Precision-Pricing-for-Profit-in-the-New-World-Orde

DONOTCOPYHarvardBusinessSchool9-999-003December7,1998ThisnotewaspreparedbyProfessorBensonPShapiro,B.P.Shapiro,Inc.,91MainStreet,Concord,MA01742,[phone].Copyright©1998BensonP.Shapiro.Allrighsreserved.Toordercopiesorrequestpermissiontoreproducematerials,call1-800-545-7685,writeHarvardBusinessSchoolPublishing,Boston,MA02163,orgoto—electronic,mechanical,photocopying,recording,orotherwise—withoutthepermissionofHarvardBusinessSchoolorProfessorBensonP.Shapiro.1PrecisionPricingforProfitintheNewWorldOrderIncreasingCustomerValue,PricingLatitude,andProfitsPricetoohighandyoulosethesale!Pricetoolowandyoucan’tmakemoney!Competitorswithdifferentcoststructurespummelyourpricestructure.Customersbatteryoursalespeople.Listpricesaremeaningless.Discountsarerampant.Theoldrulesofthumbdon’thold.Cost-pluspricingnevermademuchsenseandnowitseemsstupid.Lifeishard,andsometimesseemsimpossible—andpricingisoftenthehardestpart.Managerswhounderstandhowtopriceintheneweracanprosperandgrow.Itisn’teasybutitisprofitable.And,mostofitisnecessaryjusttosurvive.Thisarticleexplainsthesourcesofpricepressurecarefullysoyoucanclearlyunderstandthem,andthenprovidesanimprovedframework,andapowerfultoolkitforpricinginthenewworldorder.I.THEFALLOFTHEOLDWORLDORDERAmongthemorefundamentalchangeswhichcreatenewpricepressureare:1.Aprofoundshiftfromvariablecoststofixedcosts.Infact,forsomecompanies,suchassoftwareproviders,variablecostsareveryclosetozero!2.Asharpconsolidationinthesizeofcustomersandindividualorders.Itisnotunusualintoday’sconcentratedaccountbaseworldtofindcompaniesthatdonearlyalltheirbusinesswithadozencustomers.And,inmanyindustries,longtermcontracts,global/nationalsupplyrelationships,andcomplexmulti-productandserviceoutsourcingarrangementsleadtounusuallylargeorders.Ordersoftensandhundredsofmillionsofdollarsareincreasinglymorefrequent.LocomotivemanufacturersintheUnitedStatesnowhaveonlyfourmajorrailroadsaspotentialcustomersdownfrommanyjustafewyearsago.DONOTCOPY9-999-003PrecisionPricingforProfitintheNewWorldOrder23.Competitorsfromdifferentindustriesandwithvastlydifferentcoststructuresand“valuepropositions”regularlymeetinthemarketplace.Naturalgasanddieselbusescompeteincitytransit.Mainframecomputersjoustwithnetworksofserversandmicrocomputers.4.Almostnoinflationand,insomeindustries,deflation,whichmakesitdifficulttoslippriceincreasesbyincreasinglysophisticatedandvigilantpurchasingexecutivessupportedbyadvancedcomputersentries.Flatpricingistheresultofincreasedworldwidecompetition;lowertransportation,communicationandcomputercostswhichincreasethesizeofthe“competitiveset”;andhighmobilityofcapitalandknowledgewhichmeansthat“focusedmonopolies”withhighmarginsare“commoditized”muchfasterthaneverbefore.5.Electronicauctionsandnearauctions,oftenfacilitatedbytheInternet,makeithardertosurvivebecauseofmuchlowercustomersearchandacquisitioncost“friction.”Thereismorefluidityinmarketssothatmoresupplierscancompete,andmorebuyerscanshoppricesacrossmoresuppliers.ThepricesofundifferentiatedproductsandserviceswillincreasinglybebiddownbythisDraconianprocess.Inessence,weareinaworldwide,cross-industrybuyers’marketwithfewsustainablehigh-marginniches.Despitethechallenges,therearebetter,evolvingpricingapproachesthathelpinmanysituations.Performance-basedpricingisaprimeexample.Itishelpingsellerstocreatemorecustomervaluewhilebeingbettercompensatedfortheirproductsand/orservices.Thereareothersuchapproachesaswell.Beforeweconsiderthemweneedafirmfoundationforimprovedpricingandadeeperunderstandingofthemoreimportantchanges.II.THEFOUNDATION:ANINTELLIGENTPRICINGPHILOSOPHYAgoodpricingphilosophymustincorporatethecustomer’sperspective,aswellasthedualnatureofcustomer-vendorrelationships.Theserelationshipshaveacooperativecomponentandaconflict-riddencomponent.(Exhibit1)isarealincomestatementthatattemptstocapturethewholerelationship.Ithasthreehorizontallines.Thelowestiscost(atthispointitisnotnecessarytospecifywhatkindofcost–variable,total,average,etc.).Thetoplineisthecustomer’sperceivedvalue.Itisthetotalworthtothecustomerofallthetangibleandintangibleattributesoftheproduct/service.Therangeorareabetweenthecostlineandthecustomervaluelinedefinesthe“ZoneofPossibleAgreement”(ZOPA).Thecustomerwillnotpaymorethantheperceivedvalue(theymaypaylessasnotedbelow).Thesuppliershouldnotknowinglysellbelowcost(onaregularbasis).PricemovesintheZOPArange.Raisingthepriceincreasestheseller’sprofitsanddecreasesthe“customerbenefit”.Theseller’sprofitisthedrivingforcetosell,andthecustomerbenefit,thedrivingforceforthecustomertobuy.Aspricegoesup,thesalebecomesharder,andviceversa.SettingpriceintheZOPAisonlyasmallpartofthetotalpricingdecision.But,mostmanagersfocusonthezero-sumgame1intheZOPAandargueabouthowtobalancesupplierprofitandcustomerbenefitonthepricepivotpoint(Exhibit2).Moreimportant,however,ishowto1A“zero-sumgame”isatwo-partsituationinwhichthewinningsofoneparticipantequalsthelossesoftheother.It