There is no doubt about it. It is difficult to get pricing right. The dynamics are complex and it is a challenge to balance corporate needs with retail realities. Our pricing problems are compounded further by several misconceptions and false beliefs about pricing. However, in reality there are effective solutions to retail pricing effectiveness. It is not magic and it requires no psychic abilities. However, it does require a discipline that typically is lacking when managers make pricing decisions.
The unfortunate reality is that despite the availability today of some truly amazing analytic and software tools, these decisions remain 80% “professional judgment” and 20% science. In other words, pricing decisions are predominated by personal opinions and guesses. The proper approach would be the reverse. Use the science to tell you what is right. Use judgment to adjust the science for the realities of the marketplace. Certainly, a strong reliance on judgment would have been warranted in the 1960’s and early 1970’s. This was before the availability of good sales data and the development of strong analytical capabilities. In the new millennium it is an outdated approach.
To be fair, corporate decision makers do not have the power to set retail pricing. There are several federal laws that restrict what corporations can do. However, these laws do not preclude corporate managers from suggesting a pricing strategy to retailers. Retailers very often comply. But, are these strategies truly effective or just the product of unvalidated guesses, conjectures, and personal opinions. In many cases, the latter is true.
So, what are the misconceptions about pricing and how should the mindset change?
Pricing Is Only a Tool to Bring In the Results
In the effort to get pricing right, managers tend to forget one very important fact. That is, pricing is just another tool in a marketing and sales mangers toolkit to bring in the results. However, pricing is treated as something magical that has no direct bearing on corporate results. What do I mean by that? Simply, most pricing discussions start with a conversation about retail price points and competitor price gaps. Rarely do these conversations start with an explicit discussion of the sales and financial goals that are the true focus of effective pricing.
In other words, we start with a serious discussion of the means to business goals, but never get around to tying these back to the goals. We clearly put the cart before the horse and most of the time the horse never makes an appearance. As the inimical Yogi Berra once quipped, “if you don’t know where you are going, you might not get there.” In the area of retail pricing, we frequently do not!
Sometimes “Keep It Simple” is Bad Advice
In many corporations, there is a nearly fanatical desire to “keep it simple.” Maybe, executives don’t want to burden their managers with unnecessary complexity. Perhaps there is an underlying assumption that simple means easier to execute. Whatever it is, the mantra of KISS (keep it simple stupid) is alive and well in corporate America. However, is this a good approach when it comes to pricing? Is it good advice?
Let’s take an example of a fairly common pricing decision. When companies take a price increase, it is common to use a “one-size-fits-all” approach. In other words, they recommend that the price of all products in their portfolio increase by the same percentage, let’s say 5%. A sales department who doesn’t want to confuse their retail customers may drive this. It may be determined by finance who has done some calculation about what increase will give them the financial results they are after. In either case, we treat each product in the exact same way.
Simplicity is relatively easy, but is it effective? The answer in the pricing arena is generally no. Each product in the portfolio may respond differently to a price change. Some are very responsive and other may be much less so. The technical term for this is “Price Elasticity.” Price elasticity measures the sales change you could expect from a product with a given change in price. Price elasticity directly affects sales change. However, it also ripples through the calculations to financial results as well.
This is important because the price elasticity of some products will make them great candidates for a price increase. They will have minor effects on sales and produce a hefty increment in revenues and margin. The price elasticity of other products make them terrible candidates for a price increase. When price is increased, the effect on sales is disastrous and the effect on revenue and margin is either marginal or negative. A “one-size-fits-all” pricing strategy fails to leverage the power of price elasticity to bring in the best combination of results across the portfolio. Some products should go up more and others less to get the best aggregate results. You can have simple and ineffective pricing. However, if you want effective pricing, you need to live with the added complexity.
Keeping Pricing Low Is the Best Approach
This is a belief and practice normally associated with sales departments. Since pricing is one of their primary vehicles for increasing sales, they often view low prices as a panacea. While this may work in some cases, there are also several reasons why this is a bad approach to pricing generally.
The first and most important reason is that several of the product-items in your portfolio may be relatively unresponsive to pricing changes. This is simply a statement about the price elasticity or inelasticity of your products. Some items are insensitive to price changes. Others may be highly price sensitive. If you spend trade funds to reduce price on price insensitive product-items you are wasting money. You could spend these funds to reduce the price of more price sensitive products. This would produce a better sales result and return-on-investment (ROI).
When it comes to effective pricing, there is one cardinal rule: Do what works and stay away from activities that do not. This is an obvious dictate, but one that we see violated frequently. Why do we insist on decreasing the price of insensitive products and raising the price of highly sensitive items? It goes against any coherent logic.
You can always move more units by lowering price. However, is this true for increasing retail sales dollars? For price insensitive products, the increased units may not offset the cost of lowering price. In other words, you could reduce price and potentially lose retail dollar sales. If you are one of those companies that manage on dollar share, you could be spending money to lose share – obviously not a good thing.
Second, in theory retail tactics should be consistent with product positioning. If your advertising is touting high quality and superior benefits, aggressive retail pricing could be undercutting your message. Many consumers use product pricing as one cue about product quality. It is inconsistent, in the minds of consumer for you to aggressively price a product and still be able to deliver high quality. Certainly, we position many products on value. That is, we offer a basic product at a low price. This attracts consumers looking for a basic, low priced alternative. In these cases, aggressive retail prices and promotion reinforce the value proposition of these items. This is quite different from a positioning of superior quality at a low price. This message is inconsistent and largely unbelievable.
In fact, for consumers who use price as a signal of quality and who are looking for a high quality product, aggressive pricing may turn them off to a purchase. It is impossible to be everything to everyone. Therefore, you just need to decide what the brand positioning will be and make sure to align the sales tactics. Your sales tactics also need to align with the realities of the products that you have – that is, the actual price elasticities. Pricing should reflect the way various products in the portfolio actually respond to pricing.
In the new millennium, we have the information, knowledge and tools to get retail pricing right. You can live in the 1960’s and guess about what is right or you can leverage the power of the analytics and technologies that are available. The first step in the process, obviously is to adjust your mindset. This will start you down the right path.