Pricing has a substantial and immediate impact on profitability. Most companies, however, still use costs or competition as a main basis for setting prices. Product or business model innovation has a high priority for many companies, whereas innovation in pricing has received scant attention. This book examines how innovation in pricing drives profits.
Introduction
Few companies treat innovation in pricing as seriously as they treat product or business model innovation. One key objective of this edited volume is thus to raise the importance of innovation in pricing, both in academia as well as in the industry.
A historical perspective on innovation in pricing
Five decades ago, in 1968, Elizabeth Marting edited the book Creative Pricing. This book is a collection of papers by 19 scholars and pricing practitioners on creative pricing approaches. The book covers the following topics: the role of pricing, pricing policy and objectives, nonfinancial aspects of pricing, pricing by distribution channel, pricing by product type, the use of computers in pricing, and management of price changes. In the foreword, Elizabeth Marting comments (Marting 1968: 5): ‘It is the thesis of this book that with sound planning, flexible techniques, and adequate support, pricing can be made to have a positive, productive impact on company profits; in short, that it can be creative.’ We agree. Pricing can and should be a topic of innovation and creativity.
In the first chapter, Oxenfeldt suggests (Oxenfeldt 1968: 9) that ‘the notion that pricing can be creative is itself quite creative and new’. For decades, research in pricing has been dominated first by economic theory and later by cost accounting. We conjecture that price strategists and price setters have the opportunity to be creative, although ‘it runs counter to the writing and thinking of most economic theorists’ (Oxenfeldt 1968: 10).
The questions raised 50 years ago are still valid. The answers as to what constitutes an innovation in pricing have changed.
What is innovation in pricing?
Innovation in pricing regards instances in which companies innovate their pricing strategies, tactics, or organization, or where companies use an understanding of consumer psychology to change customer perceptions of value and price in order to jointly increase profits and customer satisfaction (Hinterhuber and Liozu 2014). The premise of this book is that most managers spend a disproportionate amount of time and resources on product or business model innovation while essentially neglecting innovation in pricing. This book aims to change this by offering a collection of best practices and relevant research on innovation in pricing.
Contents overview
This book is the result of a rigorous selection process of the most insightful papers dealing with innovation in pricing. Our initial call for papers generated a high interest from both academia and pricing professionals. Ultimately, over 50 papers were submitted for review. After a review process we selected 25 papers. For this second edition, we added 3 and eliminated 5 chapters from the original first edition. They are organized in four sections: innovation in organizing the pricing function, innovation in pricing strategy, innovation in pricing tactics and, finally, psychological aspects of pricing.
Andreas Hinterhuber and Stephan Liozu provide a roadmap for innovation in pricing (Hinterhuber and Liozu 2014). The authors identify a total of 21 alternative approaches of how companies can implement innovation in pricing strategies, in tactics and in the organization of pricing. Each of these approaches is illustrated with a short case study or example. This roadmap starts with a simple premise: about 95% of companies do not engage systematically in pricing innovation. Most companies invest heavily in product innovation and essentially neglect innovation in pricing. This is an error. The benefits of this roadmap are straightforward: by implementing two to three approaches of innovation in pricing strategy, tactics or organization companies can, this research suggests, substantially increase profits and customer satisfaction conjointly via pricing. This is the ultimate hallmark of an effective pricing strategy.
Innovation in organizing the pricing function
Stephan Liozu and Kellie Ecker examine options for the organizational design of the pricing function in firms. They conduct a literature review on centralization and decentralization. Four possible designs of the pricing function are proposed: centralized, decentralized, centre-supported and centre-led. The authors conjecture that centre-led pricing, which combines elements of centralization with elements of decentralization, is superior to other organizational designs. The authors also present their own research on the effectiveness of centre-led pricing. The authors hope that these research findings contribute to the ongoing debate on organizational design of pricing for performance.
Niklas Hallberg and Linn Andersson investigate the organizational barriers that prevent companies from implementing innovative pricing strategies, such as value-based pricing. This research, based on two case studies, identifies two main barriers: excessive decentralization and sales force incentive schemes. The authors also discuss how firms address these challenges: centralization of pricing authority and increased sales force control and training. The results of this study indicate that innovation in sales-force management, and, more specifically, centralization of pricing authority, is a key success factor for the implementation of value-based pricing through customer value map analysis, especially when sales force value-based pricing and value-based selling capabilities are not yet fully developed. Examining this interaction effect between decentralized pricing capabilities and the effectiveness of centralizing pricing authority is certainly worthy of future study.
