The right pricing strategy
The right pricing strategy is a key success factor for any company and should therefore be given high priority. In previous articles we have already dealt with digital pricing in general, “Price optimization with the 7Cs of pricing” and in detail with “Optimal pricing – The best methods for the pricing process” and “Price determination – methods for optimal pricing decisions”. In order to find the right pricing strategy, it is important to determine and combine the appropriate methods depending on the specific case. With the value driver analysis, this article focuses on an innovative method for finding the right pricing strategy.
The best methods for the right pricing strategy
The decision on the appropriate methods and combination depends on these criteria:
1. the status of the offer
(a) Product idea in pre-development stage
(b) Already developed offer?
(c) Product launched on the market?
2. the budget
3. the time available
4. the impact on market transparency
5. the structure of the customers (number, regional distribution, distribution of sales and profits)
6. methodological competence
In more than 300 pricing projects by our guest author and pricing strategy expert Frank Frohmann, survey-based methods (conjoint measurement and direct price queries using an adapted price sensitivity meter) have proven their worth.
Price elasticity estimates based on an internal workshop are always recommended by the author for cross-validation as a addition to customer surveys!
A combination of the adapted price sensitivity meter method with conjoint measurement and expert estimation for the company’s most important focus products is a logical step. Expert workshops can be significantly expanded in the future through the potential of artificial intelligence.
Innovative methods: value driver analysis and price value map
The following description of the value driver analysis approach combines tasks of pricing strategy and optimization in a logical-stringent approach. A variety of methods of strategic pricing (competitive advantage matrix, target prioritization, etc.) and price optimization (price sensitivity measurement, expert estimation, conjoint measurement, etc.) are combined depending on the initial situation. The combination is based on all six criteria outlined above.
The following section shows how the optimal price-benefit ratio can be derived methodically. “Optimal” comprises the best possible compromise from the customer and company perspective. It involves the two dimensions “value-to-customer” (added value) and price (value skimming; monetization).
Evaluation of the benefit-price positioning
The aim is to systematically evaluate one’s own benefit-price positioning in the first step: from the customer’s point of view and in comparison with competitors. In the second step, an optimal product positioning is derived by integrating customer requirements, competitor offers and willingness to pay.
For this purpose, one combines one’s own position in customer perception with the logic of price optimization already outlined. Value drivers are at the core of benefit-price optimization. “Value drivers” are all purchase factors relevant for the customer. They influence the decision for a vendor and the price the customer will pay. These purchasing criteria go far beyond product performance. They also result from accompanying services (such as customer service), the brand, the packaging or intangible values. The starting point for discussing value drivers with customers is their need respectively the problem to be solved.
Value criteria for product and price optimization
The following characteristics of value criteria are relevant for product and price optimization in your pricing strategy. Value drivers are
1. subjective -> the perception of the customer is key
2. relative -> the relevance always results from the comparison to the competitors
3. segment-specific -> the weighting of the value drivers varies considerably across different price dimensions, e.g. regions, customer segments or sales channels
4. dynamic -> the meaning can vary greatly over time
The combination of individual value drivers, their relative importance and their influence on various competitors determines the perceived performance of the company in a competitive comparison. The target positioning of the company’s own products is derived from the perception of the value drivers by customers.
From the four characteristics of value drivers, the following requirements for companies result from a methodological perspective:
Value drivers have to:
1. be discussed together with customers
2. be screened against important active competitors and potential new competitors
3. be assessed in a differentiated manner with regard to their consequences for segments (target groups, regions, distribution channels, etc.)
4. be constantly questioned
Phases of the value driver analysis
The individual phases of a value driver analysis are described in the following as a project outline. The starting point is the analysis of the perception of products from the customer’s perspective. Three constellations can be distinguished:
- Product ideas before the research and development phase
- Products that have already been developed and are about to be launched on the market
- Products already introduced to the market
The individual phases of a value driver analysis are described below:
Step 1: Survey design:
- Customers (Which customers should be interviewed? Which functional units are included in the case of business customers)
- Product (To which offer does the survey refer?)
