The Price Advantage E-Book

Walter L. Baker

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 521

Veröffentlichungsjahr: 2010

Beschreibung

A comprehensive look at creating pricing strategies that work in both good economic times and bad

Written by three preeminent pricing experts at McKinsey & Company, the Second Edition of The Price Advantage is a practical pricing guide for the executive or pricing practitioner who wants to identify, capture, and sustain substantial pricing gains in their business.

Pricing is by far the most powerful profit lever that managers can influence. Yet few companies approach pricing in a way that fully capitalizes on its value. This Second Edition, a major revision and extension of the first book, shows you what it takes to achieve the price advantage in today's competitive and complex business environments. Based on in-depth, first-hand experience with thousands of companies, this book provides managers with a pragmatic guide through the maze of pricing issues. It reinforces why pricing excellence is more critical than ever today and then explains state-of-the-art approaches to analyzing and improving your own pricing strategy and execution.

• Explores the fundamental role of pricing infrastructure in achieving the price advantage
• Includes new topics such as software and information products pricing, lifecycle pricing, custom-configured products pricing, pricing of high-count product lines, pricing in distributed sales environments, "razor/razor blades" pricing, and tiered products and services pricing
• Revisits the full range of classic McKinsey pricing tools, including the pocket price waterfall and value maps

Engaging and informative, the Second Edition of The Price Advantage will put this essential discipline in perspective.

Leseprobe

Table of Contents

Title Page

Copyright Page

Dedication

Preface

WHY A BOOK ON PRICING?

WHY A BOOK BY MCKINSEY ON PRICING?

WHY A SECOND EDITION NOW?

STRUCTURE OF THE BOOK

Acknowledgments

PART One - Pricing Fundamentals

CHAPTER 1 - Introduction

THE POWER OF 1 PERCENT

THE PRICE/VOLUME TRADEOFF

MARKET FORCES ADD PRESSURE

THE NOBILITY OF PRICING EXCELLENCE

WHY THE PRICE ADVANTAGE IS SO RARE

CHAPTER 2 - Components of Pricing Excellence

AN INTEGRATED APPROACH

AN INTERDEPENDENT HIERARCHY

APPLYING TO YOUR COMPANY—PINPOINTING THE OPPORTUNITY

PART Two - Exploring the Levels

CHAPTER 3 - Transactions

THE POCKET PRICE WATERFALL

THE POCKET PRICE BAND

THE SOUNDCO RADIO COMPANY CASE

POCKET MARGIN WATERFALL AND BAND

ALEN GLASS COMPANY CASE

CHAPTER 4 - Customer Value

MAPPING VALUE

CREATING A VALUE MAP

MAKING MOVES ON THE VALUE MAP

PUTTING CUSTOMERS ON THE VALUE MAP

VALUE PROFILING

CHAPTER 5 - Market Strategy

PROFITING FROM BETTER PRICE PREDICTIONS

PLANNING FOR AN EXPECTED PRICE CHANGE

MAINTAINING OPTIMAL PRODUCTION AND CAPACITY

IMPROVING PRICING CONDUCT

INFLUENCING THE ELEMENTS OF PRICING CONDUCT

A WORD ON FOLLOWERSHIP

CHAPTER 6 - Pricing Infrastructure

PROCESSES—WHAT ARE THE MOST CRITICAL TYPES OF PRICING DECISIONS FOR YOUR BUSINESS?

ORGANIZATION—WHO IS RUNNING THE PRICING PROFIT CENTER?

PERFORMANCE MANAGEMENT—HOW SHOULD WE RECOGNIZE AND REWARD PRICING PERFORMANCE?

