Summer 2005 SPG Insights
WHAT IS STRATEGIC PRICING?
By John Hogan and Thomas Nagle Although companies invest considerable time and capital to improve pricing performance, transitioning from tactical to strategic pricing in markets characterized by global competition, sophisticated procurement groups, and shortened product lifecycles is difficult, to say the least. That difficulty is magnified because most companies have an incomplete understanding of the interlocking components of pricing strategy and how they must work in concert to achieve sustainable results. When managers in these companies formulate pricing strategies, too often the unfortunate outcome is a patchwork of ad hoc tactical decisions masquerading as strategy.
The impetus to change a company's approach to pricing often starts with customer push-back about prices. When customers complain about high prices it is possible that the price is, in fact, too high relative to the competition. It is also possible, however, that the problem is not with the price but with other elements of the pricing strategy. For example, a new customer unfamiliar with the differential value of a product might, quite naturally, think the price is too high. In this instance, however, the appropriate action is not to drop price, but to educate the consumer on the value created by unique features of the
product in order to justify a higher price. A company can experience price resistance
from customers for many reasons. In most cases, however, the price alone is seldom the only cause of problem, and is often not the real cause at all. More often, it is the symptom signaling a problem with other elements of the pricing strategy. Just as a doctor is trained to look beyond a patient's symptoms to diagnose the underlying disease, companies must look beyond the pricing symptoms to diagnose flaws in their broader pricing strategy. Failing to diagnose the true cause of the pricing problem and treating only the symptom (i.e., cutting prices) can do long-term damage to profitability.
A comprehensive pricing strategy is comprised of multiple layers creating a foundation for price setting that minimizes erosion and maximizes profits over time. These layers combine to form what we call the strategic pricing pyramid. In keeping with the value-based perspective, value creation forms the foundation of the pyramid. A deep understanding of how products and services create value for customers is the key input to the development of a price structure that determines how offerings will be priced. Once the price structure is determined, marketing can develop messaging and tools to communicate value to customers. The
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final step before setting the price is to ensure that the pricing processes in the company are able to maintain the integrity of the price structure in the face of aggressive customers and competitors.
The Strategic Pricing Pyramid
Value Creation Product managers face an interesting...