Pricing: science, voodoo or bingo? How does your organisation do it?

 

Leading thinkers agree that pricing is poorly managed. Advertising guru, David Ogilvy wrote in his book Ogilvy on Advertising that ‘Pricing is guesswork. It is usually assumed that marketers use scientific methods to determine the price of their products. Nothing could be further from the truth.

Added on 05 February 2015 by Tony Cram

Are your prices too low?

Leading thinkers agree that pricing is poorly managed. Advertising guru, David Ogilvy wrote in his book Ogilvy on Advertising that ‘Pricing is guesswork. It is usually assumed that marketers use scientific methods to determine the price of their products. Nothing could be further from the truth.  Harvard Marketing Professor, Robert J Dolan, author of Power Pricing: How managing price transforms the bottom line wrote that, ‘Pricing is the manager’s biggest marketing headache. It’s where they feel the most pressure to perform and the least certain that they are doing a good job’. 

Pricing and marketing consultants, Simon Kucher and Partners state that ‘Price is the number one profit determinant. However, there is no other area in which, due to a lack of systematic analysis, such large profit potentials are left unrealized.’  A 2003 report by the consultants McKinsey & Company suggested that 80 – 90% of poor pricing decisions featured under-pricing. Finally Mark Ritson, London Business School’s assistant professor of marketing pithily summarised the situation: ‘Pricing is the worst managed of all marketing areas. How prices are decided is often a mixture of voodoo and bingo’. 

If it is so important, why isn’t it done better? The start of the challenge is the mass of data.  Each sale of each item, to each customer, each week generates data.  A wholesaler with 100,000 line items and 300,000 customers in different industries with different ordering patterns, would need a supercomputer to analyse the pricing impact of its sales statistics, a bit like drinking from a fire-hydrant.

Added to this is the number of competitors, direct and indirect whose actions may impact on the relative perceptions of customers. A commercial printer investigating firms who may bid for equivalent work could have to consider 40 rivals. 

Another factor in the pricing equation is the margin effect of changing cost prices. There are 17 ingredients listed for a Knorr chicken stock cube and the company will have other costs to consider including labour, property, transport, insurance, packaging, marketing, merchandising and others. 

Internally there are many players in the pricing process. Accounts departments will identify costs; Sales will consider customers; the Marketing department will research consumers and competitors; the Legal department will ensure regulatory compliance; Production and Distribution set supply constraints. Conflicting objectives need resolution when the Finance department view on margin calls for higher prices and the Sales team focus on revenue and share growth points to lower prices.  According to McKinsey consultants, Eugster, Kakkar and Roegner, ‘companies often base prices on the anecdotal evidence of a few vocal sales people or product managers’.

Finally it is hard to set measurable objectives for pricing.  High prices are likely to mean lost sales. Low prices mean margin left on the table. The true measure of pricing is the minimisation of profit foregone through under or over-pricing – not easy to calibrate in a balanced scorecard.

As a result of these challenges many organisations silently delegate pricing decisions to their customers and competitors. They simply react to pressures and opportunities in the market place as they arise.

Is there a better way to manage your prices? 

Learn more in our forthcoming Momentum event, Pricing for Results. How smart is your pricing? on 6 March 2014.

Tony also leads the open programme Marketing Drivers and is the author of Smarter Pricing, how to capture more value in your market, Financial Times Prentice Hall (2006).