SYSTEMS AND TOOLS—NO MAGIC BULLET EXISTS

PART Three - Unique Events

CHAPTER 7 - Postmerger Pricing

A TEMPORARY WINDOW OF OPPORTUNITY

TREMENDOUS OPPORTUNITIES AT EACH PRICING LEVEL

AVOIDING COMMON POSTMERGER TRAPS

ANTITRUST LAWS

CHAPTER 8 - Price Wars

WHY PRICE WARS SHOULD BE AVOIDED

WHAT REALLY CAUSES PRICE WARS

STAYING OUT OF PRICE WARS

GETTING OUT OF PRICE WARS

WHEN A PRICE WAR MIGHT MAKE SENSE

PART Four - Expanding the Boundaries

CHAPTER 9 - Legal Degrees of Freedom

PRICING DECISIONS THAT RAISE RED FLAGS

MINIMIZING RISKS WHILE MEETING PRICING OBJECTIVES

CALLING IN THE ATTORNEYS

CHAPTER 10 - Lifecycle Pricing

WHAT MAKES LIFECYCLE PRICING TOUGH

THE THREE PHASES OF PRODUCT LIFECYCLE PRICING

SUSTAINING RETURNS ACROSS THE LIFECYCLE

CHAPTER 11 - Pricing Architecture

MANAGING PRICE PERCEPTION

INFLUENCING CUSTOMER BEHAVIOR

PRICE ARCHITECTURE BASED ON SUPPLIER ROLE

PART Five - Advanced Topics

CHAPTER 12 - Complexity Management

SECTION ONE: CUSTOM-CONFIGURED PRODUCTS

SECTION TWO: HIGH-COUNT PRODUCT LINES

SECTION THREE: DISTRIBUTED SALES MODELS

CHAPTER 13 - Tailored Value

SECTION ONE: PRICE SEGMENTATION

SECTION TWO: TIERED PRODUCTS AND SERVICES

SECTION THREE: NEW PRODUCTS

SECTION FOUR: “RAZOR/RAZOR BLADES” OFFERINGS

SECTION FIVE: SOLUTIONS

CHAPTER 14 - Software and Information Products

UNIQUE CHARACTERISTICS THAT IMPACT PRICING

EXPLORING THE ELEMENTS OF PRICING

PART Six - Making Change Happen

CHAPTER 15 - Pricing Transformation

DESIGNING A CLEAR CHANGE PROGRAM

ACCELERATING AND EMBEDDING CHANGE

CHAPTER 16 - The Monnarch Battery Case

THE MONNARCH BATTERY COMPANY

TRANSACTIONS

CUSTOMER VALUE

MARKET STRATEGY

CAPTURING THE MONNARCH PRICING OPPORTUNITY

HARD-WIRING THE CHANGE

Epilogue

APPENDIX 1 - Pocket Price and Pocket Margin Waterfalls

APPENDIX 2 - Antitrust Issues

APPENDIX 3 - List of Acronyms and Abbreviations

APPENDIX 4 - About the Web-Based Tool: Periscope

About the Authors

Index

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ISBN 978-0-470-48177-6

For Ashley, Nancy, and Gail

Preface

As we approached the task of writing this second edition of The Price Advantage, we revisited a few basic questions—questions that our readers might have as well. Why a book on pricing? Why a book by McKinsey & Company? And finally, why a second edition now? Let us begin by addressing these basic questions.

WHY A BOOK ON PRICING?

Pricing, although one of the most critical management functions, remains one of the most misunderstood and undermanaged functions at many companies that are otherwise high performers. Pricing is far and away the most sensitive profit lever that managers can influence. Small changes in average price translate into huge changes in operating profit.

Although more companies have made gains in pricing in recent years, too few businesses have successfully tapped into the full potential that improved pricing holds. Even thoughtful general managers often feel helpless to make real progress on the pricing front. Many managers do not know where to begin to get a handle on identifying the exciting performance upside that pricing so often holds. And those who identify this upside struggle to really capture and sustain it.

This book is not designed to be an exhaustive review of the considerable body of pricing theory that has accumulated over the years. To the contrary, it has been written as a practical pricing guide for that thoughtful general manager who has been tempted by the unrealized promise of improved pricing and, perhaps, frustrated by attempts to translate pricing theory into bottom-line impact for his or her business. It is intended to provide a logical and structured approach for identifying where the most precious sources of untapped pricing opportunity reside in a business, along with practical, case-illustrated guidance on how to capture and sustain that opportunity.

WHY A BOOK BY MCKINSEY ON PRICING?

Over the past 20 years, pricing has become one of the most frequent areas in which we have helped businesses across every continent (except Antarctica!) to improve their performance. These companies represent a rich and diverse range of industries, including industrial goods, consumer packaged goods, consumer durables, banking, telecommunications, chemicals, retailing, high-tech products, basic materials, insurance, pharmaceuticals, and transportation. To support our service to clients, McKinsey has invested more than $25 million in developing practical knowledge in pricing over the past five years alone. We are credited with having developed and advanced a majority of the most useful contemporary pricing frameworks—the pocket price waterfall and the value map are just two examples.

