Importance of Pricing

Pricing is crucial as it determines the value companies can capture from their products and services.
A 1% increase in price can lead to an 11% increase in profits on average.

For example, in the technology industry, companies often adjust their pricing strategies to increase profits. One common practice is software companies offering subscription-based services. A slight 1% increase in the subscription fee for a widely used software product can lead to a substantial 11% increase in profits due to the large customer base. By carefully analyzing customer behavior, market demand, and competitive landscape, you can strategically implement price adjustments to enhance profitability while maintaining customer satisfaction. This demonstrates how a small change in pricing can have a significant impact on profits, as observed in various industries like technology, software, and subscription-based services.

Pricing has a significant impact on company profitability as it directly affects the bottom line which is the net income or profit of a company after all expenses, including operating costs, taxes, and interest, have been deducted from total revenue. this is the final figure at the bottom of a company's income statement, indicating the overall financial performance and success of the business.

Pricing influences variable costs and volume, impacting overall business performance.

Effective pricing requires understanding economics, psychology, and cross-functional collaboration. It's challenging to determine what good pricing looks like and to implement effective pricing strategies. Successful pricing involves balancing price with the value of the product, effective communication, and delivery of value. Targeted pricing and differentiation from competitors are key for success. Pricing is dynamic and can change with external factors, requiring ongoing evaluation and adaptation.

How to Start Crafting a Strategy

These are several questions worth asking to understand pricing strategies:

• What is your company's strategy?

• What do customers buy and why?

• What does your business model look like?

• Why do customers choose your company over competitors?

These questions can help in understanding the context and developing effective pricing strategies.

Analysing Customer Revenue and Net Margins

Below you can see a very typical set of data.

This happens if you've got customer revenue. You can see the net margin all over the map. So the question is, is this good or not? Well, we can't tell. It's suspicious when you've got a big spread of margins with low, small customers and that's often what you see. You see this sort of funnel shape. But you can't tell, so it really depends on what is the company trying to optimize. Is it profits, target price, market share, volume, cost, retention, plant utilization, customer satisfaction. If you can sell, you'd rather sell high margin products than low margin products. The key is comprehending why selling at a higher margin is not the norm, and how to ensure it becomes a habit in your business.

Factors Influencing Pricing Decisions

Businesses also want to manage costs. We talked about that you can break that into raw material production costs, the cost of selling stuff, R&D spend, overhead spend, things like retention or sort of buried into volume over time. These can be grouped down into market factors, sales, cost of sales, overhead which go into revenue cost which gets you to profit. So at the end of the day, the real money is in getting the right price and sometimes getting the price right.

Optimizing Pricing Strategies

Assuming what we have discussed so far, you sell more and you have a better sales mix. And that's where the 10% increase comes from. So the impact you can get out of pricing is 2 to 5 points of revenue. That is impressive. There's nothing else going to get you that without starting a new product line or something like that. In pricing software and large companies which have complex problems, this is necessary.

They don't even know the value of pricing because when you don't get a price difference, you don't know it. For instance, say you wanted to buy a shirt and the price is 29 dollars; then you get to the counter and it's 19 dollars cause it's on sale. You were going to buy it at 29. That's 10 dollars of money that's lost. You are the only person who knows that. So that's one of the challenges we have is that when you do not get the pricing you expect, people do not know it.

What are people trying to do with pricing? What affects how, what's the context that companies are operating in when they're doing pricing. There's a set of internal drivers worth considering like there's what are they trying to do strategically. What are their goals? And what do they sell? If you're a software company, it's clear that you don't sell pastries. So what are they selling? And then there's the market drivers telling what the market looks like and what are segments you are selling into or what's the competition doing. All these things affect then the pricing practices.

On the cost side, managing costs is crucial. This includes overseeing raw material costs, production expenses, selling costs, R&D spending, overhead costs, and factors like retention embedded in volume over time. These elements can be categorized into market factors, sales costs, overheads feeding into revenue costs, ultimately affecting the bottom line.

Implementing Subscription-Based Models

Pricing strategies can also be influenced by factors such as competition, technological advancements, customer preferences, and regulatory changes. You need to continuously monitor market trends, competitor pricing strategies, and customer feedback to adapt your pricing models effectively.

Moreover, implementing dynamic pricing strategies, utilizing data analytics for pricing optimization, and incorporating value-based pricing approaches can further enhance pricing effectiveness. It's also crucial to regularly review and adjust pricing strategies based on changing market conditions and customer demands to stay competitive and maximize profitability.

Another important aspect related to pricing strategies is the concept of value-based pricing. Value-based pricing involves setting prices based on the perceived value of the product or service to the customer. By understanding the unique value proposition of your offer and aligning pricing with the value delivered to customers, you can capture value more effectively and differentiate yourself in the market.