- Competition (Which competitors are included in the comparison of performance?)
- Other price dimensions (Which regions and sales channels do we want to include? Which time horizon do we use as a basis?)
Step 2: Data collection:
Evaluation by customers in individual interviews. In B2B industries, multi-person interviews in the context of a buying center are particularly efficient. Customer evaluation refers to two dimensions:
- Importance of all value drivers: Interval scale: 1 (“no relevance”) to 9 (“very important”). The importance of the price is also recorded on a scale from 1 to 9. The result of the price-related importance query serves as an initial indication of the customer’s price sensitivity.
- Perceived benefit: Interval scale: 1 (very poor) to 9 (very good) for the own company and all relevant competitors.
Parallel to the customer interviews, experts from sales, application technology, customer service, etc. should also be interviewed to assess the value drivers from the customers’ perspective. It is very helpful to analyze whether the management’s self-assessment (internal perspective) matches the perception of the customers (external perspective).
Step 3: Creation of the competitive advantage matrix:
Objective: Visualization of the market position of the product in a competitive comparison.
Step 4: Derivation of the benefit-price portfolio (“Value Price Map”):
The competitive advantage matrix is only an intermediate stage in the integrated method of value-based pricing. The trade-off between price and performance is of decisive importance. This is made methodically transparent. For this purpose, the price must be conceptually separated from the value drivers. This separation is done both numerically and graphically. The aim is to derive a price dimension and a benefit dimension.
The perceived price-performance ratio compared to all major competitors can be derived with the help of the benefit-price portfolio (Frohmann 2008b, 2014b). The aim is to consolidate the perceived relative benefit-price positioning. The total benefit of all competitors is shown on the vertical axis. Mathematically, the total benefit results from the sum of the importance multiplied by the perceived performance across all value drivers. The price positioning of all competitors is visualized on the horizontal axis. The special advantage of the portfolio is the structured presentation of the two decisive dimensions of pricing in a perception map: “value generation” (customer benefit) and “value extraction” (price).
Step 5: Detailed analysis of the benefit-price positions of all competitors:
The core of strategic pricing considerations in the context of pricing strategy is the concurrent consideration of price and perceived performance of one’s own offers relative to those of the competition. It is about positioning in terms of relative price and relative performance. The critical assumptions are as follows:
a) the price should be in a certain proportion to the benefit
b) In each product category there is a highly competitive area in terms of price and benefit. Here, significant price or product changes by one competitor lead to effects on all other competitors. This delimitable benefit-price framework is called the competition radius.
c) The positioning of the company within the competitive radius determines its exploitation of the market potential. The author’s projects have shown a high correlation between the two target values, especially in B2B industries. Whenever possible, the relative price-performance perception and the relative market share should be considered in the overall context.
Analysis of the differences in benefits
The origins of the differences in benefits between the individual companies must be analysed in detail. The relevant issues in this context include:
- Why is our position better or worse?
- How can we improve our positioning most from the customer’s perspective?
- Is there potential – with a view not least to costs – to reduce services sensibly?
- What results from all these findings for our target price positioning?
a) The analysis must necessarily be segment-specific. Regional, customer group-specific or channel-specific details shall be recorded.
b) The price willingness of end customers and sales agents is influenced by different characteristics. Where requirements and price willingness differ significantly, market cultivation must also be differentiated.
c) The relative price situation and the relative performance in relation to the competition must be optimised. A long-term, dynamic approach is crucial for market success.
d) For offers not yet introduced to the market – or for product ideas before the development phase – no price is as yet available. In these cases, the starting point for portfolio positioning on the price axis must be determined. Competitors must be positioned on the horizontal dimension in terms of price. The core of integrated value-based pricing is the subsequent case-specific integration of the results of price optimization methods into value driver analysis.