WHY A SECOND EDITION NOW?

Since the first edition of The Price Advantage was published five years ago, much has changed. First, our knowledge has advanced significantly in a number of areas—areas of growing currency and relevance that were not included in the original edition. A new chapter is devoted to the topic of managing price wisely over the course of a product’s lifecycle. In an ever-growing number of product categories, for example, high-tech products, consumer durables, and medical devices, product lifecycles are compressing, which makes this a topic of broad application and significance.

Included in this edition is an entirely new part titled “Advanced Topics,” which were not covered in depth in the first edition. This includes Chapter 12, “Complexity Management,” which addresses issues that complicate the pricing challenge, including the complexity of pricing custom-configured products, pricing when the number of individual products sold is extremely high, and pricing through a large and distributed sales force. Chapter 13, “Tailored Value,” explores issues around tailoring value to specific customers and markets, including segmenting price, pricing product line tiers, dealing with “razor/razor blades” offerings, and pricing new products and integrated solutions. Chapters 12 and 13 contain sections of information that do not apply to each and every business; but when they do apply, we have found that they are often central to a company’s realization of the price advantage. Chapter 14 “Software and Information Products,” is also new and discusses how to tackle the unique challenges of pricing software and information-based products.

Second, the legal landscape has also continued to evolve since we wrote the first edition. The United States’ pricing rules have evolved and enforcement has been generally more aggressive. EU pricing law and enforcement has moved closer to and, in some cases, surpassed that of the United States in severity. Likewise, pricing and antitrust law in many Asia-Pacific countries is gradually becoming more strictly defined and aggressively enforced. Chapter 9, “Legal Degrees of Freedom,” has been updated to reflect the changing degrees of legal freedom that companies must operate within today. Furthermore, we have updated language throughout this second edition to avoid pricing wording and phrasing that might be more likely to raise legal red flags in the current legal environment.

Finally, we have heard from businesses around the world asking for more details on how to build a sustainable capability in pricing; that is, what does a high-performing pricing infrastructure look like today and how do you best move an organization in that direction. Our overarching framework, “The Three Levels of Price Management” from the first edition, has been extended to include a cross-cutting pricing infrastructure level; Chapter 6, “Pricing Infrastructure,” is completely new and dedicated to issues of pricing infrastructure—where we have synthesized our experience in helping companies build high-performing organizations, processes, and tools. So, as we mentioned above, much has changed since we published the first edition back in 2004—so much that we deemed the writing of the second edition of The Price Advantage timely and warranted.

STRUCTURE OF THE BOOK

This book is organized into six main sections. Part One describes the price advantage and explains why it is worthwhile for businesses to pursue that rare but valuable advantage. It then lays out our overarching framework for identifying and ultimately capturing pricing opportunity. This framework, the three levels of price management plus pricing infrastructure, provides the integrating thread that weaves through the book and is applicable to most business situations.

Part Two explores each of these three levels plus pricing infrastructure in considerable detail. Part Three addresses unique pricing events that almost any company might have to face on an occasional basis. Part Four explores some of the boundaries of the price advantage—boundaries that may affect a company’s degrees of pricing freedom and boundaries that companies can expand to find opportunities beyond the fundamentals covered in Parts One and Two. Part Five covers a variety of advanced topics, as mentioned earlier. Part Six is devoted to the practical enablers and constraints to making enduring and positive pricing change happen, including a detailed case study and some final thoughts. In addition, the Appendixes are designed to provide some useful examples of the application of core frameworks discussed in the book, an overview of key points in pricing law, a list of acronyms and abbreviations, and instructions for accessing a functional demo of Periscope, a web-based pricing tool that has been loaded with realistic transaction data for a hypothetical company. This book contains a number of disguised cases to illustrate pricing concepts, frameworks, and insights. These cases are rooted in McKinsey’s extensive client work in pricing, and client identities are heavily disguised to assure protection of confidential client information and strategies. The location and nature of opportunities identified are consistent with the underlying cases, and the magnitude of improvements shown by these examples is real.

Unless otherwise noted, when we talk about a company’s “product,” we are referring to that company’s comprehensive product, service, and support offering to customers. This convention allows for more economical word usage throughout the book.

