Price optimization – The role of modern methods for market success
by Frank Frohmann
Update May 2020:
Never before in economic history has it been so important for companies in all industries to be able to flexibly adapt to customer requirements. The corona epidemic is bringing price optimization even more into focus than ever before.
The prerequisite for securing cash flow, exploiting profit potential and at the same time retaining customers in the long term is the use of innovative methods for price optimization. These methods are described in the following article and demonstrated with best practice examples. The introductory article refers to the launch of a less expensive alternative,- using Apple’s iPhone as an example. The expansion of the price-performance offer outlined there is currently one of the most discussed news items in the business media: the introduction of the Apple iPhone SE.
In this series the article on “Digital Pricing: The role of price management in the digital transformation” has already been published.
Furthermore, articles are planned on the topics of “price models for subscription and pay-per-use use cases” and “price psychology”.
Key take aways for price optimization:
1. All successful pricing strategies are based on a clear focus on customer requirements. Problems are inevitable where price acceptance and customer feedback are ignored.
2. A recent example of a temporary neglect of customer feedback is Apple. With its iPhone, Apple was a prime example of outstanding “pricing power” over a period of about 10 years. However, it was recognized too late that the luxury prices of the iPhone were subject to increasing resistance from customers with each higher-priced product generation.
3. With the model series (XS Max, XS and XR), which was introduced in September 2018, the company went overboard from the customer’s point of view.
4. Only a few months later, business media diagnosed a “landslide slump in sales figures”. They spoke of “collapsing sales”. After many successful years, Apple’s extremely high pricing power had suffered a setback in the meantime. At that time my book “Digital Pricing” had been on the market for a few months. It contained a short case study, whose assessment of the planned model series was confirmed by the market reality.
5. The use of innovative methods of price optimization (“social listening”, “voice of customer” analytics) would have made it possible to recognize the massive level of customer disapproval of the price-performance ratio at an early stage. “Weak signals” became increasingly loud in the course of 2017 and 2018. Software from companies such as SAP (Qualtrics) is available for the structured analysis of customer feedback.
6. Apple, however, learned quickly from the setback and steered against it. Countermeasures include offering new product versions that serve price-sensitive customer segments. The price structure of the iPhone 11 (end of 2019) also shows that the company has learned from the massive criticism. With this, Apple proves (as other “pricing champions” (Amazon, Microsoft, Sixt and many others before them): A major core competence in pricing is the fast reaction to changing market conditions! The current macroeconomic conditions (threatening pandemic; significantly reduced business expectations) further increase the importance of agility.
Introduction: “7C” of pricing
Every pricing measure and price optimization must include at least seven essential pieces of information.
These can be symbolised by the “7C” of pricing. Essentially, the following questions are at the heart of the matter:
- „Customer“: What are the consumers willing to pay? How high are the price elasticities of customers for our products?
- „Competition“: At what prices are our competitors selling? How will the competitors react to our measures?
- „Costs“: What are our costs made up of?
- „Capacity“: What is the capacity situation in the industry? How high is the degree of utilization of our production and service capacities?
- „Cycle stage“: At which stage of the product life cycle is our offer?
- „Company targets“: What is our strategy? What goals are we pursuing?
- „Compliance“: What is the legal framework for pricing in our industry?
The customer is factor no. 1 in price optimization
Among the 7 influencing factors, the “customer” has by far the highest relevance! Only with the knowledge of the customers’ willingness to pay is it possible to make sound pricing decisions. There are countless examples of companies that have failed with prices that are too high or too low. As a consequence, “pricing failure” comprises numerous aspects: long-term market exit, failure to meet sales and profit targets, massive customer reaction, long-term damage to the company’s image etc.
Microsoft lost 4 billion dollars with its X-Box between 2002 (market launch) and 2006. The root of the problem: too high a starting price compared to Sony. All subsequent price reductions (from 479 € to 99 € most recently) couldn’t compensate for the wrong positioning in terms of “price-performance”.
Apple case study
– Situation –
Apple’s iPhone has long been a prime example of successful pricing. The success story in keywords:
– Introduction of the smartphone in the US in June 2007.
– 2 versions at launch (4 GB and 8 GB).
– Introductory price of the higher level version: $599
– Continuous improvement of the product portfolio
1. The average price of the iphone was $765 in 2018.
2. The smartphone achieved a share of up to 75 % of consolidated net income.
3. The development of average prices was not linear but progressive. From 2017 to 2018 alone, the average selling price rose by 20 %.