Furthermore, subscription-based pricing models, freemium strategies, and tiered pricing structures are common approaches used to cater to different customer segments and enhance customer acquisition and retention. These pricing models allow companies to offer flexibility to customers while maximizing revenue streams and maintaining a competitive edge in the software market. Another crucial aspect related to pricing strategies is the implementation of pricing experiments. By conducting pricing experiments, you can gather valuable data on customer behavior, price sensitivity, and willingness to pay. Testing allows you to compare different pricing strategies in real-world scenarios to determine the most effective pricing approach for maximizing revenue and profitability.

Adapting Pricing Strategies to Market Trends

Additionally, understanding the concept of price elasticity of demand is essential when setting prices. Price elasticity of demand measures how sensitive customers are to changes in price. If you analyze price elasticity, you can adjust your pricing strategies to optimize revenue and market share while considering the impact of price changes on customer demand.

Lastly, staying informed about industry trends, emerging technologies, and evolving customer preferences is vital if you want to adapt your pricing strategies accordingly. Keeping a pulse on market dynamics and continuously refining pricing strategies based on customer feedback and market insights can maintain a competitive edge and drive sustainable growth. Pricing software provides valuable tools and capabilities to design and implement pricing experiments effectively. Pricing software enables companies to simulate various pricing scenarios, monitor outcomes, and refine their pricing strategies based on real-time data and insights gathered from these experiments.

Understanding Business Framework

It serves well to have a structured framework for analyzing market drivers, pricing practices, value and price targets, customer incentives, execution strategies, company drivers, and offer design. Moreover, taking into account key considerations such as targeting market segments, understanding competition, gaining insights for decision-making, delivering value to customers, capturing value created, aligning partner actions, ensuring pricing message consistency during execution, defining the company's business model, strategy, and long-term goals, and designing product and service packages is crucial for growth and success. Such a framework helps in comprehensive planning and strategic decision-making in various aspects of business operations and growth.

The Business Model Canvas

The Business Model Canvas was originally designed for startups to help them define their business structure. It serves as a tool to visualize how different components of a business interconnect, enabling the identification of hypotheses, assumptions, and risks. By mapping out the business processes, it facilitates the identification of areas for value addition and cost reduction, as well as the ability to adapt to changes. While initially intended for startups, this tool has proven to be beneficial for companies of all sizes in analyzing their operations effectively.

A business canvas outlines key elements of a business model, including:

Value Propositions: Describes the value a company offers to its customers, such as convenience, vast selection, high-quality service, and fair pricing.

Customer Segments: Identifies the target audience, including consumers and vendors who sell products through the platform.

Customer Relationships: Details how customer interactions are managed, primarily through the website and automated services.

Channels: Outlines the various channels used to reach customers, including website interfaces and affiliates.

Revenue Streams: Enumerates the sources of revenue, such as direct product sales, commission from partner sales, subscriptions, and web hosting services.

Key Partners: Lists essential partners like sellers, logistics partners, content providers, and others crucial for business operations.

Key Activities: Highlights key activities required for business functioning, such as website management, customer support, fulfillment, and partner engagement.

Key Resources: Identifies critical resources like brand reputation, distribution networks, and data analytics necessary for business success.

Cost Structure: Outlines the costs associated with IT infrastructure, product/service development, convenience offerings, and more.

Example of the Amazon Business Canvas  

Taking Amazon as an example, let's explore their value proposition. Amazon's core value lies in convenience, offering low prices, free shipping, exceptional customer experience, fast delivery, a vast selection of products, and high-quality service at fair prices. Their customer base includes individual consumers, small businesses, and vendors who sell products through Amazon's platform. Amazon's customer relationships are predominantly managed through their website and automated services, constituting a significant portion of their interactions. Revenue streams for Amazon encompass direct product sales, commissions from partner sales, Prime subscriptions, music subscriptions, and web hosting services – showcasing a diverse and dynamic revenue mix.

Amazon's unique approach of being a price follower rather than a price leader, has allowed them to maintain market control and avoid perceptions of market manipulation. Their historical focus on low costs and utilizing investor money to acquire market share, leading to its current position as one of the most valuable companies globally emphasizes the significance of understanding business strategy and business model as a valuable tool in sales conversations and project assessments, suggesting the use of the business model canvas for gaining insights into a company's operations efficiently.

Why Strategy Matters

When discussing business strategies understanding the goals is paramount. This becomes even more important when it comes to pricing as the three should always be tied. To be able to see the connections, you need to make sure that they are aligned and measurable as well as achievable. Consider the following factors in your strategy and further in pricing:

Competitive Analysis: Understanding the competitive landscape is vital for businesses to identify their strengths and weaknesses relative to competitors. When you analyze competitors' strategies, products, pricing, and market positioning, you can make informed decisions to differentiate and capitalize on market opportunities.

Market Positioning: Market positioning involves how a company presents its products or services to target customers. It defines where a brand fits in the market relative to competitors and helps establish a unique value proposition that resonates with the target audience.

