Getting the Price Right: What
Gets in The Way?
Management Professor Joe Urbany
the TV show, "The Price Is Right," contestants guess
the sticker prices of a variety of products. Today, companies
play a different kind of pricing game. Their challenge is to
price their goods and services low enough to promote sales and
high enough to protect-or increase-profits. Yet many firms get
their prices wrong.
Why do companies
often err in making pricing decisions? There are
many reasons (particularly related to lack of information),
have received limited attention. The first is force of habit.
Managers get used to making decisions the way the company has
made decisions. They always mark up X% below their competitors.
clear-cut rules are easy to use because they are organizationally
supported and protect managers from having to make riskier judgment
calls that could wind up hurting their careers. But they may
lead to the most profitable results.
reason companies make bad pricing decisions is that it is
hard to predict competitors' reactions. Instead, they act on
intuitive belief that short-term, aggressive pricing will increase
their market share and lead to longer-term profits. Often the
opposite occurs. When a company cuts prices, competitors often
follow suit. That makes customers increasingly price sensitive,
margins continue to erode.
It is not
surprising that many firms shy away from riskier pricing
strategies and stick with the tried-and-true. Organizations
focus more directly on competitive reactions and incremental
That Get It Right
illustrate how companies can improve their pricing by changing
In the mid-1990s, Ford Motor Company began to conduct consumer
research to understand demand at different price points. It
also asked customers to describe product features they valued,
but that manufacturers had been slow to deliver.
this new information, decision makers experimented in
five sales regions with a revamped pricing strategy. They lowered
the price on higher-margin cars such as the Crown Victoria and
Explorer, which boosted sales in the category by 600,000 cars.
for lower-end vehicles like the Escort and the Aspire, they
prices. The net effect? Unit sales in these regions dropped
420,000 and market share dropped nearly two points from 1995
1999, but total earnings shot up. In fact, the experimental
policy netted profits that exceeded regional targets by $1 billion.
In the slow moving, paper binding industry, customers tend to
relentlessly hound sales reps for discounts. As a result, Booklet
Binding, Inc. (BBI) found that, despite its growing sales, profits
remained flat. Rather than taking more obvious measures such
as raising prices or downsizing, BBI invested in sales training
and a new information program. In effect, that changed the rules
of the game. Salespeople received information about each customer's
annual sales patterns so they could help them place orders in
advance, thereby enhancing customer service. BBI also trained
its sales force to do cross-selling and to promote higher-margin,
value-added products. The result? Sales rocketed to $23 million
in 1996, compared to $9 million just two years earlier. Pre-tax
margins were twice the industry average.
An industrial products firm faced aggressive competition from
a new entrant. Rather than making the obvious choice-cutting
prices to protect market share-the company took an uncommon
tack: in the low-growth, commodity segment of its market, the
firm raised prices, a move that succeeded in discouraging the
new competitor from entering with low prices. In the remaining
two segments, the company added faster service and guaranteed
supply-features that redefined its competitive positioning to
emphasize quality rather than price.
Companies Can Do
report suggests a variety of tactics that companies should consider
to help focus greater attention on profitability as a decision
top management commitment. To change the way managers
make pricing decisions, leaders need to reinforce principles
such as valuing profitability over market share and calculated
risk taking over reactive price cutting.
data and feedback to improve decision-making. When
price, cost and demand data are linked together in the same
information system, managers can predict margins and profits
more accurately. Good customer data lets them understand customer
price sensitivities and the product features they value. And
information about competitor behavior helps them predict likely
reactions, rather than simply matching their rivals pricing
decisions after the fact.
letting some customers go. It may be more profitable,
in the long run, to let some customers slip away and to focus
instead on less price-sensitive segments.
the sales force. By training sales people to promote
high-margin offerings and then rewarding them for doing so,
companies like Ford have enhanced overall profitability.
adaptive thinking skills. To overcome deeply ingrained
habits-for example, the tendency to cut prices and hope for
the best-companies need to educate decision-makers to think
differently about the pricing game. Simulation training can
help them see pricing's long-term impacts on customers' and
competitors' behavior. Managers should also be encouraged to
make "vaguely right" decisions, watch what happens
as a result, and then make necessary course corrections.
customers' perceptions. Customers who understand the
rationale for pricing changes are less likely to object. Companies
may also manage the pricing issue by reducing its importance.
For example, rather than nickel-and-diming against competitors,
they can shift the focus away from price by emphasizing customers'
needs and how they will be met.
there is no one-size-fits-all pricing strategy. But by factoring
in competitors' likely reactions and incremental profitability
their decision-making process, companies can move beyond educated
boost long-term profits.
Urbany is Professor of Marketing and Associate Dean of Graduate
Programs at Notre Dame's Mendoza College of Business. This article
is excerpted from "Justifying Profitable Pricing,"
published in the Marketing Science Institute's working paper