Acknowledgments

As we embark on this journey for a second time, we do so with a full understanding and appreciation of the level of support it takes to write a book. As with the first edition, our colleagues, our clients, our firm, and our families continue to support us in extraordinary ways. To them we extend a hearty thank you in the hope it captures our true appreciation for what they have contributed.

We start our acknowledgments with the “godfathers” of pricing. Those that saw the power of pricing before the rest and persisted in sharing the story—Kent B. Monroe, Tom Nagle, Dan Nimer, and Arleigh Walker. And to the leaders at McKinsey & Company who supported and invested in the development of our pricing knowledge—David Court, Tom French, Marc Singer, Robert Garda, Philip Hawk, Ralf Leszinski, Andrew Parsons, Hajo Riesenbeck, and Rob Rosiello—thank you for believing in us and the impact we could have for our clients. We also want to recognize the tremendous support of Eric Roegner, an author on the first edition. Eric’s ideas and contributions remain at the foundation of this edition.

There are some special people who accompanied us on this journey and we would like to take the time to recognize them. Cheri Eyink served as our undaunted project manager. Beyond driving the process of creating this second edition with resolve and enthusiasm, she acted as an irreplaceable thought partner to the authors—adding content, insight, and clarity at every turn. Sarah Smith was our trusted editor—pushing us to express in written word the knowledge we had gathered over many years of serving clients. She gracefully and persistently challenged us to share our best with our readers in a clear and concise manner. To them both, we are grateful.

A number of past and current McKinsey colleagues contributed their deep content expertise to this book, including John Abele (postmerger pricing), Scott Andre and Robert Musslewhite (market strategy), Daniel G. Doster (solutions pricing), Dieter Kiewell (pricing tools and implementation), Andy Kincheloe (lifecycle pricing), Stephen Moss (pricing infrastructure), Adolfo Villagomez (market strategy), and John Voyzey (price wars). Special thanks to Gene Zelek, partner and chair of the Antitrust and Trade Regulation Practice Group at Freeborn & Peters LLP in Chicago (legal issues). In addition, we would like to thank current and past McKinsey colleagues who made significant contributions to the knowledge we shared here: Kevin Bright, Hugh Courtney, Gareth Davis, Tom Dohrmann, David Dvorin, Jonathan Ford, Amit Jhawar, Kristine Kelly, Michal Kisilevitz, Eric Kutcher, Eric Lin, Glenn Mercer, Jamie Moffitt, Derick Prelle, David Rosenberg, David Sackin, Mike Sherman, Philippe Stubbe, and Florian Wunderlich. Thanks also to George Gordon, partner and co-chair of the Antitrust/Competition Group at Dechert LLP in Philadelphia and Lynda Martin Alegi, of Counsel in Baker & McKenzie LLP’s EC Competition and Trade Unit based in London.

We would also like to take this opportunity to thank the editing and publishing experts at the McKinsey Quarterly, past and present, including Don Bergh, Stuart Flack, Allan Gold, Rik Kirkland, and Allen Webb, as well as those at John Wiley & Sons, including Bill Falloon and his team.

Mary Turchon spent countless hours taking care of all of the details required to publish a book. Creating exhibits, scheduling meetings, formatting text; the list could fill pages. Her excellent skills and willingness to help out in a crunch are deeply valued. We would also like to recognize the research assistance provided by Danica Reed and the graphics support of Janet Clifford and Mary Ann Brej.

We close with recognition and appreciation for the hundreds of McKinsey & Company consultants that have worked alongside us over the past 30 years, expanding our knowledge and bringing the power of pricing to thousands of companies. And to our clients, who opened the door to their businesses and allowed us to be a part of their transformations.

PART One

Pricing Fundamentals

Part One describes what the price advantage is and explains why this is such a worthwhile and profitable advantage to pursue. This part also introduces an overarching framework for identifying the magnitude and location of pricing opportunities—and for sustainably capturing those opportunities.

CHAPTER 1

Introduction

What’s your advantage? What capabilities distinguish your company most from its peers, allow your business to perform better than your competitors, provide the foundation for superior returns to your shareholders? Is it a cost advantage—do you purchase better and manufacture more efficiently than your competition? Is it a distribution advantage—are your products sold through the best wholesalers, retailers, and locations in your markets? Is it a technology advantage or an innovation advantage? Or is yours a brand advantage or a capital structure advantage or a service advantage?