Innovation and Adaptation: Innovation is crucial for staying ahead in competitive markets. You need to continuously innovate to meet changing customer needs, improve efficiency, and differentiate from competitors. Adaptation involves adjusting strategies in response to market dynamics, technological advancements, and evolving consumer preferences.

Customer-Centric Approach: Putting customers at the center of business decisions is essential for long-term success. By understanding customer preferences, behaviors, and feedback, you can tailor products, services, and marketing strategies to meet customer expectations and build lasting relationships.

Risk Management: Risk management involves identifying, assessing, and mitigating risks that could impact your objectives. Companies need to proactively manage risks related to operations, finance, compliance, and external factors to safeguard their business continuity and reputation.

Measurement and Evaluation: Measurement and evaluation involve tracking key performance indicators (KPIs) to assess the effectiveness of implemented strategies. These help identify areas of success, areas needing improvement, and make data-driven decisions to optimize future strategies.

Connecting Pricing and Strategy

Strategy is a multifaceted concept with various dimensions that can sometimes conflict with each other. A useful approach is to frame it in terms of contrasting elements, such as market share versus profit focus, a specialized distribution network versus a broad one, high support versus low support.

For example, British Airways provides more support compared to Ryanair, while Emirates offers even more. Companies may adopt strategies that are more premium or mass-market-oriented, with differing risk appetites – some preferring higher risks while others opt for lower risks. Understanding where a company stands on these contrasts, recognizing the importance of each aspect, and anticipating how these priorities may evolve over time can be incredibly beneficial in strategic decision-making.

Interplay of Volume, Revenue and Price

Going deeper into this concept involves understanding what companies aim to maximize. They may strive to maximize volume, leading to lower prices and potentially operating at a loss. Alternatively, maximizing revenue entails setting higher prices to avoid selling to unprofitable customers, thereby increasing gross profit.

It is commonly observed that the peak for gross profit surpasses the peak for revenue, except in cases where there are no variable costs. It is mathematically impossible for a company to maximize both profit and revenue simultaneously unless variable costs are zero. This trade-off highlights the importance of prioritizing between profit and revenue, with profit typically taking precedence in the long run but not necessarily in the short term when rapid scaling is a priority. While it is worth questioning a company's strategy if it seems illogical, ultimately, understanding their strategy is more critical than challenging it, as it remains their prerogative to determine and execute their chosen strategy.

What Customers Buy

This is subtly different than what people are selling because this is the perception of what the customers purchase. This can be broken down to what is the core product. For instance, BMW sells fast cars that drive very comfortably, have a navigation system and stop you from running into the back of other people and many other features.

Then there's the packaging issue around this. That is not a core component but matters. So the quality could be represented by the packaging. With consumers, particularly in case of packaged goods, the brand is important along with the styling even if these are more intangible factors.

Furthermore, you need to factor in support like the warranty or spare parts, maintenance, and repair, all the add-on options. As such, understanding what a company truly sells is interesting.

Airline Pricing Analysis

Let’s look into a segmentation analysis of airline pricing to provide you with a better understanding of the concept. Airline pricing is intriguing as the core service is transporting passengers from one location to another (A to B), yet the packaging and additional services can vary significantly. Charges in baggage fees, seat allocations, and other supplementary services have become common in the airline industry, impacting the overall pricing strategy.

Understanding these variations is crucial for pricing decisions as it enables you to comprehend the factors that influence consumer willingness to purchase. Factors such as baggage fees, seat selection charges, in-flight amenities, and overall customer experience play a significant role in shaping customers' perceptions and their willingness to pay for airline services.

Defining Your Target Customer

Let's take a look at the identification of our target customers. While we will explore further segmentation details in later segments, it is imperative for companies to consider the characteristics of their ideal customer base. For instance, a small software company specializing in CRM software tailored for mobile sales teams can demonstrate a clear focus on their niche, catering to small teams engaged in selling physical products. Their sales representatives primarily engage in order taking, aligning perfectly with their operational model. Additionally, they extend their services to both smaller and larger enterprises that prioritize technical expertise over traditional order-taking processes. By strategically seizing opportunities in these areas, they effectively differentiate themselves in the market. Understanding not only who they serve but also who they choose not to target is crucial. While it may be challenging for businesses to articulate their non-target audience, identifying the boundaries of their market focus is paramount for strategic alignment and sustained growth.

Identifying who you are not selling to is paramount for effective resource allocation, brand positioning, strategic focus, efficient marketing, and risk mitigation. If you understand your non-target audience, you can focus your efforts towards serving tyour ideal customers, align branding and messaging, focus on delivering tailored products/services, save resources on marketing campaigns, and reduce risks associated with serving incompatible customer segments.

How Companies Sell

In this example, you are looking at a very complex channel structure in the crop protection space.

