is just going after capacity utilization. I can set it up. Predatory pricing, tit for tat, etc.
I have my students run the simulation three different times, in the same market, for three different competitor types. And what they learn is that the competitor is evil and they’re irritating, but what do I want? And the consumer products students tend to say, “well, let’s go for market share.” And I’m like, “is that what I told you? I’m after I’m after profitability.” And about the third time they realize: ignore market share, just focus on what delivers more profitability in my market, given my set of knowledge.
And the variation of profitability is like a factor of four between the best and the worst students on these simulations. You know, what really kills the profitability? I set it up so the market is tanking, meaning there’s less demand most quarter after quarter. And then they start losing a $100m dollars and there’s nothing you can do about it. Or I set it up so that the market is growing quarter after quarter, and there you can’t do anything wrong – you’re going to make money. So the market itself is probably more important to think about than that particular competitor.
I’m not saying ignore the competitors – I’m saying acknowledge them, but really focus on what your value is to whom, and why, and how much that segment will be willing to pay for you. Given that they know that there’s an alternative, all prices are set compared to the alternative – better or worse. Do they care?
What are some strategies for overcoming resistance from frontline sales or product management when implementing value-based pricing strategy?
First, they often don’t know what it means. So you have to clarify what it means. Second, they don’t know how much that’s going to impact their pocket. If their incentives are that they are paid on revenue, you have to show them how this actually impacts the revenue in their product line or in their customer group.
You have to walk them through this and show them, case-by-case, account-by-account, what your pricing outcome suggestion implies for those individual accounts. And this is where that account matrix comes in. Did they absorb a price increase? Are they getting a better mix? How much do my accounts command? You’re counseling the salespeople as to where they can move the accounts to make them more money. Now, if you’re making a price change for, say, $2 to $20 in one year, you’re going to scare everybody. So you had better be able to convince and provide evidence that the market is going to be better by raising the prices that much, or maybe instead of doing $2 to $20 in one year, you do it over time. All prices should be dynamic.