For all of the advantages that businesses pursue, there is one powerful advantage that is accessible to virtually every business, but actually pursued by too few—and ultimately achieved by even fewer. That advantage is the price advantage.

Setting prices for goods and services is one of the most fundamental management disciplines. It is, in truth, unavoidable. Every product and service sold since the beginning of time has had a price assigned to it. Setting that price is among the most crucial, most profit-sensitive decisions that companies make. Ironically, very few companies price well. For a host of reasons, few ever develop anything resembling a superior, business-wide, core capability in pricing. In other words, few companies build pricing into the distinctive business advantage that it can be.

In this book, we discuss the details of creating and sustaining the price advantage, where pricing excellence generates superior returns to shareholders and enables a company to invest in sustaining its advantages in other areas. But first, let us look at why getting pricing right is so important, and why so few companies realize this advantage.

THE POWER OF 1 PERCENT

Why is it so vital to get pricing right? Because pricing right is the fastest and most effective way to grow profits. The right price will boost profits faster than increasing volume; the wrong price can shrink profit just as quickly. The exhibit above illustrates this dramatically. In Exhibit 1-1, the average income statement of the Global 1200 (an aggregation of 1,200 large, publically held companies from around the world), shows just how quickly the right price can create profit. We use a five-year average to reduce sensitivity to yearly economic variations.

Exhibit 1-1 Average Economics—Global 1200

Starting with price indexed to 100, we see that fixed costs (items like overhead, property, and depreciation that do not vary when volume changes) amount to an indexed average of 20.5 percent of price. Variable costs (expenses like labor and materials that shift in tandem with volume) account for 68.0 percent. This leaves an average return on sales (ROS) of 11.5 percent.

Now, given these Global 1200 economics, what happens if you improve your price by 1 percent? Price will rise from 100 to 101. Assuming volume remains constant, then variable costs will remain constant as well—as will fixed costs. Operating profit, however, rises from 11.5 percent to 12.5 percent, a relative increase of 8.7 percent.

The clear message is that very small improvements in price translate into huge increases in operating profit. When you talk about creating a pricing advantage, you may have to recalibrate your thinking about how large a price increase needs to be to have a meaningful impact. Pricing initiatives that increase average prices by only a quarter or a half percent are important because they bring disproportionate increases in operating profit. A 1 or 2 percent price improvement is a major victory with significant profit implications. Find 3 percent—and many companies can, once they start looking—and operating profit can jump by more than 25 percent, if your cost structure is similar to the Global 1200 average.

Exhibit 1-2 Comparison of Profit Levers

Not only that, but pricing is far and away the most powerful profit lever that a company can influence. Continuing with average Global 1200 economics, Exhibit 1-2 illustrates the impact on operating profit when individual levers improve by 1 percent while other factors stay constant. Pricing has by far the strongest impact, raising profit by 8.7 percent.

Variable cost is the second most significant one, increasing operating profit by 5.9 percent for every 1 percent decrease in costs. However, most companies have already wrung a lot out of variable costs in recent years through purchasing and supply management initiatives, labor productivity improvements, and other measures. As a result, continued improvement in variable cost structure has become increasingly difficult.

Fixed cost decreases have an even smaller effect on operating profit. A 1 percent improvement generates only a 1.8 percent operating profit increase. While making other cost-cutting efforts, companies over the past decade were also busy trimming fixed costs; as with variable costs, further improvements have become elusive.

The low impact of volume increases on operating profit can be a real surprise to many managers. A 1 percent increase in unit sales volume only increases operating profit by 2.8 percent, if per unit prices and costs remain constant. This is less than a third of the impact of a 1 percent improvement in pricing. But which lever gets the majority of the attention and energy from marketing and sales people? The volume lever, despite its much smaller impact on profit—a fraction of what pricing delivers.

Unfortunately, the pricing lever is a double-edged sword. No lever can increase profits more quickly than raising price a percentage point or two, but at the same time nothing will drop profits through the floor faster than letting price slip down a percentage point or two. If your average price drops just a single percentage point, then, assuming your economics are similar to the Global 1200 average, your operating profits decrease by that same 8.7 percent.