These are companies that, in this particular market, sell to private distributors, mostly regional co-ops and a little bit to direct farms and to a retail network as well. They sell to farmers and the farmers have a segmentation that is complicated.

Even though in the SAP system the farmers may all be customers, they have a different type of relationship with the seller, so the seller will have to do different segmentations. This is particularly important to try and understand when you're building that data model.

Data Readiness

All this becomes even more important if you work with or for Pricefx as a lot of what we do relies on a set data structure that has good and clean data. If you're starting a project and you're asking for data, and you get the route to market which is coming from ERP, SAP or Oracle and it's good clean data and you have a level of granularity that you're basing the project off of (see bottom level on the slide). But then, if they come back to you a few weeks or months later saying that they have these indirect channels, then the data structures are different and therefore data granularity and quality will be different.

These are aspects that need to be explored and identified up front so that you understand the full scope of the business where most of the revenue and most of the sales are coming from, where are the large customers are, where the value is. As such, when you are asked questions about analysis or insights into the data or affecting price changes, you know at what level of granularity you have data, what are the data structures, and what is the data quality across all the various route routes to markets.

Understand that this is critical for you and Pricefx to get right at the beginning of the project so that you don't have to rework when you find out things later. A blank version of this setup that you ask customers to help fill in is a powerful way to do it.

Knowing the end customer in pricing is important because it affects the value of the product you're selling. Even though it can be messy and challenging to have clear visibility into pricing data, this issue won't just disappear. While pricing software cannot solve everything, understanding end customer pricing is crucial for effectively managing and navigating through pricing.

Understanding Your Competition

Understanding who your competition is plays a crucial role in business. It involves not only recognizing your direct competitors but also considering the indirect competition - those alternative options that customers are exploring. Insights into this can help you make better-informed decisions. Customers typically have a range of choices and consider various factors when making decisions. It's important to grasp this evaluation process as it directly impacts the perceived value, a topic we'll delve into further in our next discussion.

Competition in business refers to the rivalry among companies in the same industry, all striving for market share, customers, and profitability. You need to know the competitive landscape of your businesses as it shapes pricing strategies, product differentiation, customer acquisition, and overall business performance.

Key Aspects to Consider in a Competitive Landscape

If you want to excel in pricing within a competitive business environment, there are some key aspects to keep in mind. Firstly, understanding the competitive landscape is crucial. This involves identifying direct competitors, studying their pricing strategies, offerings, and market positions.

Another important aspect is crafting a strong value proposition that sets your products/services apart from the competition. Highlighting the unique features, benefits, and value your offerings bring to customers will help justify your pricing strategy.

Market research is also essential. Understanding customer needs and willingness to pay will help you determine the optimal pricing levels for your products/services.

When it comes to pricing, accurate cost analysis is key. Calculating your costs meticulously will help you establish a pricing strategy that ensures profitability while keeping you competitive in the market. Consider both fixed and variable costs, as well as overhead expenses when setting prices.

Remaining agile and responsive to market changes is also important. Implementing dynamic pricing strategies that allow for adjustments based on demand fluctuations, competitor actions, and market trends will help you stay ahead.

Consider adopting value-based pricing, where prices are set based on the perceived value of your product/service to the customer. Emphasize delivering value to customers to justify premium pricing.

Lastly, strategically position your prices relative to competitors. Determine whether you want to compete on price, differentiate based on value, or opt for a premium pricing strategy that aligns with your overall business strategy and target market.

Remember that understanding your competition, creating a strong value proposition, conducting thorough market research, analyzing costs accurately, implementing dynamic pricing strategies, considering value-based pricing, and strategically positioning your prices are all key components to excel in pricing within a competitive business environment. These considerations will not only help you stay competitive but also enhance your overall business performance and profitability.

Basic Approaches to Pricing

There are three basic approaches to pricing.

Take cost-plus pricing. The problem here is you are looking internally without helping externally. Competitive pricing now at least we're looking outside the company. So that's a that's an advantage, but we're not really thinking about our differentiation. We're not competitors, prices might not be right and it's certainly not profit optimal. So value pricing is the gold standard. It is profit optimal.

If you're doing pricing right, you think about everything that might associate with value, and you get a consistent price structure. But it is a lot of work and there's no way around it. Value based pricing is the gold standard, but all three approaches have some application and we'll go into that now.

P. Drucker said that customers don't buy products; they buy the benefits that these products and their suppliers offer to them. The answer to that is that customers buy based on perceived value, even if a company doesn't price and sell based on the value.

These pricing approaches being like a triangle,  where you've got 3 dimensions can place you anywhere in this triangle. This means you can have a mix. That's the point. So sometimes cost plus is more important, other times value pricing is more important. So value pricing really dominates when it's a highly differentiated product. Unique selling value, low competition. Competitive pricing tends to dominate when it's. There's a supply demand dynamic going on.

