Many times when we talk to clients about pricing, they say that they have already worked out pricing because consultant XYZ did a strategic pricing initiative for them.  As we ask questions about what they actually did, we usually uncover that the initiative was really more of a transactional pricing analysis, which for some reason is often called “strategic pricing.” 

In our view, real strategic pricing always starts with a clear understanding of the value you create for customers and how this is different from their alternatives. In our water pipe analogy for value leakage, this is the input – the water pressure at the source, if you will. Fixing leaks in the pipe is great, but you can never get more than what you started with, which is why we are so adamant about the starting point being the customer value that you create.

That is why we find it very ironic that the most tactical part of pricing is what is often referred to as “strategic pricing.” We would call transactional pricing Price Discipline, and it is the one place in our value pricing framework where value isn’t really taken into account.  This is the final step where you are attempting to eek out the last couple of percent of price.  While it is last in our framework, it is where many companies start their pricing efforts, so let’s explore it a bit deeper.

Price Discipline

The first, and often easiest area to stop value leakage is ensuring that you have price discipline within your organization.  Is your sales team unnecessarily discounting, or giving customers volume discounts even when the volume commitments weren’t hit?  Are you providing warranty or other service beyond what is necessary?

Now we have done our share of transactional pricing work and the results are almost always positive. Even though these efforts are not necessarily grounded in customer value, there are several reasons why they work:

• Companies are often reluctant to raise prices and may need a push to motivate them. We have to laugh when we hear “we raised prices and didn’t lose a customer” – this doesn’t mean you are now value pricing, it just means that your prices are probably still too low!
• Nearly everything is price inelastic in the short term – raising prices 2-3 percent is rarely enough to get your customers to search for alternatives, especially if you are not a major component of their cost structure. However, this too is not value pricing and may backfire in the long run when your customers do evaluate their options.
• Pricing and discount structures tend to get more complicated over time and almost certainly contain anomalies – we remember one client where we discovered that average discounts across regions were correlated with the average tenure of the sales rep – yes, the longer a rep had been in a region, the lower their relative prices.

So, while good transactional pricing analysis almost always produces some short-term gains, it is not a substitute for value pricing. Value pricing is always grounded in the economic value of your offering to the customer. This requires a clear understanding of your differentiation and an objective perspective on how customers value that difference.

Nor is price discipline the only type of value leakage. Let’s explore the other areas of value leakage from continuing to work from right to left.

Value Selling

Imagine walking into a Mercedes dealership to buy a car. You look at different models, test drive one or two, and evaluate available options. After deciding which model and specific features you’re interested in, the sales rep comes back with a price.

At this point, you pull out a Hyundai ad and tell the rep you can go down the street and get this car for half the price. Do you think the dealership will negotiate with you on price? Absolutely not! They will tell you to go talk to the Hyundai dealer. Why? Because they know that the next best alternative for their target customers is not Hyundai, and that you are wasting their time.

In B2B sales, understanding your differentiation and demonstrating how that creates value for your target customers is crucial.  This requires clear segmentation communicated to your sales team and often value selling tools to help them highlight the value created to prospective customers and prevent them from falling back into bad habits like negotiating against the wrong alternative.

Value Sharing

This brings us to the only area of value leakage that is necessary.  In order to motivate your customer you must share some of the value you create.  Value sharing may also be required with channel partners along the value chain. The amount of value that you share vs. the amount that you capture is the art of value pricing.  We explore value pricing in many other posts and aren’t going to go deeper here.  It requires long term insights into both customers and competitors to anticipate their range of responses.

Value Understanding

This is usually the biggest leakage point because it is the most difficult to overcome.  In fact, it is more like untapped pools of water that never make it into the pipe in the first place. As we’ve said elsewhere, developing an informed understanding of customer value requires deep insight into your customers, or as we like to say “becoming a student of your customer.” Also, since value is always relative to the customer’s next best alternative, you must also have a deep and realistic understanding of the competitive alternatives.  If you don’t know how much value you create, you can’t hope to capture any of it.

Conclusion

Remember, your ultimate goal is value capture.  The only way to optimize your value capture is to first stop the value leakage by not understanding value, not selling the value you create, and not maintaining price discipline. 

What is often referred to as strategic pricing, is really more focused on enforcing pricing discipline through an analysis of transactional pricing.  Although this analysis can deliver some significant bottom line results, it is not likely to fix all of the areas you are leaking value.  You need to start with a strong understanding of the value your offering creates, price to that value, and train your sales team to sell based on that value to optimize your total value capture.  We are on a mission to stamp out the improper use of “strategic pricing” when really referring to transactional pricing.  The only real way to stop price leakage is Value Pricing, which is therefore the only real Strategic Pricing!