The value of good pricing policies

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Among the most difficult, almost mystical, tasks marketers face is how to price their products-and in particular whether to discount. Product differentiation, competition and demand, along with myriad other factors, go into setting prices or offering price breaks.

"There are three core pricing principles," said Paul Farris, professor of marketing at the Darden Graduate Business School at the University of Virginia. "The cost of the product is the floor, its value is the ceiling and the competition determines where you settle in between. Take any one of these away, and you can't understand pricing."

A given in the b-to-b environment is that a slight product advantage or superior sales force will provide a price premium. After that, discounting can be a useful tool, but only to accomplish certain tasks.

"I think discounting is an essential part of business-to-business marketing," said Tom Nagle, senior partner at Strategic Pricing Group, a division of consultancy Monitor Group. "The idea that you can squeeze it out and make it go away is ridiculous. On the other hand, a company without a corporate discount policy often gives too many people the authority to discount. Chaos results."

Nagle, co-author of "The Strategy and Tactics of Pricing," now in its fourth edition, notes that well-considered discounting can do more than boost sales and profits. It can also help realize strategic goals, such as loyalty ("sign a three-year contract and get a discount") or product customization ("unbundle our services for just the ones you want, and get a discount").

"This is not bad discounting," Nagle said. "You're forcing the customer to decide what it is he values and to think about value trade-offs. The important thing is, he now views his sales rep as a partner in helping figure out the stuff he should buy at the lower price."

Price contamination

Without such a strategic discounting policy, imposed from above the sales level, a company may fall prey to "price contamination," said Frank Luby, a partner at Simon-Kucher & Partners, a major international pricing consulting firm.

"Discount one deal and it completely recalibrates the next one," Luby said. "The sales guy got his win, but hurt the next four or five deals. It's rare for the sales level to have foresight here."

Luby said that if product differentiation is strong enough, discounting becomes less necessary. Along with product differentiation, other factors that can lessen the need for discounting include superior salespeople, barriers to customers switching vendors and companies that enjoy a closer relationship to buyers than their competitors.

"Knowing the answer to these things is worth money," Luby said. "It's money many companies are afraid to charge ... or are unable to charge because of misalignment between marketing and sales."

In general, marketers must decide if it makes sense to obtain new customers through discounts.

"If I'm dealing only with the purchasing department, and I don't see the potential for a business relationship, I want to get away from this," said Jerry Shapiro, the Marlborough, Mass.-based promotional products manager with Office Depot. "Instead, we want to deal with facilities, sales and marketing, safety or HR, and build a relationship with them. Loyalty is better than price."

Volume buying tends to prompt discounts, but companies that sell time rather than products may be even more discount-oriented.

"The more minutes and months a client subscribes to, the better the deal," said Dave Halter, director of sales and marketing for the AnswerNet Network, a call center company. "And it's more than mere sales volume; keeping a certain number of agents busy and paid for over time can realize great cost efficiencies for me."

Nagle cited two basic metrics in determining appropriate discounting: gross margin analysis and price band analysis.

The first is fairly straightforward: If your gross margin is, say, 10% and you discount your product by 5%, you have just cut things in half. You now must double sales to keep margins even, and do even better than that to gain in profitability.

By contrast, if you have a healthy 50% margin and offer the same 5% discount, you're now only cutting your take by a tenth. Here, total sales need to increase by only 10% to keep margins the same, and anything over that should mean higher margins.

Keep margins in mind

Of course, sales should increase with a discount. In using gross margin analysis, companies need to determine whether their profits, product demand and sales departments are robust enough to justify the tactic of discounting. Otherwise, margins will suffer.

Price band analysis is more complex. It's a statistical model that measures what customers should pay (price points within an ideal "band," or boundary, on a chart) versus the high or low prices they actually pay that fall outside the band. The method identifies situations where a product's price is unpredictable, looks at those customers who are offered inappropriately low or high discounts and creates a formula for explaining the discrepancy.

"Price acceptance" here depends on many things, including geographic location, pressure from centralized purchasing, the talents of top salespeople, length of the customer relationship, competition ... and rogue salesmen offering rogue discounts.

The key in all cases, experts agree, is to have a corporate strategic discounting policy, rather than one driven by short-term goals or quotas.

"When pricing is controlled by marketing people, both marketing and sales tend to measure performance by the top line," said Nagle. "It's not hard to sell things by giving them away. But there's no surer way to drive yourself into a hole."

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