Pricing Basis: Examples

Imagine you have an oil well. In the context of pricing examples, when everyone in the market is closely observing and basing their prices on what competitors are charging, especially in markets with low product differentiation and many competitors, this situation typically leads to competitive pricing strategies.

On the other hand, cost-plus pricing is commonly seen in markets with undifferentiated products, an abundance of supply, and a lack of strict market discipline. The driving forces behind these pricing strategies are influenced by factors like value pricing, competitive intensity, product differentiation, and market dynamics.

As the competitive intensity increases and more sellers offer similar products, the differentiation of your product diminishes, often resulting in a shift towards competitive pricing strategies. Conversely, in situations of excess supply, cost-plus pricing strategies tend to prevail.

Moreover, you cannot overlook the importance of market discipline. In markets with a limited number of competitors where there is a sense of cooperation rather than cutthroat competition, engaging in price wars to win market share is discouraged. Price wars are noted to destroy value and should generally be avoided in most cases to maintain profitability and market stability.

 Key Success Factors of Pricing Strategies

Consider various pricing examples and strategies based on different levels of differentiation and competitive intensity in the market like pure value-based pricing that Apple has with products such as the Apple Watch and high-end fashion items. These products are perceived as offering unique value, where customers are willing to pay premium prices without much consideration of alternatives.

You also have products that fall somewhere in the middle, combining differentiation with competitive pricing elements like Samsung smartphones, specialty chemicals, and certain electronics, which have some differentiation but face competitive pricing pressures due to market dynamics.

 Furthermore, you have purely competitive pricing scenarios, such as in the airline industry, electronics, automotive parts, and commodities like crude oil. In these cases, prices are heavily influenced by market competition and industry standards rather than product differentiation or value.

 Now think about cost-plus pricing models, where products like steel are facing challenges due to excess supply and market conditions, leading to pricing based on variable costs. Additionally, configured-to-order products, like customized packaging solutions or shipping services from companies like DHL or FedEx, are examples of cost-plus pricing with some value considerations.

It is important to align pricing strategies with the nature of the product and market conditions. Understanding customer value segments and adapting pricing strategies accordingly is crucial for success as well as incorporating a balanced approach to pricing strategies based on the product's value proposition, market competitiveness, and cost structures to optimize pricing models effectively.

Value as a Pricing Factor

Value is or should always be something of a factor. It comes in three places from a pricing software company’s customer: we can help them manage their costs, lower their costs and long-term costs, and help them increase their revenue or profit.

Short-term costs play a crucial role in helping businesses save money immediately. Often, this translates to offering products or services at a more competitive price. For example, Pricefx software may be priced lower than competitors' software while still being powerful and easy to quantify in terms of value. This cost-saving approach can lead to long-term benefits such as improved efficiency, lower maintenance costs, increased sales, higher pricing options, a more diverse product mix, and better customer retention. These factors collectively contribute to revenue growth and profitability.

In contrast, long-term costs present various opportunities to save expenses, especially considering capital costs. For instance, investing in an electric car may initially cost more but results in long-term savings due to lower fuel consumption and maintenance costs. Additionally, intangible benefits like risk reduction, enhanced company reputation, and brand value can significantly impact business success. For instance, insurance may seem costly but helps manage risks and improve the company's standing.

It is worth mentioning that on average value is compared against the next best alternative or alternatives. The latter can encompass a wide array of options from direct, indirect or partial competitor to home built, process work arounds or simply doing nothing. You need to be aware that switching costs should be and usually are also considered. Next Best Alternative(s) usually vary depending on customer segment, level of customer pain or need, and innovation.

Key Buying Factors 

Furthermore, understanding key buying factors is essential for pricing people to determine the value, cost sources, and pricing strategies effectively. Key buying factors involve assessing the importance and differentiation of product features to customers. Identifying distinctive features that truly matter to customers, rather than mere distractions like logo color, is crucial in aligning pricing strategies with customer preferences and decision-making processes.

Ultimately, recognizing and focusing on key buying factors that align with customer needs and preferences can significantly impact pricing strategies and enhance overall business success. Understanding the sources of value and how they tie back to customer preferences will drive informed decisions and consequently, business growth.

What Is a Value Map

A value map, also known as a context map, compares performance against price and establishes a fair value line. Products positioned on this line are considered to have a fair price. For instance, in the context of cars, a BMW 5 Series would be placed at the high end of both price and value, justifying its cost. On the other hand, a budget car may be positioned at the lower end, offering basic features at a lower price point.

Products that deviate from the fair value line, such as those with a high price but perceived low value, are at risk of losing market share. Understanding these dynamics is particularly valuable in competitive markets to gauge product positioning and customer perceptions.

How Pricing Software Can Help Value Mapping

Utilizing pricing software can assist in creating value maps to analyze market positioning effectively.