THE PRICE/VOLUME TRADEOFF

This inevitably leads us to the age-old question of the price/volume/profit tradeoff: If I lower my price, can I increase volume enough to generate more operating profit? Exhibit 1-3 explores how that tradeoff works—or, more accurately, does not work. If a business takes steps that effectively reduce average prices by 5 percent, how much of a volume increase would be necessary to break even on an operating profit basis?

Exhibit 1-3 Breakeven Price/Volume Tradeoff

With economics similar to the Global 1200 average, a 5 percent price decrease would require an 18.5 percent volume increase, just to break even, much less increase operating profits. Such an increase is highly unlikely. For a 5 percent drop in price to generate a 18.5 percent volume rise would require a price elasticity of -3.7 (price elasticity is equal to the percentage change in volume that occurs with a percentage point change in price; in this case 18.5 divided by -5). In other words, every percentage point price drop would have to drive up volume by 3.7 percent. Our experience shows price elasticities commonly reach a maximum of -1.7 or -1.8. On rare occasions, usually for consumer items purchased on impulse, it might be as high as -2.5. In the real world, -3.7 price elasticity is extremely rare.

As this example shows, the basic arithmetic of decreasing price and increasing volume to increase profits just does not add up. You should do this calculation using the economics of your own business to confirm how the tradeoff works for you.1

But the point to remember is that profits are extremely sensitive to even minute changes in prices. Each percentage point of price represents a precious nugget of profit that should be held tight to the chest and never given up without a hard fight. Unfortunately, sales reps (and often even general managers), propelled by their incentive systems, routinely negotiate away five percentage points at a time through discounts, special offers, and other inducements to close deals. Companies with a superior pricing capability—with the price advantage—consistently let fewer of those nuggets slip away.

MARKET FORCES ADD PRESSURE

The second reason managing pricing is so important is because even if nothing changes internally, most companies, whether selling to consumers or to businesses, face unprecedented downward pressure on prices. If nothing is done, these external forces will depress prices and erode profits quickly.

Exhibit 1-4 Consumer Price Squeeze

A combination of fundamental business and demographic changes are squeezing prices in consumer markets as illustrated in Exhibit 1-4. Discount retailers such as Walmart, Home Depot, and Costco are growing larger and accounting for ever-increasing shares of volume in their markets. These giants use their market power to extract lower prices from consumer goods suppliers. The growth of the Internet, as well as the increased use of price advertising by such discounters, makes it easier for shoppers to find and compare prices of consumer products. Meanwhile, private-label packaged goods, often sold under a retailer’s brand name, have witnessed quality improvements that put added pressure on traditional brands in many product categories.

Generational shifts are leaving their mark on the consumer market as well. The baby boomers who fueled much of the rampant consumer spending over the past few decades are throttling back purchases now that they are helping children through college, supporting aging parents, preparing for their own retirement, and carrying other financial burdens. The generations behind the baby boomers are notably more price sensitive, having grown up surrounded by discount retailers of every stripe.

Business-to-business (B2B) companies are also feeling price pressure from changes in the market environment, as shown in Exhibit 1-5. Buyers are tougher and more skilled than ever in extracting every last penny of price from suppliers. Efficiency programs in recent years have unleashed newfound excess capacity into many markets. Open-book costing, in which powerful buyers insist on knowing the details of a supplier’s costs for each component of a product, including individual component materials costs, direct labor, and overhead, has become more common. This greater visibility provides buyers with significantly more leverage when negotiating prices. Prices in some instances have become even more transparent, with individual customer price quotes being highly visible to not only other customers but to competitors as well—particularly if the quoted price is extremely low. We refer to this higher visibility of lower prices as “asymmetrical price transparency”—a condition that actually exerts even more downward force on prices that may already be low.

Exhibit 1-5 B2B Price Squeeze

Furthermore, many industrial suppliers have already cut their own costs—have themselves become leaner and meaner—and thus generally feel more confident competing more aggressively on price to secure business. Global companies increasingly shop the world for the best prices, and then insist on those unified low prices for all their buying locations. Just as in consumer distribution, B2B distribution channels are becoming more concentrated and more powerful relative to suppliers.

The forces that are putting pressure on companies that serve consumers and businesses alike are gathering strength and are not likely to subside in the foreseeable future; indeed, they have shown no signs of subsiding since we wrote the first edition of The Pricing Advantage in 2004. A company that neglects pricing, that does not actively develop an enhanced pricing capability and a price advantage to combat this onslaught, will inevitably see its prices crumble away under the weight of these prevailing forces.

