Pricing is one of the most important levers your organization has, therefore pricing decisions are some of the most important it will make. Set the price too high, and you won’t sell anything. Worse yet, set the price too low and you are leaving money on the table.
That leads to the question, what department or function within your organization is in the best position to set the price in order to maximize earnings? Over the years, we have heard a lot of strong opinions. Some (usually salespeople) say that since sales is closest to customers that they should be in charge of price. Others believe that operations or finance should control prices because they have the best understanding of the cost of the offering. We have even seen companies establish an independent pricing group that reports outside the day-to-day operations, in one case, even reporting to legal!
We are going to make the case that pricing should almost always be owned by strategic marketing.
Why Shouldn’t Sales Own Pricing?
Although sales has more actual interaction with customers and is likely to have first-hand knowledge of competitive offerings and price in their area, there are several reasons that sales should not have ultimate price authority. That is not to say that sales shouldn’t be given some price discretion, within a set of bounds, but that the price framework and the discounting rules should be maintained elsewhere.
A big reason, but not necessarily the most important reason, is that historically most salespeople are compensated based on sales revenue. Knowing that lower prices can 1) attract more customers and 2) help overcome customer objections, sales has a natural incentive to lower prices. Even if a company has made a shift to compensating sales on margin or profitability, salespeople will tend to price too low. This is due to a built-in asymmetry in incentives: price too low, and they get a slightly lower commission, price too high and they get nothing. But incentives aside, there is an additional problem with sales owning pricing.
Salespeople only have insight into their target customers or what’s happening in their particular territory or region. What is true for them does not necessarily hold true for other markets, other territories, or the competitive situations of their colleagues. As mentioned earlier, sales should often be allowed some price discretion so they can respond to local market conditions. But that leeway should be limited, because individual pricing decisions can sub-optimize pricing on the aggregate, which can damage overall profitability for the company.
What Happens if Operations or Finance Own Pricing?
The primary point of reference for both operations and finance is cost. This inherently leads to the price being set based on CoGS, or at best total cost to serve. As we have discussed before, price should always be based on value and not based on cost.
True, cost is one input to pricing – specifically, you should never price below your cost because you can’t make it up in volume. But pricing based on target margins over cost is using an internal reference point that is completely unrelated to customer value.
Sometimes organizations will use external sources and 3rd parties to evaluate competitive pricing in the market and set prices based on those sources. Although this market-based pricing is one step better than cost-based pricing, it still doesn’t take into account differentiation and value delivered. Often, relying on pricing gurus is putting a band-aid on the underlying issue – no one else can be trusted to set prices because they lack the information, tools or incentives.
Why Marketing Should Own Pricing?
Strategic marketing is about understanding customer needs and value at each step in the value chain and using this understanding to build and maintain differentiation that allows us to capture more value in our target segments. Pricing to maximize earnings over the life of an offering is an integral part of this function. An effective strategic marketing team should have all the elements to set the price based on value:
- Market understanding of customer needs
- The customer’s next best alternative (think competitors)
- Your offering’s differentiation relative to that next best alternative
- The value created by that differentiation
- Groups of customers that have similar sets of needs (segments)
- The total cost to serve each segment of customers
- The potential impact that the price of this offering could have on other offerings
Marketing, when done properly, is in the best position to set the optimal price for each segment of customers. Obviously, they shouldn’t do this in a vacuum. They should rely on input from sales, operations, and finance to ensure that they have the most accurate picture of the situation, but marketing should almost always be the owner of pricing.
Setting your optimal price means that you are maximizing the total lifetime profitability for the offering. That means you have delivered adequate value to your customer while capturing enough value to be profitable and continue to invest. But importantly, it does not mean maximizing price on each individual transaction.
We find that, all too often, when someone other than marketing owns pricing, it is a sign that there is a gap in strategic marketing capabilities. If your marketing team is consumed with the activities of marketing and not driving pricing decisions, it may be time to investing in building a strategic marketing capability. In the words of one of our customers, “marketing is more than marketing.”