While implementing such tools may vary on a case-by-case or customer-specific basis, they serve as strategic aids for companies to gain insights into their market positioning. Customers in certain industries, such as crop protection, may utilize these tools to evaluate product offerings based on effectiveness, pricing, and problem-solving capabilities.

Understanding Price Elasticity

Price elasticity is the gold standard, but very hard to do in B2C.

Price elasticity is: if you raise the price, what will happen to the volume? If you lower the price, what will happen to the volume? Anything will have a price elasticity of -1. It's always negative. If you raise the price, the volume goes down. Say you increase the price by 1%, you lose 1% of volume. That would be -1.

Understanding price elasticity for a specific product within a market segment is a powerful tool as it allows you to map the relationship between profit and price, determining the optimal price point for maximum profitability. However, this process presents challenges that require a significant amount of accurate data. It is often a one-time analysis due to the complexity of the task. Companies like Amazon invest considerable effort in this analysis to fine-tune their pricing strategies, sometimes leading to frequent price adjustments as part of their experimentation to gauge consumer responses.

Measuring price elasticity traditionally involves conducting a key buying factor study and utilizing discrete choice modeling. Discrete choice modeling entails presenting consumers with various product configurations and price points to assess their preferences and willingness to pay. If you analyze these trade-offs, you can understand individual price sensitivity and calculate price elasticity, particularly effective for markets with simple product offerings and limited options.

Conjoint analysis, a similar technique to discrete choice modeling, is also utilized for understanding price elasticity. While historical data can be used for this analysis, it poses challenges due to external factors impacting pricing decisions. The process requires meticulous data collection and isolation of variables to accurately assess price elasticity over time.

Price Elasticity in Pricefx

Another critical point to consider is the array of tools available in our toolbox for pricing analysis. Among these tools are Price Builder, which offers a business rules engine, and Price Optimizer, which provides algorithms to enhance the capabilities of Price Builder. Within the Price Optimizer toolkit, we can leverage various tools such as running elasticities, conducting price segmentations, analyzing margin quartiles or percentiles, and more. Price elasticity analysis is one of the widely recognized tools in our toolkit.

When considering utilizing price elasticity analysis, it is essential to step back and assess the specific use case, scenario, and problem we aim to address. While price elasticity analysis is a valuable tool, it is crucial to recognize that it is not the sole solution and may not always be the most appropriate tool for every situation. It is vital to understand that we have multiple capabilities at our disposal to tackle pricing challenges effectively.

In a strategic approach, it may be beneficial to start with simpler tools like Price Builder and progressively move towards more advanced tools like Price Optimizer based on the complexity of the problem at hand. This incremental approach allows for a better understanding of the tools available and their suitability for addressing specific pricing challenges. Doing so, we can effectively communicate, conceptualize, and address pricing issues with our customers.

 Segmentation in Pricing

Segmentation in business refers to the practice of categorizing customers based on various factors to tailor marketing strategies, sales approaches, and pricing models accordingly. Effective segmentation allows companies to differentiate their offerings and target specific customer groups with customized solutions. However, segmentation is only valuable if it leads to actionable insights and drives distinct business strategies.

In other words, this is about you, and how you act differently. This can mean how often your sales force visit, how many calls they do, pricing, how are the service levels different. So, segments that do not help you do something differently are not useful.

The question that arises then is why do we even do price segmentation? Well, this is your classic volume v. price. Simply put, as you raise the price, you sell less. If you have one price across, then you make a fixed amount of profit. This is because of the basic formula profit = volume x price.

Without segmentation you would have people who would buy your product even at a higher price. Conversely, without segmentation, if the price is too high people who cannot afford it will not buy it. So if you can have segmentation you can capture more of the area under the curve (see graph below) because that's where the profit is. So, segmentation allows you to capture more value.

Price segmentation, for example, is a common practice that involves analyzing the relationship between volume and pricing. By segmenting customers based on their price sensitivity and willingness to pay, companies can optimize pricing strategies to capture more value. This approach aims to strike a balance between maximizing revenue and meeting customer demand at different price points. 

In practical terms, price segmentation can be complex as it requires setting boundaries and implementing measures to prevent customers from exploiting pricing differentials. For instance, offering discounts or coupons selectively to incentivize certain customer segments while discouraging others from taking advantage of lower prices. This strategic use of segmentation helps companies maximize profitability by targeting customers willing to pay higher prices without compromising overall revenue potential.

Pricing Segmentation in Airlines

Airlines provide a classic example of product segmentation in action, where different pricing tiers are offered based on seating options and amenities. By segmenting customers into various classes, airlines can optimize revenue by catering to diverse customer preferences and willingness to pay for additional services or comfort levels. While some airlines like Southwest adopt a simpler operational model with no class distinctions, others like Ryanair and EasyJet focus on cost efficiency and offer limited segmentation options to streamline operations.

