In today's episode - Aidan and Joanna discuss what is the concept of anchoring in pricing - and how you can use it to your advantage.

We discuss how people generally can only interpret pricing versus other prices.

We discuss how anchoring can be used in practise and how it can benefit you from negotiations to simply selling your car!

In today’s episode, we want to talk about one of those more dark art style aspects of pricing that isn’t purely cost-plus pricing strategy but the topic of anchoring.

Anchoring, it’s a concept that sits within the area of behavioural economics which fundamentally, largely has to do with psychology and behavioural psychology. The founding father of behavioural economics is a guy called Daniel Kahneman, he was the first person to question the economic theory of people buying logically rationally and suggested that people buy emotionally irrationally and this is where that concept of anchoring drives. 

I think our listeners and nearly everyone will be aware of being influenced to some extent you know when the road shopping. A classic example is you go into a clothes retailer to buy some new clothes and you see 30% sale discount signs and somewhere in your mind, you think this must be a great deal because I'm getting a lower than a potentially even an artificially high anchored price. So, what’s happened here? You’ve been anchored to that higher price and with that, you think you’re getting a great price note. 

Pricing is a good way to anchor people and to help them understand what value is. Because people find it very difficult to think about value. It's an abstract term, so they need it to be sort of framed for them and need to be anchored and positioned correctly for them to understand what's good, what's not so good.

Yeah and I think this topic has been covered in a couple of very good and easy reading books, covered by the child Eeinie influence I think was one where he covered it. And also, the book Priceless by William Poundstone, both of which give a number of examples of this topic. One thing that struck me was when you ask people how tall a mountain is or a hill is often they can't give it, they're often not aware unless they see it in reference to something else. And in many regards pricing is similar, It's the price compared to another price.

I suppose in terms of simple cost-plus pricing we were thinking about that earlier, and how people set prices on cost. If you look at that in terms of anchoring, you can see by setting prices on costs, you're lowering your potential to get a higher price because it's gravitating and anchoring everyone to cost, and you're not thinking about willingness to pay, how customers perceive value, and not testing that price ceiling.

I think that you can even argue yourself in a negative way, and you can even knock your own sales team. If you can't go on about the cost, there is a tendency for people to push it down to that cost. They will see it as the cost, the number that will be anchored in their mind as well. Another classic example in some of these things can be a little bit hard to believe unless you saw the statistical evidence. The classic example of buying or selling a used car. All the evidence suggests that if you want to sell it at a high price, you should ask the seller, you should just quote, get in there first and quote a high price, then you will anchor the purchaser to a higher price for the later negotiation.

There’s another reason why people don't like estate agents, for instance, they were quite reluctant in the past to use auctions because it has a tendency to pull things down but in a boom, however, they found that an auction can increase the price point because people are anchoring themselves by a dream of the best house in a lovely suburb. So, in a downturn, it's probably not good to do an auction, but in a boom time, it's probably a good option to use the auction as a way to sell houses.

Yeah, very often it's the way the question is presented to people, not just necessarily pricing but you can use this anchoring concept in many regards. You will see it in things such as referendums and countries the way questions are asked in political questions, the government's are often very concerned about framing the question in a certain manner. Because that is statistically proven to influence the outcome, even though the question is largely the same, the answer you get can be very different.

In Deniz Berkeley, there's an interesting study about how the concept of anchoring not just applies to prices and numbers but also applies to ideas. In this study, they wanted to see if the presentation of an exam influenced people's results, in particular women's results. And they found that having a different format, a more positive gender format increased marks for women by 10 to 20%. So literally how they framed the study, the exam did make people perform better, women perform better in exams.

I think we're going to wrap it up quite shortly. I think what we covered today really indicates that pricing and the pricing profession is much more than just numbers on a spreadsheet, there's a science but there's also an art to it and where that line is drawn, who really knows. But there is certainly room for people with very very talents in this profession, and hopefully, different people find this podcast interesting.

When you think about it, what does customer focus pricing mean? You are moving into more psychology behavioural economics, you are looking at finance and maths, but you're looking at things in its entirety. The market isn't easy to understand, people are easier to understand, but you have to try and find those different measures to gauge and improve your price setting.

