Guest post by Stephan Liozu of Ardex America Inc.
Of the three main approaches to pricing in industrial markets ─ cost-based, competition-based and value-based ─ the latter has been shown superior in many circumstances (see John Hogan’s study on this). Despite this, my research suggests that only 17% of industrial companies have adopted the value-based approach to date. Cost-based and competition-based approaches still play a dominant role in industrial pricing practice.
Many reasons have been suggested for the low adoption of value-based pricing. There remains confusion as to what ‘value-based pricing’ means. Practitioners often mention issues with value assessment, internal communication breakdowns between marketing and sales teams, and the lack of incentive alignment. One of the least-mentioned barriers to the increased adoption of value-based pricing is the difficulty of measuring and selling the required investment and the return on investment to top management in the C-suite. So how can one justify the investment in value-based pricing?
Define the Scope
The first difficulty lies in defining the scope of the value-based pricing. What are the relevant programs, activities and costs? A recent paper published in January 2012 in the Journal of Revenue and Pricing Management that I published with my colleagues reveals the difficulty companies have in conceptualizing value-based pricing. Practitioners create their own definitions in an ad-hoc way. A shared framework for value-based pricing is needed, one that is responsive to changes in the economy and to emerging best practices. A software platform such as that provided by LeveragePoint provides a compelling way to do this.
Understand the Transformational Journey
Adoption of value-based pricing is a journey. This journey requires organizational transformation so that the company gets aligned around creating and communicating value for customers.
Because of the many unknowns on this journey, it can be difficult to analyze and project its exact duration. Some firms will spend more time in the experimentation phase to create the number of successful case studies necessary to maximize buy-in. Others will take time to organize systems around value. Achieving value-based pricing requires ongoing investment, regular innovation, and a commitment to training as the organization integrates new businesses and personnel.
Benchmarks and Case Studies Are Not Enough
Firms internalizing value-based pricing go at various speeds and with various intensities. The nature of their programs is adapted to their environment and their existing internal capabilities. External benchmarks typically consist of qualitative case studies available through the Professional Pricing Society, other practitioners or consulting firms. Benchmarks of successful transformation can help, but often do not provide the necessity rationale and scientific support. Benchmarking can even encourage imitations and copy/paste behaviors that can be detrimental to real adoption.
Need for Quantified Success
The case for value-based pricing is typically based on qualitative case studies and incomplete data, leading to reduced credibility. Convincing C-Level executives will generally require hard data on the economic benefits. This is an area where practitioners and academic researchers need to put more effort.
Bottom line: justifying investments with top executives in value-based pricing demands a thorough understanding of what the transformation requires and a clear delineation of the value-based pricing scope. There is no silver bullet or template, but the following ideas may provide some guidance.
Include Costs Associated to All Organizational and Behavioral Programs
Based on the transformational nature of the implementation, break the value-based pricing story down into several modules or sub-projects. These modules might be based on the 5-C model of Champions, Capabilities, Center-led management, Change and Confidence). Value-based pricing is a real transformation of the firm DNA from cost or competition to value. Besides typical costs of building capabilities (models, software, tools, pricing training, market research, etc.), firms will have to think holistically and include all relevant costs. Including these activities will strengthen the budgeting and planning process in building the business case.
Create a Formal Pilot Program and Make the Case for Increased Scope
Another good option is to reduce the initial scope of the value-based pricing project and to focus first on one or two pilot projects in a region, a business unit or a product line. Narrowing the scope of the case in the short term will reduce the uncertainty associated with an entire effort. The relevant costs will be easier to calculate. Choosing a “friendly” region or business unit led by a champion who is aware of the potential positive impact of value-based pricing will open the door for more collaboration and support to create a powerful financial case to be presented to upper management. Having the regional or business unit leader on board from the get-go will help justify the project.
Define Specific Value-Based Pricing KPIs in the Business Case
A critical element of the business case is the definition of clear, relevant and quantitative KPIs for tracking success. These need to be specific to the value-based pricing implementation. Top executives need to be reassured that progress will be measured and that success will be reached. Having the right dashboard included in the business case will tell the story of “how do we win?” “how do we know when we are done?” or “what defines success?” types of questions. These KPIs might include number of trained people, pricing realization index, incremental pricing with new products, etc.
Diagnose Where You Stand on the Pricing Maturity Model
The most important question to be asked before preparing the business case for significant investments in value-based pricing is “What is the existing level of pricing maturity?” Understanding where the organization stands in the price maturity model is important to defining the scope of the project and the intensity of the required investments. Some organizations may require initial training programs to bring everyone in the organization to the same level. Others may require up-front investments in systems and tools. Therefore, conducting a diagnostic of the current pricing capabilities is should be included in the overall business case. Before one knows where to go and what is needed, one needs to know where one stands!
Bring the Outside In to Showcase Successful Transformations
Over the past 12 months, I have talked to many management teams and have explained to them what is needed to take the journey towards value-based pricing. Inviting thought leaders who have no commercial interests can bring a candid and transparent understanding of the required investments and necessary steps to get started. During these one- to two-hour sessions with executive committees, I was able to explain the 5-C model of that transformation and the need to understand “short-term pains for long-term gains.” Bringing the outside in generates more pragmatism and realism in the value-based pricing story.
Over the past three years, I have been conducting academic research in the area of value-based pricing and pricing excellence. My intention is to demonstrate academically and statistically that adoption and internalization of value-based pricing leads to superior firm performance. Additionally, I have designed a study to validate that the 5-C model can also lead to superior profits. Stay tuned for more knowledge sharing!
Stephan Liozu is President & CEO of Ardex America Inc (www.ardexamericas.com), an innovative and high-performance building-materials company located in Pittsburgh, PA. He is also a PhD candidate in Management at Case Western Reserve University and can be reached at email@example.com.