THE NOBILITY OF PRICING EXCELLENCE

The last reason building the price advantage in your business is so important goes beyond profit economics or market forces to the spirit, heart, and pride of your organization. There is genuine nobility to pricing done well. Individuals responsible for setting prices hold a sacred trust. They assure that a business gets fairly rewarded in the marketplace for products and services superior to its competitors—that there is a real payoff for being better.

The price advantage is not about gouging customers or employing tricks to gain undeserved revenues. Quite to the contrary, the real price advantage is a source of organizational pride. The highest compliment a customer can pay a supplier is to knowingly pay more for that company’s goods and services. In doing so, the customer is saying, “You are higher priced, but you are worth it; you are superior to my other supplier alternatives.” Businesses that, lacking the price advantage, fail to have their superiority rewarded with higher prices, often lose their drive—and even their ability—to continue to be superior.

WHY THE PRICE ADVANTAGE IS SO RARE

The reasons for pursuing the price advantage are compelling, but few companies have achieved a level of competence in pricing that could be described as the price advantage. Although many companies may attribute much of the double-digit profit growth that was so common in the 1990s and the mid- 2000s to improved pricing practices, in fact the bulk of this growth can be traced to cost cutting and increased demand. Pricing had little to do with the profit growth during this period and remains a largely untapped opportunity.

A number of factors explain why companies undermanage the opportunities inherent in pricing and why so few businesses have ever developed the price advantage.

• Pricing is a complicated topic that requires the analysis of large amounts of data and customer insights, as well as the ability to influence entrenched opinions of many people—from frontline sales people to senior management.

• Under past buoyant economics brought on by strong demand and sharp cost cutting, many companies sensed little need to develop advanced pricing skills and to pursue pricing as a source of increased profits.

• Companies often did not believe that pricing was manageable. They saw prices as set by the market, by customers, or by unreasonable competitors.

• Data to support pricing decisions was either not available or not current enough to help with real-time pricing decisions.

• Price differentiation and other pricing actions were misperceived as always illegal, and therefore degrees of pricing freedom were internally limited.

• Pricing mistakes and errors were hard for most companies to detect. If your sales representative in Scotland negotiated a price that was 5 percent lower than it could have been, it was unlikely to raise a red flag at headquarters.

• Frontline pricers often had virtually no incentive to stretch for an additional percent in price.

• Senior managers often had little, if any, involvement in pricing.

• Many companies did a more than adequate job of identifying opportunities to improve pricing but failed to make changes in infrastructure, mindsets, and behaviors necessary to deliver and sustain pricing improvement.

As we show in later chapters, the obstacles outlined here are real but can be overcome with some effort. Indeed, the barriers to building pricing capabilities are not trivial, and creating the price advantage is hard work. But the payoff is so large that knocking down these barriers is well worth the effort.

The price advantage is a powerful advantage worth pursuing and is achievable by each and every business, but fully realized by very few. It deserves pursuit because pricing is such an extremely sensitive profit lever, with small swings in price levels generating huge swings in bottom-line profitability.

As we have shown, a 1 percent increase in price can increase your profit by 8 percent or more; a 1 percent slip in price can erode profits by that same 8 percent or more. And rare are the circumstances where decreasing price can generate nearly enough additional sales volume to offset the effects of a price cut and produce incremental profitability.

Furthermore, the price advantage deserves pursuit because of prevailing market forces—both in consumer and business markets—that are putting unprecedented downward pressure on industry-wide price levels and showing no signs of subsiding. Failure to take real initiative in pricing today virtually assures that percentage points of price will slip through your hands annually—and that huge chunks of operating profit will drop off your bottom line. Finally, achieving the price advantage can be a source of organizational pride as employees are reassured that their hard work to create superior products and services does not go unrewarded.

CHAPTER 2

Components of Pricing Excellence

The reasons, economic and otherwise, for pursuing the price advantage are compelling. But the sheer breadth of pricing issues in most companies makes it challenging to even know where to start. Managers must constantly deal with pricing issues that are seldom simple and isolated; rather, they are intricate and linked to multiple business aspects. Even pricing issues that may seem entirely tactical often have strategic implications and affect other prices, other customers, even competitors.