In this episode of Pricing College - Aidan and Joanna discuss a very pertinent question in the era of Covid-19.

What is price gouging and is it always wrong?

We provide a definition of what price gouging is?

Why should a business owner not pursue price gouging?

Do customers sometimes accept higher prices - and not regard that as price gouging.

In today’s episode we want to cover the question, what is price gouging? And when we find out what it is, Is it always wrong? 

Going through the covid crisis we heard a lot about price gouging in various businesses like masks, medical equipment and some grocery goods. Is it right? Are they gouging? or Is it just a price increase? But first of all, what is price gouging? Price Gouging is basically when you are exploiting customers by increasing prices to drive a large amount of profitability all at one go.

I think in certain situations, we can all imagine where people would pay any amount of money for very non-descript items in other scenarios, such as if you’re extremely thirsty you pay infinite money for a glass of water. In Australia, during the covid crisis, people would have done anything for toilet roll but that’s a topic for another episode. But yeah, it’s exploiting the person who is in there of need and will do anything for that product or service at that point in time and then taking advantage of that scenario. 

I think sometimes people mistake price gouging just like a basic price increase, they use those terms kind of interchangeably but they are different. It’s okay for businesses to make money. Why shouldn't they? They’re in the business to make money but sometimes when there is a demand for things like toilet paper, and mask because of certain crises businesses have to increase the price because they’ve got to make more of the products and they got to cover the production cost. 

 I think in many industries and sectors people completely accept that prices increase and sometimes increase massively. We’d give the example of the Cannes film festival in the South of France, somewhere I’ve never been but my understanding is for that one or two weeks when the film festival runs trying to book a hotel room would cost you maybe ten times on what it might cost at a lower peak part of the year. Another example will be in the United States, the Super Bowl weekend if it’s in a certain city I think you’d be foolish not to expect hotel rooms to be more much expensive, restaurant bookings all those sorts of things. That’s something people accept, they accept that for this reason, they will pay much more for that product or service.

It’s like the markets have been educated in a certain context like Airlines and Cruises to pay more when there’s a higher demand. In another context, especially for B2B, it’s almost seen as criminal to increase your prices to make even a small margin and literally, that’s come down or it could be just tradition convention and people are very reluctant to say we’re increasing prices because we were underselling our offer but rather they sort of hiding behind, we’re increasing prices to cover our costs and that B2B market which is an interesting comparison between B2C and B2B 

Sometimes the way I look at price gouging I think of it is the question, Is it gouging or not? I would say it is gouging if it leaves such a bad taste in the customer's mouths. If they’re so annoyed by it that literally, they’ll never do business with that company or person ever again. The fact they’ve got exploited once and that’s it, they never go back. In theory, the shopkeeper of the business, what they’re doing is they’re making a lifetime profit on that one transaction and then they’d be burning the future. 

In B2B, sometimes procurement teams react in the same way. They’re almost appalled if you increase your prices even by a small tiny percentage simply because it goes against convention even though it could be underselling your products and you’re just claiming back the value really that you deserved. 

I think price gouging becomes an issue when the person or customer has to buy it and there’s no other venue to get the same product or equivalent product elsewhere,  the examples of an emergency hurricane and those sort of things where there’s another plausible scenario. I think if a company can go and get their supply from somebody else then it’s just a normal business I don’t think in any way it is price gouging. The other thing I say is the example we give of the Super Bowl and that sort of stuff, those are leisure activities and I think nobody has the right to go on Super Bowl every year. We get into much greyer areas much more questionable areas with units of medications and certainly new medications, Yeah, this is something for another topic but certainly a much more valid question. 

I think that’s really what the debate was it’s like when the boxes of the masks, the medical masks are being priced hundred of dollars people did object and rightly so just because of a peak in demand, there may have been supplied side issues as well at the same time that is gouging.

If you’ve bought a product and service I’d say just ask yourself this question, throughout the crisis if you bought something and you thought you were exploited to the position that you wouldn’t go back to that shop ever again I would say that qualifies probably as a price gouging.

No, it’s a lesson.