In the steps 6 and 7, the starting point of the portfolio is determined on the price axis (abscissa).
Step 6: Integration of market research data on price acceptance (adapted PSM method):
First the optimal price is calculated on the basis of the adapted PSM method.
Step 7: Inclusion of the optimal price based on an expert estimate:
The aim is to cross-validate the results of the customer survey through an internal expert workshop.
The starting price – as the starting point for the further analysis steps – is determined by an overall optimization within the framework of the adapted PSM method and the expert estimate.
Step 8: Optimization of the benefit-price portfolio:
In this phase, scenarios for portfolio optimization are derived. The focus is on possible adjustments to the price-benefit position. The essential information basis for this is:
1. the additional customer benefit for performance improvements (e.g. a reduction of the delivery time from three weeks to two weeks)
2. the internal costs for possible variations of the value drivers
There are two main options in the event of unfavourable positioning:
a) Lower the price of the product while maintaining constant performance.
b) Improve the value positioning while keeping the price unchanged.
To determine the exact extent of the adjustment, the trade-off between performance and price is relevant from the customer’s point of view. This requires a focus on the value drivers that are particularly important for the customer. The maxim is: Differentiation from the competition should be made on the value drivers that are of paramount importance to the customer. When determining the target positioning, it is imperative that the overriding specifications of the strategy (product, product line, business unit strategy) and the business model are taken into account. The target positioning does not necessarily have to be geared to profit as a target. Other possible guidelines for determining the optimum price are maximizing sales or achieving a minimum quantity or a target market share. Particularly in digitized industries, the price-performance perceptions for products introduced to the market must be checked regularly. In certain constellations, companies choose a target positioning that combines a relatively low price with a high relative performance. When entering digitized markets or in the course of expanding existing market shares, a particularly attractive price/performance ratio can make strategic sense.
Summary: Objectives of value driver analysis for the development of the right pricing strategy
The overall objectives of value driver analysis can be described as follows:
1. Integration and standardisation: Methods for measuring benefits (e.g. competitive advantage matrix) and price optimisation (e.g. adapted PSM method; expert estimation) are linked in a contextually logical sequence. Benefit data and price acceptance are stored in a decision support tool without media discontinuities.
2. Flexible use of methods: Methods and analyses are tailored to the specifics and restrictions of individual product categories and industries. Among the most important framework conditions are: Financial resources; time budget; product status; access to customers.
3. Cross-validation: Combined use of methods to increase the validity of results. The strong focus on price – as a disadvantage of isolated price queries – is eliminated. For example, the adapted PSM method is linked to a discussion of benefits. Price acceptance can be measured for different product constellations. Benefit and price are considered as a whole by combining the methods.
4. Extension of the results: The results are to be used efficiently in upstream and downstream processes. The analysis of the benefit-price positioning of relevant competitors can be used as input for strategic scenarios. The competitive strength index is one of the most important input data for pricing strategy derivation.
In addition, to derive the price models of a company, the input data of the value driver analysis can be used very effectively.
5. “Value selling” in the context of implementation (cf. Chapter 6, Frohmann, 2018) is based directly on the process steps of value driver analysis. The perspective there is turned towards the individual customer: from the derivation of target prices for a product, individual target prices are derived for negotiations with customers in the context of “value selling”.
6. Basis for the pricing of new products:
The method is particularly suitable for products that have already been developed and are about to be launched on the market. The customer’s perceived positioning in the benefit-price portfolio is the starting point for defining the target position in relation to the competition. In essence, it is a matter of balancing between short-term profit (margin focus) and long-term growth (volume focus). In the first case, one will enter the market with a – relative to the benefit – high price. If the priority is on volumes and market shares, this argues in favour of positioning in the upper left quadrant. Two well-known standard strategies in pricing result from the considerations outlined above: Skimming pricing and penetration 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.
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.