In essence, segmentation strategies in pricing and service differentiation play a crucial role in revenue optimization and customer satisfaction. By understanding customer preferences, price sensitivity, and market dynamics, companies can strategically segment their offerings to meet diverse customer needs effectively while maximizing profitability in competitive industries like the airline sector.

Segmentation in pricing involves categorizing customers and products based on various factors to tailor marketing strategies, sales approaches, and pricing models. There are three main types of segmentation commonly used for pricing: product segmentation, channel segmentation, and end customer segmentation.

Types of product segmentation

ABC Classification

Product segmentation focuses on leveraging psychological cues to influence consumer behavior. Customers tend to pay more attention to prices for products they frequently purchase or consider essential, compared to items they buy infrequently. For low-frequency products, customers are less price-sensitive, allowing companies to implement price increases more effectively on high-demand items.

Channel segmentation considers the distribution channels through which products are sold, with pricing strategies often reflecting the value added by each channel. Different channels may cater to distinct customer segments, influencing pricing decisions based on the perceived value and service levels provided.

End customer segmentation involves analyzing customer behavior and preferences to determine pricing strategies. Factors such as product usage, geographical location, market power, and behavioral patterns play a role in setting prices tailored to specific customer segments.

Margin and Differentiation as Discount and Rebate Drivers

Another scheme is based on product differentiation versus margin, then broken into four schemes. In A, products are highly differentiated, and customers really want them, so they sell themselves. As such, these products shouldn't need much incentive to buy. People just walk in and buy them. 

The second one is a high margin product, but they're much less differentiated. And there's a surprising number of these around. These are push products when you may need to offer a lower price in some cases. So, these tend to have a bigger price corridor that you're working between.

Customer and Channel Segmentation for Price Differentiation

Channel and customer segmentation for end users, oftentimes focuses on the importance of product utility, meaning its application. Secondly it matters where you are selling. In channels, the big difference is value added services. So, if the channel is providing value, they should get some compensation for that because you don't have to.

To make segmentation work though, you need to have fences so that people would pay a high price.

List and Target Prices: Key Questions to Ask

 What are your primary pricing drivers (value, market, cost+)?

What are your key value drivers for customers?

What price mechanisms do you use to capture a share of the value created?

How do you track customer value over time?

What alternative solutions are customers considering?

How quickly are things changing?

Which customer segments do you use?

How do prices vary across segments?

How do you manage fences between segments?

Introduction to Discounts and Rebates

In this section, we will look into discounts and rebates. The complexity surrounding discounts and rebates often leaves businesses confused about their purpose and utilization. Our aim here is to demystify these practices. When engaging in sales through channels, such as selling to distributors, a common practice, raises a fundamental question: Why do you engage distributors in the first place? Distributors play a vital role by adding value to your operations. They extend your reach, handle billing, and perform various tasks that contribute to the sales process. Consequently, offering incentives like discounts or rebates serves as a means to compensate them for the value they bring to the table.

Discounts and Rebates as Incentives

Understanding the roles and contributions of distribution partners is crucial in determining appropriate compensation through discounts or rebates. Ensuring the alignment of channel incentives with your objectives is paramount for success. 

It is essential to examine the commercial terms of discounts and rebates and assess their alignment with your goals. It's surprising how often discrepancies exist in this regard, with past structures often lacking clarity in their rationale. Moreover, incentivizing performance through rebates becomes significant. Rebates come into play when rewarding individuals based on achieving desired outcomes, such as increased sales or purchases.

Moreover, distributing discounts and rebates effectively across different products poses another consideration in optimizing channel incentives. If you consider these aspects you can enhance the effectiveness of your strategies in driving performance and fostering beneficial partnerships within your distribution network.

When Should You Use Discounts and Rebates

Previously we talked about push and pull products and how they should have very different discount or rebate allocations. For push products, pull products you shouldn't have to discount. Poor products need to get discounted.

Here is an example of a situation when a good product and a confident producer may not use rebates nor discounts to incentivize purchases or further sales. A global pharmaceutical and medical equipment producer wanted to purchase iPads for their sales team. Initially, they approached Apple to buy 1000 iPads and were quoted the list price of $699 each. Despite requesting a bulk purchase, Apple reiterated the price per unit without offering any discount. This was possible because Apple had confidence in their product and its value proposition, which eliminated the need for discounts.

In the realm of product allocation, discounts, and rebates, it's essential to discern which customers should receive them. Core customers with significant business potential might be more likely to receive price flexibility compared to opportunistic customers with potential challenges in servicing. In cases where customers with baggage are involved, no discounts may be offered, and it's acceptable whether they make a purchase or not.

Complexities arise in managing rebates, making them more cumbersome unless they provide tangible value. In such instances, opting for simple discounts might be more practical. Evaluating the rationale behind discounts and rebates involves considering factors like customer segmentation, value proposition, and overall feasibility to determine if these strategies align with the business goals effectively.