In Layman’s term obviously, but yeah I think every one of them that’s a good way to look at it.  

I think it’d be a good topic and we’ll discuss this later. How you can justify a price increase? Yes, you’re going to have some customers who will reject or even feel emotional about any type of price increase. But this goes into understanding your business model, understanding the value that you offer and being confident in having that higher price and then being willing to forego some customers that don’t agree with you.

In today's episode of Pricing College Aidan and Joanna discuss 5 obvious problems with cost plus pricing.

If you come to a podcast on pricing - you may not be surprised that cost plus pricing is not a perfect system.

We discuss issues such as:

 - should you lower selling prices if you find a new way of manufacturing

 - why cost plus can destroy value creation

 - why choosing a margin often makes little sense

 - why using cost plus can give procurement teams to push you down on price.

In today’s podcast, we are going to cover five reasons why cost-plus pricing may not be that good.

Before we touched upon the cost-plus pricing, looking at some of the benefits that we said it seems to be rigorous fair and logical. So yeah, today we’re gonna look at some reasons why maybe you shouldn't use cost-plus pricing 

I think we picked a nice odd number like 5 which means that Joanna drew the short straw, so she has to do three reasons and I only do two. 

Let’s start off with one, cost-plus pricing can be an overly complex cost allocation formula. It looks at both fixed and variable costs to set a cost position which basically means that it tries to allocate all these different costs across the product portfolio. If you’ve got a hundred different products, that’s going to be very complex. 

Okay, so that’s number 1. Number 2 for me is that it tends to lead to a complete lack of innovation or financial benefit to innovating. If you think about the product, let’s say you’re manufacturing a telephone, it’s a new smartphone and you charge a 20% markup on that as your profit through cost-plus pricing. In that scenario, we’ll say you find a new technology and a new method of making a telephone that means it’s half as expensive to manufacture.  Does that mean that you should cut your selling price by 50%? In that scenario, innovation will actually destroy your business. 

From the point I made, it’s a very complex cost allocation formula but yet the mark up on that cost formula is simplistic, the percentage markup on cost.  It takes a lot of that hard work why would you do very complex cost accounting and then sort of just make up a margin on top, it doesn’t really make much sense.  

Actually, I just cover a lot on that one with Joanna’s point number 3 and I think yeah, financial people love cost-plus pricing because it seems to be rigorous and factual and then just make up a margin.

Yeah, that margin fundamentally means you either overcharge your customers or undercharge your customers.

I think that is point number 5, I’m gonna go with point number 4 . So my point number 4 is that when you practice cost-plus pricing and your customers know about it especially if there’s an aggressive procurement style customers know how to drive down the price. If they know that you practice cost-plus pricing they’re gonna want to know, and it’s the worst thing to any salesperson when they start asking about an open book or seeing your cost structure, the warning bell should be ringing. I remember I worked in the sales business and when the customer said we only make a 4% margin why should you be making 15% we want you to make 4% as well and it’s when they know what your cost structure is. It’s real trouble for you. 

The last one would be that cost-plus pricing doesn’t take into account the market. It doesn’t look at the relationship between price and volume on cost and just focuses on that pure accountancy view in the spreadsheet. Misses out and lost the market dynamics and unfortunately, because of that, you can have this great innovation, a product innovation but really if using cost-plus pricing you can often undersell the innovation because you’re not looking at the value of the offer and adding that additional price premium that you deserved, underselling yourself.

I think we’ll leave there. I suppose as a final point for me if you believed in your product and want to give value to your customer really improved their lives and cost-plus is not a great way to do it. 

There’s a lot of different methods now we’ve moved on from that basic, the cost-plus markup and we’re gonna discuss those different methods in future episodes

In this episode of Pricing College - Aidan and Joanna look at the polar opposite of a value based pricing strategy - i.e. a commoditisation approach.

Under commoditisation - we really assume that a product or service has no real value adds - and is identical to other competitors in the market.

This approach generally leads to lower prices, less profits and a lack of investment in enhancing value.

In today’s episode, we want to take an almost counterintuitive approach and we’ve talked about what is value-based pricing in the past. In this instance, we’re going to ask what is the polar opposite of that, What is the commoditisation of a product or service?