Stephan Liozu, Andreas Hinterhuber, Sheri Perelli and Toni Somers explore the topic of the role of top executives in supporting and leading corporate pricing activities and programmes. The authors report the results of a quantitative inquiry with 557 CEOs and business owners of firms from around the globe that evaluates the levels of championing involvement of the pricing function, their perceptions on pricing and how they organize for pricing. The authors propose a structural model which includes first- and second-order measurement models. The results suggest that the level of championing from CEO and business owners in pricing positively influences firms’ decision-making rationality, pricing capabilities, level of collective mindfulness and pricing orientation, thereby leading to significantly higher firm performance. This study is thus a strong call to action for CEOs aiming to improve organizational performance. The main implication: champion the pricing function.
Ronald Baker and Stephan Liozu conjecture that the nature of senior management is changing. Firms face strong levels of competitiveness, and their business models are being challenged as a result. The authors suggest that value management at the organizational or corporate levels is becoming a number one priority. Although chief marketing and chief commercial officers are highly qualified to manage value processes, they do so along with performing a multitude of other functions or processes that distract their attention from the core function of value management. The authors propose that chief value officers, whether functionally or process-oriented, offer CEOs an expert and an ally dedicated to leading value strategies and processes at the organizational level. With their expertise, drive and dedication, they manage business value centrally and make sure that all firm processes and functions are aligned to create, quantify and capture value. This focused attention on value leads to a transformation of the firm’s DNA and the adoption of business value as the firm’s raison d’être.
In an interview Andreas Hinterhuber and Todd Snelgrove explore how a Vice President of Value can drive profits in industrial markets: This emerging, fascinating and demanding positon requires, of course, customer value quantification and documentation, creating case repositories of quantified value, capturing the voice of the customer for marketing and new product development, and maintaining the organizational momentum in value-based pricing and selling. Value quantification is demanding: few companies excel at this capability. Among the not yet fully resolved questions is the issue of how to quantify the value of intangible elements in B2B, such as the value of relationships, brands, or expertise. Quantifying intangibles, the authors suggest, essentially means translating intangible elements into tangible features that customers value.
Mark Stiving examines the difficult topic of measuring return on investment (ROI) for pricing systems investments (Liozu & Hinterhuber, 2014). The author clarifies the benefits of using IT-based pricing systems by explaining their three biggest capabilities (execution, analytics and science) and the types of data typically used by these systems: customer master, transaction data, waterfall data and competitor pricing. The benefits of using IT-based pricing systems can be found in: increased margin, increased win rates, more opportunities, lower costs and reduced liabilities. Finally, attention is paid to the set of steps to incorporate all these elements in an ROI study.
Innovation in pricing strategy
Stephan Liozu and Katie Richardson examine the role of business model innovation in the context of innovation in pricing. The authors highlight that innovation in pricing requires effective market segmentation, customer value quantification, change management, sales force training, management of distribution channels, and an understanding of how to integrate new pricing models with legacy pricing structures. Finally, new pricing models should be tested before implementation.
Rafael Farrés further investigates the role of customer value-based pricing in industrial companies. The author makes it clear that even research-intensive, innovative companies should adopt a variety of alternative pricing strategies across their product and service portfolio. The author highlights firm and environmental conditions that make value-based pricing particularly suitable and illuminates under which conditions cost- and competition-based pricing approaches are appropriate for industrial firms. The author also presents a series of pricing tools that have enabled industrial companies to implement value-based pricing strategies: the price waterfall, the price-value map, turnover build-up, terms and conditions analyser, the pricing explorer and the price-volume scatter plot. Especially for practising executives at the beginning of the transformational journey towards value-based pricing, the discussion of these pricing tools and metrics will be useful.
Linda Trevenen proposed a grounded and practical essay on the art and science of customer segmentation, which she refers to as the heart of a profitable market strategy. In this essay, she suggests that grouping customers based on what they value enables a firm to provide distinct offerings and prices to each of these customer groups. However, too often, many firms do not make the effort to segment their customer base or simply fall back along traditional segmentation lines – demographic or geographic – because these data are available and require minimal effort to distinguish between customer types. As a result of not applying a deeper needs-based segmentation, the firm is faced with price variability, lack of adherence to contracts and a culture of ‘giving in’. The author makes a few recommendations that smart firms can apply for better customer segmentation: set boundaries and fences, create pricing policies, and have a deeper level of customer understanding that leads to profitable growth. This chapter explains the importance of segmentation, and the strategies and practical activities for deploying it, and describes how to implement segmentation best practices into the organization so that a segmentation strategy realizes greater profitability.
Ralf Drews conjectures that, in many companies, the ‘value-based pricing’ of a new product offering is applied only after the product has passed all design stages in R&D. In addition, often the pricing approach is focused only on the offering itself. Although it seems to be common practice, the author argues that this approach has major disadvantages: first, the pricing is neither considered nor made in the context of a company’s other important value contributors; second, the value of the product’s features is unclear because they are not seen in the context of application; and last but not least, the new product is not tailored to the needs of a specific customer profile or to cultural buying preferences. If companies seek to create a product with superior value, it must be defined and priced before R&D even knows what it will look like. Furthermore, it is critical that the buying psychology of a specific customer be taken into account. In this unique paper, the author describes how companies can achieve this and which critical success factors are necessary for this uncommon but useful approach.