From the company’s point of view, this is an enormous success with regard to goals such as margin, sales and profit (“company targets”). However, from the customer’s point of view (“Customer”) it is a sword of Damocles. The purchasing behaviour of Apple customers changed over time, partly due to a change in the influencing factors outlined above:
a) Increasing maturity of the smartphone market (“cycle stage”)
b) Increased competition (“Competition”) and
c) Overcapacity in the market („Capacity“).
The overly strong focus on profit as a company target increasingly proved to be a risk for Apple’s long-term market success.
– Analysis –
In 2017 and 2018, it became clear that Apple was forcing its high price policy at the expense of market share and customer satisfaction. In emerging markets such as India, the market share fell dramatically. This development was ignored by experts for a long time. In my book “Digital Pricing” I described the increasing imbalance. The starting point was a market survey using methods such as “price sensitivity measurement”, “expert estimation” and “value driver analysis”. The insights of the methods were integrated. The “Value-Price-Map” shows a clear picture: Most smartphone users perceived the relationship between the benefits offered (vertical dimension) and the price demanded (horizontal axis) as not balanced in the case of Apple. This analysis was carried out in 2018 shortly before the launch of the new series, which experienced the described decline.
In September 2018 Apple introduced 3 new versions of the iPhone: The premium version XS Max (512 GB memory) at a luxury price of 1.649 €. Within a few months Apple had to face significant declines in sales and profits. The year-on-year decline in sales at the turn of 2018/2019 was 30 percent. In the business media, terms such as “moon prices”, “irrational pricing policy”, “absurd high-price doctrine”, “price gouging”, “dictate of profit maximization”, “aloof pricing policy” were used in reference to Apple. In its 1/2019 issue, Manager Magazin chose the term “falling fruit”. About half a year after my case study, the public perception and evaluation of Apple’s pricing took a major turn. Experts particularly criticized that Apple was reluctant to bring a low priced entry-level device onto the market.
– Further development since the beginning of 2019 –
The good news is that Apple has learned from its misalignment. After two quarters of decline in the first half of 2019, Group CEO Tim Cook regretfully admitted to mistakes in the first half of the year. At the beginning of 2020 there is talk of introducing a more affordable version. Apple’s advance into the low-price segment is based essentially on the painful realization that the high-priced smartphones deterred some of Apple’s customer groups. Case studies of successful “less expensive alternatives” can be found in numerous industries.
Methods of price optimization
After this introductory article I will present the most important methods of price optimization in detail in the following series. The series will be continued here shortly!
I will illustrate which methods can be used in which decision-making situations. A special focus lies on the case-specific combination of methods.
The profit potentials of professional pricing described at the beginning of the series depend directly on the application of the pricing methods. Without method support, the data basis for “pricing excellence” is missing – those responsible for pricing are then simply flying blind!
Whitepaper “Digital Transformation and Pricing” by Frank Frohmann
When Frank Frohmann’s book “Digital Pricing” was published by Springer Gabler in September 2018, it generated great interest, not only in the German-speaking market. Before an extended English edition is published, the gap will be closed with this white paper, which describes essential aspects of digital price management.
Digital Transformation and Pricing
About Frank Frohmann:
Frank Frohmann has already been engaged with questions of digitalization in projects for B2C and B2B companies at the end of the 90s. His comprehensive wealth of experience with digitization strategies and price optimization is based on three main fields of activity: External management consulting (Simon-Kucher & Partners; since 1996), operational price management (Lufthansa; cargo and passenger) and in-house consulting (Bosch and Evonik, among others). His book “Digitales Pricing” (only available in German) was published by Springer Verlag in September 2018.
Frohmann has been working as Business Development Manager Pricing at Vistex GmbH since September 2019.
Vistex Inc. was founded in 1999 and has its headquarters in Hoffman Estates, USA. As a Global Solution Extensions Partner of SAP SE, the company offers SAP-based IT solutions with specialization for the automotive, chemical, consumer goods, food, high-tech, manufacturing and pharmaceutical industries, as well as retail and wholesale, especially in the go-to-market sector.
At the Subscription Leaders Summit in October 2019 in Frankfurt, more than 120 participants met to discuss the future of the subscription business in six keynotes, three panels and six deep dive sessions. Frank Frohmann led the Deep Dive Session on the topic of “Pricing”.
The video shows the highlights of the event.