We sort of touched on that with the commodity mindset but, it’d be an interesting conversation just to unpack what that means in terms of how different business leaders think. 

From my personal experience, I’ve worked in companies where the marketing people could talk about the value all day long but sooner or later someone in the finance department would argue and say “no, no we only sell at a low price, the customer only buy at a low price”. I supposed they’re the polar opposite of the same polar opposites of the spectrum when we look at value pricing and what we’re trying to sell. If you are competing at a purely low price, you’re making an assumption that the product or service you’re selling is literally identical to that of your competitors, new entrants or anybody else in the market.  This could be true in the instance of buying a share in the stock market where the share you’re buying would be a share in Qantas or any company you want to think of. The stockbrokers may give you different services or experiences but you’re buying on the market and the price you pay will be the market-clearing price at that point in time. You could also think of what are the very commoditise products, we think of raw materials things like coal, timber and oil those sort of things. As long as they’re coming from the same area, the material is chemically the same as another one it’s pretty close to being commoditised. 

People think in that commoditised way of thinking about it as if they are trading in the stock exchange. They’re thinking about things as a sum of its parts, there’s a very component-based, unit-based sort of pricing thinking and logic. Equally, I would say we can’t dismiss that because there are some customers that buy in the very same way and we call those price-sensitive customers. But on the other hand, there are customers that don’t see an item based on what it’s made of. They think about the value it can give them and the problem it solves at a particular point in time. I think they’re both perspectives can be seen on the buyer side and the seller side.

I think another area that nearly everyone in the pricing profession, at least in the B2B environment has looked at is doing tenders where you’re dealing with procurement professionals who almost are trying to shout at you that your product and service is commoditised and it’s purely a red card exercise and they want the lowest price and that they’re not considering the additional value. That’s something many of us have gone up against and it’s trying to explain, we’ll give you the example if you’re buying two apples, people also had apples and apples. You’re comparing two apples, but if your two apples were on the table you want to ask:  How fresh are both apples? Were they’ve grown organically? Were they grown with modern chemicals? Will that apple will be delivered to me? Or will I have to go and collect that Apple? Can I pay that Apple with cash? Do I have to pay for it with credit terms? There’s an infinite number of things that could be slightly different about that apple. That’s something that is seemingly commoditised by the time you eat it, consume it and then enjoy it. It’s a completely different experience.

It’s quite strange if you’ve talked about all those things that can be involved in just buying an apple but often they’re sold based on what they look like, the features and benefits and all of those other risk drivers is what I’d called.  What you are really saying is deliberate time, and failure to supply or things like that I really never discussed but potentially that’s why the procurement do is gravitate unit pricing discussions. 

It does not mean in the gone on now about apples but I find it quite interesting. I believed in Japan, there is a very common gift that people give. It is a very aesthetically pleasing fruit, but the fruits are not designed to be eaten but it’s designed to look at. It will come in a nice box and presentation gift set which is a completely different value driver than somebody eating the apple. So yeah it’s, what is the product really for? Are the product and service are commoditised items? or is it the paraphernalia that goes with it? 

I supposed that to summarise it’s the value in use and the value at risk principles and you need to appeal aesthetics show of value at use. Some people buy purely on that, but other people buy the value at risk and they want to ensure that a certain product is going to come to them without any delay. There’s not going to be any product failure and they want you to describe to them how you’re going to do that and that is the discussion that does drive additional price premiums, especially with procurement.

I think there’s often a huge amount of risk in the purchase decisions and what you want to do as a smart buyer is reduce any potential risk. You go to buy like a Rolex watch, you can either go to a reputable jewellery store buy the watch you see the exact type of it, you’ll get a guarantee or a warranty that if it breaks you can bring it back to get repaired. It will also likely come in a beautiful gift box, all wrapped up and it’d be presented to whoever is going to. The alternative is you buy it from a dodgy guy on the street corner. He has assured you it’s fine and you probably get it at a much-reduced price but, are you really buying the same item? There’s a very high chance it is the same item as a basic watch but the paraphernalia around that you’re purchasing reduces your risk that’s makes you happy, they’re trouble chase. 