Magnus Johansson investigates the role of pricing capabilities and processes in fast-paced B2B firms. Extant theory treats the two processes of value creation and value capture (i.e. pricing) separately. This paper suggests departing from this conceptual separation when dealing with pricing and value creation processes in fast-paced business environments, such as the semiconductor industry. In these environments value creation and value capture are iterative and intertwined, value is co-produced together with customers, and there is a high uncertainty around the total value jointly created between the supplier and the firm. This paper suggests that, in these circumstances, pricing processes have to be iterative as well and that price-setting authority has to be more localized. The contribution of this paper is thus a sketch of required pricing capabilities and processes in highly dynamic environments, which are markedly different from capabilities and processes described by extant research in static environments.
David Dvorin, Jered Haedt and Vernon Lennon address one of the critical elements of the mergers and acquisition process: improvements in pricing. The authors propose a robust framework for assessing opportunities of improving pricing during the mergers and acquisition process; they also highlight how to implement price increases during this process. The authors finally summarize the impact of price improvements on the enterprise value of merged or acquired businesses.
Nelson Hyde discusses four widely held pricing myths. Pricing managers seem to believe that lower prices lead to higher volumes, that customers are price-sensitive, that prices have to be set at prevailing market prices, and that lower prices increase the likelihood of closing the sale. These assumptions are, as this paper suggests, myths that prevent companies from creating and communicating customer value and from implementing value-based pricing. Overcoming these myths thus enables companies to adopt customer value-based pricing strategies.
Todd Snelgrove traces the past and present of total cost of ownership (TCO) approaches and highlights in which direction TCO could evolve. As the ‘sum of purchase price plus all expenses incurred during the productive lifecycle of a product minus its salvage or resale price’ (Anderson and Narus 2004), this approach is exclusively concerned with the cost side of customer value and neglects the value of customer-specific benefits (Anderson and Narus 2004). In this paper the author shows how TCO approaches can be expanded to incorporate the value of customer-specific benefits. Through case studies, this paper illustrates the difference between lowest initial purchase price, lowest TCO and an expanded view of TCO that includes the sum of all customer-specific value created. This paper also highlights the importance of communicating the price and value premium in industrial markets. The contribution of this paper is thus to illuminate that TCO can be compatible with customer value-based pricing.
Fernando Resende discusses how to optimize profitability through pricing in an environment where prices are negotiated. This paper illustrates how suppliers of complex projects can reduce their own costs through scope optimization and service-level adaptations. This paper also suggests ways to avoid price leakage through discount optimization and through a shared understanding of future required volumes, service levels and price developments.
Innovation in pricing tactics
Customer value communication is an integral element of pricing tactics. Christopher Provines analyses a series of different value-communication tools in business markets. These tools differ by interactivity and complexity. Non-interactive tools are economic benefit claims that are developed based on observational studies or customer interviews. Interactive tools are decision-support analytical models such as ROI tools and value calculators. Complex interactive tools are workflow and business-model studies. This paper then suggests using different value communication tools depending on the degree of outcome risk and the complexity of the product offering. In sum, this paper offers an up-to-date summary of case studies and recent research on innovative ways to communicate customer value in B2B markets.
Harry Macdivitt reinforces the fact that understanding, using and communicating the value created for their customers is a challenge for many businesses. He claims that this results in an inability to respond assertively and confidently to customer demands for deep discounting. Margin erosion, premature commoditization and loss of market share follow. At the heart of the issue is the lack of a unifying framework for analysing, quantifying and communicating value. In this paper, the author introduces a framework for analysing customer value. He illustrates the application using two contemporary case studies. The author claims that the proposed tool led to new insights and the creation of deeper, richer and more focused customer value propositions. This structured approach thus facilitates the implementation of customer value-based pricing.
Neil Biehn and Craig Zawada examine alternative approaches to measuring customer willingness to pay. The quantification of customer willingness to pay is clearly at the centre of effective, profitable pricing strategies. The authors critically examine alternative approaches to measuring customer willingness to pay in industrial markets. The authors then illustrate the importance of measuring customer willingness to pay in five specific B2B pricing models: spot pricing, agreement or contract pricing, list or matrix pricing, subscription pricing and promotional pricing.
Steven Forth highlights the role of collaboration and conversations between stakeholders to implement innovative pricing approaches. Traditional pricing-management software is based on the analysis of transactions and its use has been limited to quantitatively oriented pricing experts. In this paper, the author describes software for quantifying customer value. The software quantifies customer value to enable collaborative processes around the pricing of B2B goods and services in negotiated markets. Collaborative approaches facilitate customer value quantification. The author suggests that in the future, pricing will need to draw on and support a more diverse group than in the past.
