Students studying strategy and marketing are taught that price is an important aspect of product positioning. Price is the odd-one-out of the marketing mix because it generates revenue. In contrast, product, promotion and place incur costs. Although there are no universal rules to what constitutes a good pricing policy, students are taught that pricing strategy will be generally determined by a combination of factors. These usually include the prices of competitive products, product maturity, production cost or the product’s price elasticity. However, the underlying economic motivation should always be to cover the incurred cost.
It is therefore essential that companies understand how to set prices because both undercharging (= lost margin) and overcharging (= lost sales) will have dramatic effects on profitability. The creation of a single European market and the introduction of a common currency did not diminish this threat. These developments have increased competition and put downward pressure on prices. In the past, European companies tried to increase their profitability by price discrimination and product differentiation.
Now, however, as price differences across the Eurozone become more transparent, and as customers increasingly turn to pan-European sourcing, there is the threat that companies will lose the potential to offer products at significantly different prices in different locations. To survive and succeed in the future, European business-to-business companies, such as ThisCo, first had to assess both the technical and business implications of the introduction of the Euro for their environment. Subsequently, they needed to review their old pricing policies in order to obtain a new transparent, standardized and consistent pricing system.
Formerly, ThisCo offered heterogeneous products across Europe. Thus, its customers found it hard to compare products and prices. It was, therefore, easier for ThisCo to charge different prices. Moreover, some products sold in different European markets were at different stages in their lifecycles, allowing different prices to exist in different markets. ThisCo set list prices by cost-plus pricing. However, due to its decentralized structure, both the “cost” and the “plus” were differently defined and thus also differently computed in each of ThisCo’s sixteen operating companies. Hence and yet again, customers were not uniformly charged across Europe. Apart from the above weakness, the system also had the potential for price escalation since the different channel structures and degrees of retailers and distributor power impacted on the size of the markup in each operating company. Furthermore, the system lacked flexibility.
ThisCo’s cost-plus pricing did neither explicitly consider the price sensitivity of demand nor the pricing practices of competitors. Therefore, as each operating company was characterized by a different competitive structure, local salesmen needed to have a degree of freedom to decide on the most appropriate pricing level for local conditions. Additionally, ThisCo’s frequent use of ad-hoc pricing led to further significant price differences. As international customers regularly expected price reductions in some markets, the prices paid were occasionally very different from list prices. The difference between the list price and the realized or transaction price was described by ThisCo as the price waterfall and was accounted for by order-size discounts, loyalty bonuses, payment terms discounts, volume bonuses and an annual rebate.
Obviously, by solely and selectively deploying such pricing to certain customers, ThisCo’s clearly challenged its credibility and integrity. Naturally, some ThisCo’s price differences were also exogenously influenced by differential raw material prices, overheads, wages and local value added consumption taxes. Given all these factors, it can be inferred that ThisCo’s integrity was at stake by continuing the old pricing system in the new European environment. The price differences clearly resulted from the unstandardized and ineffective pricing system and shortcomings within ThisCo. Given the future harmonization of products, ThisCo needed to thoroughly review its pricing system in order to regain integrity and optimize its profitability.
In its migration from a heterogeneous product landscape toward a homogeneous and rationalized product portfolio, ThisCo concentrated on the advancement of a standardized pricing system. Corporate information was collected companywide and centrally analyzed. Hence, every new product was given a price corridor with European target prices. Consequently, customers paying prices below the corridor were asked to pay the minimum target price or walk away. As ThisCo knew henceforth the standard European cost price for each of its products, it could use it as basis for pricing and was enabled to optimize its profitability.
Moreover, ThisCo managed to overcome the earlier corporate shortcomings as the price corridors were controlled centrally. However, adjustments to the systems were conducted locally. Next to standardized “cost” price, ThisCo also developed a standardized framework for the “plus” enabling them to manage and understand the price waterfall which is a key element in achieving a satisfactory transaction price. ThisCo recognized that discounting was a fact of commercial life and built in negotiating margins that allowed prices to fall from list price levels but still permitted profitable transaction prices to be achieved.
With the new pricing system and its corridors, ThisCo is henceforth enabled to regain integrity as it can justify its prices. Furthermore, by knowing its true “costs” and better managing the “plus”, ThisCo can deliver more accurate price tenders to its customers. From now on, they no longer ask too much or too little. However, careful and consistent communication from central to local management will be necessary in order to successfully implement and execute the new pricing strategy. Furthermore, changes in ThisCo’s business environment, such as parallel imports and the development of e-commerce, should be closely observed as they require further adjustments to the pricing system. ThisCo has to realize that the Euro is not the only factor which triggers price differences. Yet again and in the future, in order to remain its profitability and integrity, ThisCo needs to ask the right price: not too little and not too much.