Largely we buy because we want to avoid risk as well as the actual thing that we’re buying. A good pricer will think about what a product is when they’re setting prices but also the risk the customers are avoiding by buying that product from that business and that really is one of the secrets of really great pricing. Setting pricing on value, unpacking value in terms of value at used and some value at risk

Aidan and Joanna discuss the topic of penetration pricing and how and when it can be used.

Is it a suitable approach for a new business - or to give people a taste of a service or product.

Is it difficult to increase prices once a service becomes associated with low cost in customers minds?

Does penetration pricing go against value?

In today’s episode we want to talk about, What is a penetration pricing strategy? 

Basically, it’s when you have a new entrant in the market where the products are fairly similar to other products out there already but they want to break into the market. They’re gonna do so by taking somebody’s else’s market share, maybe one of the bigger players.

When we are talking about capturing market share in this instance, we’re generally thinking about pricing it at a rate so competitive or thinking probably a low price that will make these other competitors cheaper seeming to be a similar product that people can make an immediate switch for and save money. 

That’s the assumption in this strategy that if we break into a market you do need to sort of drop prices to be competitive, to be seen, and to be noticed, a differentiator. Other people would have argued that this strategy possibly isn’t the best pricing strategy to take even if you are a new entrant that wants to break into the market. 

Obviously, if the company launch a new product, a new service or even the company itself in many instances there’s a certain volume required for the company to be viable. Whether that’s producing enough products, using the factories or fixed assets that you have you need to hit a certain rate or amount of products being sold just to be break-even before your cash runs out as a company. Getting to that position quickly can be a key target for many companies. 

But market differentiation isn’t always based on prices, you have to personally think about the product and the product’s innovation. You need to know that your product or be it similar to other people’s products, has to have an edge, or a difference to capture people’s attention. Then think about the pricing, because research has shown that by dropping pricing too low you don’t necessarily break even and get the numbers that you want because not everybody buys on the price they buy on value. 

Yes. From my perspective, if you think about a marketing approach a lot of people may think that their product is great, it’s better than other ones in the market. If people get a test of it, they will continue with it in the future. Whether it’s a loss later is a different question, but a very competitively low priced offer for the introductory fears to get that mass-market testing experience they may think that will lead to longer-term referrals, longer-term sales and wider market who can review it etc. 

True. At the same time, it’s very hard to increase prices once dropped to a certain level. So then, you could have a great product that you spent a lot of money on and it’s very different from your major competitor's product but you’re underselling yourself and you're forever then struggling to increase prices and justify the value.

One thing I think anyone who’s ever worked in a pricing role will understand is the difficulty in getting to a price rise whether it’s an annual price rise,  a price adjustment or whenever you want to phrase it.  Customers who are used to paying a dollar, tend not to want to pay a dollar fifty. If you start of your users, consumers and whoever purchased that product or service on a certain price then coming back to them after six months or a year saying that ‘You know what we’re actually going to jump that price.’, the response you get may not be what you hope for.

This could be a failing of the penetration strategy argument, the assumption is that you can easily just increase prices and the market won’t mind. It’s just not the case and many prices will tell you that. But there are some good examples of new entrants that have come into the market with similar products and have been able to justify more above-average prices. One of them is a competitor to Doritos and they’re called Harvest Snaps, I don’t know if you’ve had them, Aidan, those dried peas and lentils salty snacks they’re very popular, very similar and competitor to Doritos but command a higher price even though the weight and the package is smaller. 

To be honest, I have had them and I have enjoyed them. I think what I’ll say is, do people purchase products based on purely low prices or is it the features, benefits and value or whatever it is with that product.  In the instance of salty snacks, are people buying them for a cheap price, or enjoy buying them as an alternative. Is it even just because the product has been positioned in a convenient location on the shelves in their local supermarket? Are they also just bored of their incumbent? And ease the product you’re buying now isn't a direct competitor for what is there. In penetration pricing, you could also have that system whereby it’s a completely new product that nobody’s seen before and they don’t want to take a risk on it. But if you can give them a test at a low rate that doesn’t hurt that pocket then you may be successful, and you may grow that market share. People may think that I love this new type of salty snacks as we talked about and I might continue buying it even at a slightly higher price.  The other thing to bear in mind is once you become used to purchasing something in the supermarket at a dollar and you or the kids want it after a while you probably don’t even look at the price. 