The sales function has a fundamental role in the process of communicating and delivering value to customers. Mike Moorman proposes a sales-effectiveness framework composed of three parts to implement value-based selling. First, an analysis of competitors, customers and markets delivers customer insight. Then, the go-to-market-strategy is built on a segmentation strategy, a value-proposition strategy, a channel strategy and robust sales processes. Finally, operational excellence aligns sales resources, sales force capabilities, motivation, tools, marketing programmes and sales support tools to implement value-based selling vis-à-vis customers. The key feature of this paper is a structured approach blending customer, company and competitor insight (Hinterhuber 2004) to implement value-based selling.
Psychological aspects of pricing
Ben Lowe, Julian Lowe and David Lynch provide a comprehensive overview of behavioural aspects of pricing. Behavioural economics has now definitely entered the mainstream research in management: in a recent special issue in the Strategic Management Journal (Powell at al. 2011), Levinthal (2011) asks the question ‘A behavioural approach to strategy – what’s the alternative?’ Research examining behavioural and psychological aspects of pricing seeks to understand how customer perceptions of value and price are formed. Consequentially, the paper analyses the following salient aspects of behavioural pricing: factors driving customer value perceptions; the role of internal and external reference prices, fairness perceptions in pricing, implications for price reductions (e.g. discounts, coupons, free gifts) and price increases, price endings, price quality perceptions, consumer price knowledge and, finally, price setting in nonmarket contexts. This paper emphasizes that customer willingness to pay is driven by both utilitarian value (‘economic utility’) and psychological value (‘psychological utility’). As pricing and marketing managers gain an improved understanding of factors driving psychological value, their ability to set profitable prices also increases.
Carmen Balan specifically examines research on odd prices. Odd prices (e.g. 99 cents) have a long history: in 1965, the retailer Dave Gold discovers that charging 99 cents for all bottles of wine increases sales of all bottles, including those which previously had cost 89 cents or 79 cents. He exits the liquor business and becomes a highly successful entrepreneur after launching the 99 Cents Only chain of stores (Porter 2011). This paper summarizes current research on odd prices which points out that odd prices lead to increased demand due to both a level effect (i.e. customers underestimate prices) and an image effect (i.e. the product appears to be on sale). Odd prices still seem to work, although most of what we know stems from research in consumer-good markets. This paper suggests both an increased use of odd prices in industrial markets as well as further research examining the effects of odd prices in B2B environments.
The next frontier in pricing
The final paper in this collection is by Kevin Mitchell. This paper highlights the evolution of the pricing profession over the past three decades. Pricing evolved from a clerical position to a tactical, commercial function to, finally, a C-level function deeply aligned with – and in many cases driving – company strategy. The author highlights the reflections of the Professional Pricing Society on critical elements for the future of the pricing function.
As the editors of this book, we have been honoured to work with highly talented pricing practitioners and scholars from around the world. We are blessed by the level of innovative and creative thinking that we have been able to bring to the surface by giving these experts an opportunity to share their thoughts, approaches and views. We thank all authors for their contributions to and participation in this exciting project.
It is our intention to contribute to the future evolution of the pricing profession. We are dedicated to making pricing gain the respect it deserves and to transforming the perceptions of pricing from a pure analytical and static science to a more strategic, innovative and impactful element of the marketing mix. Please join us in our journey to advance the pricing profession.
References
Anderson, J. and Narus, J. (2004). Business market management: Understanding, creating, and delivering value (2nd ed.). Upper Saddle River, NJ: Prentice-Hall.
Hinterhuber, A. (2004). Towards value-based pricing – an integrative framework for decision making. Industrial Marketing Management, 33(8): 765–78.
Hinterhuber, A., and Liozu, S. (2014). Is Innovation in Pricing Your Next Source of Competitive Advantage? Business Horizons, 57(3): 413-23.
Levinthal, D. A. (2011). A behavioral approach to strategy – what’s the alternative? Strategic Management Journal, 32(13): 1517–23.
Liozu, S., & Hinterhuber, A. (2014). The ROI of pricing: measuring the impact and making the business case. New York, NY. : Routledge.
Marting, E. (1968). Foreword. In E. Marting (Ed.), Creative pricing. New York: American Management Association, Inc., pp. 5–6
Oxenfeldt, A. (1968). Introduction: The role of price and pricing reconsidered. In E. Marting (Ed.), Creative pricing. New York: American Management Association, Inc., pp. 9–26.
Porter, E. (2011). The price of everything. London: William Heinemann.
Powell, T. C., Lovallo, D. and Fox, C. R. (2011). Behavioral strategy. Strategic Management Journal, 32(13): 1369–86.
