Working out how much to charge for a company's products or services is one of the most basic management decisions there is. Or so you might have thought. In fact, pricing decisions are often pushed to the margin of management activity. And when they are thought about, prices often emerge as a result of what London Business School academic Mark Ritson has called a 'mixture of voodoo and bingo'.
Worse still, accountants are too often on the outside of the decision-making loop in their companies. New research has shown finance professionals are ‘very involved’ in pricing decisions in only 30% of companies. That puts them well behind sales managers (on 60%) and marketing directors on 49%. In fact, in 31% of companies finance is not involved at all or only marginally involved.
These disturbing statistics emerge from a new Chartered Institute of Marketing report called Pricing for Profit – the Critical Success Factors.
Report author Colin Coulson-Thomas, the UK’s first-ever professor of competitiveness, is head of the Centre for Competitiveness at the University of Luton.
Coulson-Thomas straddles the marketing and accountancy worlds so can see both sides of the issue. He ran CIMA’s international marketing programme but is also an FCA and FCCA.
He says: ‘It’s quite right that marketing and sales should be heavily involved in pricing decisions. After all, they’re at the sharp end dealing with customers. But finance professionals have more to bring to the party than they’re contributing at the moment. The pay-off from improved pricing is a healthier bottom-line.’
Accountants in practice ought to be paying attention to this, too. Often their contribution is to advise clients on price-setting and product margins, sometimes the result of a bit of management accountancy work and sticking a wet finger in the air. A broader grasp of the strategy and tactics of pricing could enrich the quality of the advice, not to mention generating opportunities for extra fee income.
In the worst cases, there are real financial dangers in letting sales types hijack pricing. For example, sales people will always find a reason to offer a discount if they think it will win an order. But unauthorised discounting, rife in many companies, can nibble away at margins and deliver an unexpectedly painful hit to the bottom-line at results time.
What’s often bedeviled discussions about pricing in the past is the dearth of information about how companies take decisions. Most firms play their pricing cards close to their chests, sometimes because of commercial confidentiality, sometimes because they’re not sure what’s going on.
Coulson-Thomas persuaded 73 companies to provide data on 127 factors which could affect pricing decisions. He correlated this data against a measure of how effective the companies are at using pricing policies to achieve their broader business objectives, such as growing market share or improving profitability. He then compared the most successful companies at using pricing management to achieve business objectives (the leaders) with the least successful (the laggards). The result: a detailed statistical picture of what matters in pricing.
For many companies, pricing decisions are a seat-of-the-pants affair.
There is a generally low take-up of the analytical tools and techniques an accountant would expect to use in making financial decisions. The most extensively used technique was ‘face-to-face’ research. Says Coulson-Thomas: ‘This could mean methodologically robust surveying in some firms but in others, no more than relying on anecdotal evidence.’
What is especially striking here – as in other parts of the research – is the gap between the leader and laggard companies (figure 1). Leaders make more extensive use of all nine of the tools and techniques. With those that can make a real contribution to pricing decisions, the leaders are far ahead.
For example, 37% of leaders make ‘very extensive’ use of competitor analysis but only 17% of laggards. Similarly, 30% of leaders are heavy users of activity-based costing for pricing management but only 16% of laggards. Leaders outstrip laggards by something like two to one in their use of break-even analysis, economic value analysis and price sensitivity measurement.
Coulson-Thomas says: ‘This clearly suggests companies which are most successful with pricing decisions use an evidence-based approach to give reliable insights into what’s happening in the marketplace and factors which are important when fixing prices.’
His point is that while gut-feeling for the price a market may bear is useful, it has serious limitation for more complex decisions. He says: ‘A manager may instinctively feel products should be priced as a line rather than individually. But it may still be necessary to calculate whether the increase in profit overall will more than cover reductions in profit on individual products within the line and the costs of implementing a line-pricing strategy.’
But lest it look as though pricing is little more than the technical matter of manipulating a few tools and techniques to get the right answers, it’s important to recall that pricing policy has a growing propensity to blow up in your face. In the last couple of years car prices have featured in ‘rip-off’ Britain tabloid news stories, small business bank account charges have been condemned as part of ‘complex monopoly’, and petrol prices triggered a nationwide revolt which threatened to bring down the government.
Says Coulson-Thomas: ‘All are timely reminders that pricing is a management decision which can derail a whole business strategy.’ This makes it more important for each company to have a clearer view of what’s driving its own prices. The research identified two sets of drivers – price and cost.
There are three price drivers that are more important than others. These are selling on value as opposed to price, segmenting your marketplace (and applying separate pricing strategies to each) and taking a long-term price management view.
This last may involve using tactics such as ‘penetration pricing’ to enter a new market or ‘pre-emptive pricing’ to protect market share.
Coulson-Thomas found leader companies generally ahead of laggards on selling on value and on market segmentation pricing. The laggards did more of the long-term pricing but this often proved to be little more than perpetual price-cutting to defend market share, rather than a strategic programme to build a market with improved margins.
But it was when he turned to the cost drivers of pricing that Coulson-Thomas found truly startling differences between leaders and laggards (figure 2). The leaders are about five times more likely than laggards to have a business strategy which focuses on increasing volume to improve economies of scale. By contrast, laggards are more likely than leaders to focus on product costs in order to gain the flexibility to cut prices.
Says Coulson-Thomas: ‘The leaders seem to have a different psychology from the laggards to building markets for their goods. They focus on customer segments, differentiate products to serve them, pay attention to quality and deliver on customer care. This costs money, but they see it as a way of reducing unit cost and delivers the economies of scale which lead to competitive prices and market leadership.’
Significantly too, the leaders are more likely to use realistic cost allocation methodologies, such as activity-based costing, when they take pricing decisions. Some 62% of leaders ranked this either ‘very important’ or ‘important’ compared with just 23% of laggards.
‘Confident – and profitable – pricing depends on knowing direct and indirect costs attributable to a particular product or service,’ says Coulson-Thomas. ‘It’s not surprising leader companies take better pricing decisions when they are more likely to have this information at their fingertips.’
He believes a key theme which comes through from the research is that companies need to be more aware of trends and developments in the business environment and customer buying centres that impact on prices. ‘It may be worth establishing a formal price issue monitoring and management system to track the various factors influencing pricing decisions. That makes it easier to assess their likely impacts and determine what should be done in response.’
In most cases, prices won’t become the kind of national issue that happened with cars, businessbanking and petrol. But with consumers more militant, Coulson-Thomas warns there could be more price hotspots. ‘Keep a watch on what people feel about prices in your company and industry and respond,’ he says.
If such joined-up thinking will happen in pricing management, companies will need to take a look at who is, or should be, involved. In many cases, they will find pricing handled in a fragmented and uncoordinated way. There is not necessarily a case for centralising pricing – in a multinational, for example, only decentralised decision-making is flexible enough to respond to local markets.
But a company needs a clear pricing management process – Coulson-Thomas sketches out the questions to ask when creating one in his report.
It will also mean that finance professionals playing a more involved role in pricing decisions alongside marketing and sales colleagues. Pricing will not contribute more to fulfilling strategy unless the accountant and the marketer, like the farmer and cowboy, can be friends.
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