Strategic Pricing

How to adjust pricing to strategy

Published in Hebrew in Status - Management Thinking Magazine  Issue 244,October 2011
By Ari Manor, CEO of ZOOZ

Is pricing a tactical or strategic issue? Who should dictate the pricing of your products and services? How do you know what the right pricing is for your business and marketing strategy? What pricing will allow you to grow and increase your revenues in your market? This article will attempt to answer these questions, while focusing on the strategic aspects, and on matching the pricing to your strategy

A. Pricing - Tactic or Strategy?

Pricing has tactical aspects, especially if it is specific pricing, such as negotiations with a large customer, a price quote as part of a tender for service provision, or a sales promotion of a shelf product. There are tactical pricing principles that you should employ in these cases.

For example, prior to negotiations with a large customer, you should determine in advance the lowest price (based on the minimal cost and profit that will suit us), the highest price (based on market prices, above which the customer will refuse to buy), and an intermediate price that we can aspire to (based on the profit and the positioning we wish to attain - as a company providing either cheap, intermediate, or expensive solutions). During the actual negotiations, you should start with the highest price, which is above our target price in any case, and if necessary - lower the price in increasingly smaller increments, to indicate to the customer that we are reaching our lowest possible price.

There are also similar tactical principles for pricing quotes as part of tenders, and to pricing sales promotions. For example - with certain tenders, it is recommended to offer the customer a range of discounts according to future purchase volumes. Details about successful pricing for Gilat's antennas using this method appear on page 53 of the book Ekdah Bekrav Sakinim (Gun in a Knife Fight) by Yoel Gat. With certain sales promotions, it is standard practice to raise prices one month before the sale. For example - raising the price of books one month before the annual Book Week sales.

Strategic pricing is a key to profitability

So, there are tactical aspects to pricing, and tactical principles for specific pricing. However, on a macro-scale, pricing also has a decisive strategic effect. Pricing is one of the 4P's of the marketing mix (product, price, position, promotion), and it is therefore a cornerstone of the marketing strategy. Pricing indicates to customers our positioning in the market relative to the competitors (for example - basic, premium, super premium). The pricing we choose must match our business strategy (in other words - our market, and what products / services we will offer). For example - a company that offers subcontracting services must offer competitive prices to its customers, who will undoubtedly compare with other suppliers.

 Later in the article, we will focus on the question of how to match pricing to strategy. In other words, according to what strategic principles must we price all the company's products and services. This is an important question. The CEO and the Marketing Director are meant to have their say, to answer this question, and to dictate to the entire organization the strategic principles for appropriate pricing.

B. Strategic Pricing - What should those stuck in the middle do?

In any given market, there are generally three strategic pricing options:

1. Cheap prices - suited to a cost control strategy
2. Intermediate prices - for those who are "stuck in the middle"
3. Expensive prices - for those offering differentiation and added value

 According to Michael Porter, an expert on Competitive Strategy, the second option, those "stuck in the middle", characterizes 80% of the companies and suppliers in any given market: whether they offer baby bottles, furniture, dental equipment, plastic piping, education services, photography services, or any other solution. The suppliers that are "stuck in the middle" are generally trying to give a little bit more than the competitors (so that people will buy from them), but cannot get a higher price in return.

There are many reasons why these suppliers give "a little bit more for the same price", or "the same thing for a little bit less". They either feel uncomfortable asking for more (compared to the competitors and to the market standard), or the added value that they provide is not important enough to customers (and therefore the customers are not prepared to pay more for it). Moreover, some of these suppliers would like to offer cheaper prices, but cannot because they are not streamlined enough, or they do not have a size advantage, and generally because their operating costs are too high. Either way, those "stuck in the middle" all suffer from low profitability. They are not unique enough to sell expensive, and they are not streamlined enough to sell cheap. Their profits from each sale are mediocre, as are their sales volumes.

The only thing that those "stuck in the middle" have going for them is their relatively low level of risk. Michael Reiner, an esteemed Innovation expert, used data from the Canadian Small Business Authority and found that new companies that offered intermediate pricing (neither cheap nor expensive) survived longer on average than new suppliers that offered cheap or expensive prices.

So what can businesses "stuck in the middle" that offer intermediate pricing do? They can lower expectations (knowing that they won't earn huge profits, but that their risk level is low), or change.

One option for change is to offer low prices. They can streamline, improve the automation production processes, conduct mergers and acquisitions, grow and acquire a size advantage, purchase higher volumes of raw materials and at lower prices, and gradually offer increasingly lower prices. This is a complex process that can last decades, and is not suited to a market that already has gigantic cheap and streamlined corporations.

Alternatively, companies "stuck in the middle" can try to raise prices while investing in R&D, innovation, and branding, and offer customers real added value, that they will be truly willing to pay more for. If you are "stuck in the middle", like 80% of the readers of this article, this may be the direction you will choose to improve your profitability. The key point here is to understand what the actual customers define as added value. Or, in other words, what will customers be willing to pay more for?

C. Competitive Pricing - The Cheapest Possible

In a competitive market, the main marketing strategies are cost control strategy (offering the most competitive and cheapest prices), or differentiation and added value strategy (offering relatively expensive prices).

In order to offer the cheapest prices in your market, you must be more streamlined than the competition (using automation production processes, low employment costs, geographical proximity to the market, aggressive procurement, etc.), and concurrently be larger than the competition. A significant size advantage will enable you to acquire raw materials and marketing avenues at lower costs than the competitors, and accordingly further lower the price of the solutions you offer. As stated, this is a complex and long-term strategy, requiring non-organic rapid growth by means of a long line of mergers and acquisitions of other companies.

