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TERRYALLENpricingThepoweroftfewmomentssincetheendofWorldWarIIhasdownwardpressureonpricesbeensogreat.Someofitstemsfromcyclicalfactors—suchassluggisheconomicgrowthintheWesterneconomiesandJapan—thathavereinedinconsumerspending.Therearenewersourcesaswell:thevastlyincreasedpurchasingpowerofretailers,suchasWal-Mart,whichcanthereforepressuresuppliers;theInternet,whichaddstothetransparencyofmarketsbymakingiteasiertocompareprices;andtheroleofChinaandotherburgeoningindustrialpowerswhoselowlaborcostshavedrivendownpricesformanufacturedgoods.Theone-twopunchofcyclicalandnewerfactorshaserodedcorporatepricingpowerandforcedfrustratedmanagerstolookineverydirectionforwaystoholdtheline.Insuchanenvironment,managersmightthinkitmadtotalkaboutraisingprices.Yetnothingcouldbefurtherfromthetruth.Wearenottalkingaboutraisingpricesacrosstheboard;quiteoften,themosteffectivepathistogetpricesrightforonecustomer,onetransactionatatime,andtocapturemoreofthepricethatyoualready,intheory,charge.Inthissense,thereisroomforpriceincreasesoratleastpricestabilityevenintoday’sdifficultmarkets.27MichaelV.Marn,EricV.Roegner,andCraigC.ZawadaTransactionpricingisthekeytosurvivingthecurrentdownturn—andtoflourishingwhenconditionsimprove.ASuchanapproachtopricing—transactionpricing,oneofthethreelevelsofpricemanagement(seesidebar“Pricingatthreelevels”)—wasfirstdescribedtenyearsago.1Theideawastofigureouttherealpriceyouchargedcus-tomersafteraccountingforahostofdiscounts,allowances,rebates,andotherdeductions.Onlythencouldyoudeterminehowmuchmoney,ifany,youweremakingandwhetheryouwerechargingtherightpriceforeachcustomerandtransaction.Asimplebutpowerfultool—thepocketpricewaterfall,whichshowshowmuchrevenuecompaniesreallykeepfromeachoftheirtransactions—helpsthemdiagnoseandcaptureopportunitiesintransactionpricing.Inthisarti-cle,werevisitthattooltoseehowithasheldupthroughdramaticchangesinthewaybusinessesworkandinthebroadereconomy.Ourexperienceservinghundredsofcompaniesonpricingissuesshowsthatthepocketpricewaterfallstilleffectivelyhelpsidentifytransaction-pricingopportunities.28THEMcKINSEYQUARTERLY2003NUMBER1Transactionpricingisoneofthreelevelsofpricemanagement.Althoughdistinct,eachlevelisrelatedtotheothers,andactionatanyonelevelcouldeasilyaffecttheothersaswell.Businessestryingtoobtainapriceadvantage—thatis,tomakesuperiorpricingasourceofdis-tinctiveperformance—mustmasterallthreeoftheselevels.Industrypricelevel.Thebroadestviewofpric-ingcomesattheindustrypricelevel,whereman-agersmustunderstandhowsupply,demand,costs,regulations,andotherhigh-levelfactorsinteractandaffectoverallprices.Companiesthatexcelatthislevelavoidunnecessarydownwardpressureonpricesandoftenemergeasindustrypriceleaders.Product/marketstrategylevel.Theprimaryissueatthissecondlevelispricingaproductorservicerelativetothecompetition.Todoso,companiesmustunderstandhowcustomersper-ceiveallofferingsonthemarketand,mostpar-ticularly,whichattributes—productaswellasserviceandintangibleattributes—drivepurchasedecisions.Withthisknowledge,companiescansetvisiblelistpricesthataccuratelyreflectthecompetitivestrengths(orweaknesses)oftheirofferings.Transactionlevel.Thefocusoftransactionpricingistodecidetheexactpriceforeachtransaction—startingwiththelistpriceanddeterminingwhichdiscounts,allowances,pay-mentterms,bonuses,andotherincentivesshouldbeapplied.Foramajorityofcompanies,themanagementoftransactionpricingisthemostdetailed,time-consuming,systems-intensive,andenergy-intensivetaskinvolvedingainingapriceadvantage.Pricingatthreelevels1SeeMichaelV.MarnandRobertL.Rosiello,“Managingprice,gainingprofit,”HarvardBusinessReview,September–October1992,pp.84–93.Nevertheless,inviewofevolvingbusinesspractice,wehavegreatlyexpandedthetool’sapplication.Theincreaseinthenumberofcompaniessellingcus-tomizedproductsandsolutionsorbundlingservicepackageswitheachsale,forinstance,meansthatassessingtheprofitabilityoftransactionshasbecomemuchmorecomplex.Thepocketpricewaterfallhasevolvedovertimetotakeaccountofthistransition.Today,itismorecriticalthaneverformanagerstofocusontransactionpric-ing;theycannolongerrelyonthedouble-digitannualsalesgrowthandrichmarginsofthe1990stoovershadowpricingshortfalls.Moreover,atmanycompanies,littlecost-cuttingjuicecaneasilybeextractedfromoperations.Pricingisthereforeoneofthefewuntappedleverstoboostearnings,andcompaniesthatstartnowwillbeinagoodpositiontoprofitfullyfromthenextupturn.AdvancingonepercentagepointatatimePricingrightisthefastestandmosteffectivewayformanagerstoincreaseprofits.ConsidertheaverageincomestatementofanS&P1500company:apriceriseof1percent,ifvolumesremainedstable,wouldgeneratean8percentincreaseinoperatingprof-its(Exhibit1)—animpactnearly50percentgreaterthanthatofa1percentfallinvariablecostssuchasmaterialsanddirectlaborandmorethanthreetimesgreaterthantheimpactofa1percentincreaseinvolume.Unfortunately,theswordofpric-ingcutsbothways.Adecreaseof1percentinaveragepriceshastheoppositeeffect,bringingdownoperatingprofitsbythatsame8per-centifotherfactorsremainsteady.Managersmayhopethathighervol-umeswillcompensateforrevenueslost