How to Differentiate Discounts and Rebates

We discussed in the previous section about how important it is to pay the distributors for their work. Let’s look at an example to explain this better. Imagine different parts of a business where this can happen: for instance in some countries, the distributors can be paid 30% of the sales, while in others, only 5%. This difference makes sense because if they're only doing basic tasks like handling deliveries and collecting money, they shouldn't get paid a lot. For instance, pharmacy managers might earn small commissions for their work. But if they are actively involved in selling and supporting products, they should get more money.

Now think that distributors grow bigger and more influential. They might ask for higher profits because of their size. For example, the biggest distributor in a certain industry can negotiate better prices because of their size. However, there's a risk that these higher costs may end up being passed on to customers.

When you sell something, you need to think about the price for the customer, how much the middleman gets, and how much profit you make as the supplier. It's important to keep these things separate, even though they might all look like one big number in your system. Balancing how much distributors get paid and how much profit you make is crucial but can be challenging to figure out. Regardless, it's essential to pay the distributors based on the value they bring to the table.

The Importance of Aligning Discounts and Rebates with Strategic Objectives

In this section we are looking at different objectives of a rebate and discount scheme, including increasing market share, boosting profits, strengthening partnerships, reducing operational costs, and managing commercial risks. It is important to categorize and standardize discount and rebate schemes to simplify management and improve visibility. In return, this will allow flexibility for larger clients making the process more streamlined and effective.

Key Objectives in a Rebate/Discount Scheme

In the context of a rebate and discount scheme, there are several key objectives to achieve. These include growing market share by increasing sales volume, enhancing profits through higher prices or product mix, strengthening partnerships to promote sales, reducing operational costs through measures like improved forecasting or bulk purchasing, and managing commercial risks such as payment terms.

To effectively address these goals, it is essential to categorize and standardize the various discount and rebate schemes available. If you organize them into a library of distinct types, you can simplify management and gain a better understanding of similar schemes for harmonization, improved visibility and easier management.

The approach involves establishing standard conditions for the majority of transactions, aiming to process around 80% of business through these standardized schemes. For larger clients with specific requirements like major corporations such as Procter & Gamble for instance, customized solutions can be accommodated. Cataloging and understanding these schemes, allow you to navigate the complexities effectively, even if not all schemes are fully harmonized.

Conditional vs Unconditional Discounts and Rebates

The main issue here is how rebates are divided into unconditional and conditional categories, with the latter being task-based and the former being outcome-based.

In an unconditional scenario, for example, a distributor may receive a 15% rebate for certain activities, which is considered fair. Additionally, it is advisable to set a list price as a recommended retail price, offering a margin upfront.

Conditional task-based rebates involve compensating partners for actions that can potentially boost product sales, such as training or expanding product portfolios. Conditional outcome-based rebates, on the other hand, are tied to specific results.

A balanced approach that combines both types of rebates has proven to be most effective. You can maximize impact by using a mix of these strategies. This principle also applies to sales reps' incentives – rewarding them for the right actions and outcomes.

Benefits of Maintaining a Trade-off Mentality

In negotiations, it is crucial to maintain a trade-off mentality when offering incentives. Setting up pricing structures with various package options allows for flexibility in negotiations and enables constructive conversations around value versus cost. In other words, giving something for free, may diminish its real value simply because there is a lack of tit for tat attitude.

You can engage in productive discussions with partners and customers to find mutually beneficial solutions if you implement a tiered approach in pricing strategies, such as offering good, better, and best bundles. This fosters positive dynamics and supports commercial partner growth across different business segments.

Understanding Conditions for Rebates and Discounts

Key questions arise when considering which discounts and rebates companies utilize and how conditional rebates are structured. It is crucial to understand the conditions under which these rebates are applied and whether they align with the company's objectives.

In a case study conducted in a mature country, the focus was on increasing profits, yet 80% of the rebates were centered around volume. Upon realizing this discrepancy, the company acknowledged the inefficiency without external intervention. This highlights the power of self-discovery in optimizing discount and rebate strategies.

Many companies lack clarity on effective discount and rebate management practices. Once they get perspective on best practices, they can reassess their approach and drive improvements in their strategies.

 Furthermore, it is essential to address how these incentives are managed. Identifying areas of complexity and potential inefficiencies can help you minimize revenue leakage and prioritize valuable customer relationships over less beneficial ones.

 Key Questions to Ask when Dealing with Discounts and Rebates

Here are some key questions to ask when embarking on this discovery journey.

• What discounts and rebates do you use?

• What behaviors are you trying to drive with discounts and rebates?

• How effective do you consider your discount and rebate programs?

• How are conditional rebates structured?

• How are rebates allocated across customer segments?

• How does rebate spending vary across product segments?

• How do you manage rebates end-to-end?

• Which aspects are most difficult to manage?

• Where does the most unintended price leakage occur?