Teva's Acamol - The cheapest in the world

Since two thirds of the mergers and acquisitions in the world fail, an organization that wants to get ahead this way must be aware of the risks and specialize in optimal execution of mergers and acquisitions. Even when such an organization grows and develops, it must continue to advertise "low prices" to its customers and employees, and to maintain a modest organizational culture. Teva and Keter Plastic are two Israeli manufacturers that managed to do this, but hardly any other Israeli manufacturers took this route. In the retail domain, the Rami Levi chain in Israel and Walmart in the U.S., and the "dollar store" chains worldwide, are excellent examples of streamlining and competitive purchasing, which made it possible to offer customers the cheapest prices.

D. Differentiation and Added Value - Expensive but Worth It

There is a third option if you don't want to be "stuck in the middle" and cost control does not appeal to you: you have to offer your customers differentiation and true added value that they will want to pay more for.

One option is to provide more expensive products and services, once you have understood what benefits your customers are willing to pay more for, and you have focused on positioning and differentiation around one such benefit. If you have invested in R&D, design, innovation, and branding that support an important benefit to customers, you may be able to charge higher prices and earn more.

Apple products, for example, provide a higher quality user experience: meticulous design and branding, a more user-friendly and intuitive interface, and a somewhat cult following. Teva Naot's shoes are more comfortable thanks to a cushioned insole that you feel as soon as you try on the shoe. HighQ, a psychometric exam preparatory institute, invested in the learning materials, including interactive presentations and computerized questionnaires, and used pricing as an important method of highlighting its advantage. For years, whenever the competition raised their prices, HighQ raised theirs even more. Thus, their message to customers was that the "most expensive = the best = HighQ".

E. Premium Pricing - Pricy but Prestigious

When it comes to luxury products, the high price is an important part of the strategy. Customers pay much more for premium products, partly because they are a status symbol.

The Lacoste emblem on a shirt - for premium prices

The shape of the Absolut vodka bottle, the Lacoste alligator on the shirt, the Mercedes logo on the hood of the car - all symbolize premium products, and the affluence of the buyer. Because price symbolizes quality - when a perfume's price is decreased dramatically, its sales actually go down (who wants to buy a $4 perfume?).

This trend is further reinforced when it comes to super-premium products. Prices here can really go through the roof, and soar way above the standard market prices. A round-trip ticket from Israel to New York in El Al's First Class (Super-Premium) costs $8,209, double or more than Business Class (Premium) - where you will "only" pay about $4000, and 6 times or more than Economy Class, where you will pay $1,400 and less. Beluga Gold vodka (super-super premium) is sold in Israel for about 1,400 NIS a bottle, compared to premium vodka (Grey Goose, for example), sold for about 200 NIS, and "regular" vodka sold for around 50 NIS a bottle.

F. Pricing and Expertise - Expensive Because We Know You

Another option for providing an added benefit is to specialize in a particular population, such as people over the age of fifty, urban women, children, cats. You can specialize in one or more specific customers (mutual dependency strategy) - especially when it comes to large customers that have thousands of employees and large procurement budgets: the I.D.F., Shufersal, Boeing, Petroleum of Venezuela.

The more specialized we become in a particular niche (fifty year olds), and the better acquainted we are with a specific customer (Shufersal, for example), and the closer our relationship with these customers are, the greater the temptation to lower our prices for them. Doing so is a serious strategic mistake!

When you specialize in a particular target audience, you get to know these customers better than your competitors do. You give them better service, you know their needs well, and are familiar with how they like to receive products and services. Therefore, you are worth more to them! And since you only focus on a portion of the market (a specific segment of the market or certain large customers), your risk increases. For example, if a large customer leaves you, it may jeopardize your entire business.

That is why you have to price your expertise, and your risk - and get more money from those that you do more business with. Think about all the profit that you could lose if you accustom your loyal customers to pay you less. Instead of doing that, make sure you sell them products and services at relatively higher prices, maintain these prices, and even raise them over the years.

G. Maintaining Prices in a Blue Ocean

There is also an alternative option to the various options for strategic pricing in a competitive market. You can move away from the competition in a crowded "red ocean", where competitors are drawing blood eating each other alive, to a competition-free "blue ocean".

According to the Blue Ocean strategy, to do this you must first identify a central benefit that most customers want more than anything else. Then, develop a new marketing mix while improving and adding components to a product or service that support this benefit, while concurrently reducing or obliterating other components that are not associated with this benefit. This way, the pricing does not change and the prices remain as they were, since the costs involved in reinforcing the desired benefit were offset by the savings from the other components.

The IKEA Catalog - Attainable Design

For example - IKEA offers stylish furniture, and invests in designers and furniture design innovations, but saves costs on raw materials, and also puts the onus of the furniture delivery and assembly on the customers. Thus, IKEA's furniture is competitively priced despite its high level of design.

With regards to pricing, the important point here is not to raise prices, even though you provide a greater added value. You give more in an area that is important to customers, and save on what's not important. Companies that work this way benefit from greater sales volumes, and profit nicely from each sale, even though they generally offer very competitive prices. Studies have shown that companies that adopt the Blue Ocean strategy, that avoid direct competition, earn on average ten times more than companies that do not adopt this strategy, and that operate according to what the competitive market dictates.

H. Summary

Pricing has several tactical aspects as well as fundamental strategic aspects and implications. It is therefore important that your company's CEO, Marketing Director, and senior management determine the pricing policy according to your business and marketing strategy, and subsequently dictate the pricing principles to the rest of the organization. This is how you will be able to maintain the positioning you wanted to attain in your market, and you will also be able to grow and develop according to your strategic planning.

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The article was written by Ari Manor, CEO of ZOOZ Marketing & Organizational Consulting. ZOOZ conducts training for managers and employees. Send your comments to ari@zooz.co.il.