It becomes a habit. I think with the Harvest Snap example, they came in a good time. Consumer sentiment now is much more in favour of healthy eating, people still however love salty snacks and we know that obesity is still on the increase. People are still consuming fatty goods at the same time people want healthier alternatives so that came in on that sort of site geist and they were able to get and claim that additional price premium and at the same time take market share which is the objective of the penetration pricing strategy.

I think in all things pricing in business you have to consider why you’re doing something and what is the strategy behind it. Then once you have the strategy, you look at the tactics to implement. Often there’s no right answer but you have to know why you’re doing it and what you want to achieve from it. Penetration pricing sometimes can go alongside market share objectives where a lot of companies still have it’s almost a chest-beating concept where they want to have the largest share in that market and that’s the point of pride, even if they’re losing money.  You’ll see that in any industry from the automotive industry traditionally to pretty much anything. It’s what does your company want to achieve? Is this a suitable tactic? and Does it work? 

That’s right. You can’t just apply a strategy verbatim as they say. You’ve got to customise it and look at the market and your customer base will tell you how you should customise any sort of theoretical strategy 

I’ll finish off by saying if you’ve got a product or service that is a great service and people want, that will improve their lives and give them value.  Selling it at a too low price can’t be the right idea unless you have to get acceptance or people have something holding them back from trying it and price is what’s holding them back. If that’s what your market intelligence tells you, potentially that’s the right option other ways, always ask some more questions.  

This is what prices do. Looking at optimal pricing, what is the best price? Yes, it could be low but, does it have to be the lowest? That’s the question and this is what you've got, you’ve got to test but don’t test with rock-bottom price first because you’ll find it incredibly difficult to get the price back up and then you’ll forever be thinking I’ve undersold myself. 

Aidan and Joanna discuss (or some say argue) about the difference between pricing and revenue management.

Is revenue management a sub segment of pricing generally - or is it a standalone area.

Is revenue management only related to capacity constrained industries - and does Aidan always talk about airlines and apples?

In today’s episode, we want to talk about, what is the difference between pricing and revenue management?

In broad terms, I would say price management concerns setting and managing prices to drive profitability for the business and your customers, whereas, revenue management concerns allocating inventory to optimise your revenue. 

You probably notice if you’re applying for a job in the pricing sector is that revenue management being honest, seems to be more jobs. There seem to be more jobs that describe this revenue management particularly in fields that are very much affected by covid bizarrely; Airlines, hotels, rental cars, and cruise ships those sort of things. 

This is because pricing is often misconstrued as revenue management and considered more of the tactical lever as opposed to a strategic lever. People use pricing and revenue management interchangeably because they want to drive volume or tactically discount in the market to push volume. 

To my mind in Layman’s terms, I think of revenue management as a sub-sector of pricing. If the entire sector is called pricing revenue management to me it applies to a certain sector which is capacity-constrained areas, ideas such as hotels, and airlines where you have a certain number of seats, rooms or cars that you can rent out. If demand goes through the roof overnight, you can’t increase a supply hugely. You’re trying to maximise revenue while assuming that your supply is constrained by physical capacity. On an airline, if flights flying from New York to London tomorrow there are 500 seats on that flight no matter what you do, you can’t make more.

This is why revenue management is moving into more forecasting demand so they can use that information to increase supply and know ahead of time that they need to produce more. In the instance of airlines, more flights.

Fundamentally, you could put on a very busy route you could put a different flight on. The way I look at the famous example as always the flight about to leave in one minute and there’s one seat left. What would it be profitable to sell that seat at? A famous example is a dollar or even one-cent as long as you’re not consuming excess fuel in the flight any extra money you bring in is profitable to the company.

Yeah. Because you wouldn’t have sold it anyway. That’s right. Another example would be fuels and energy gas, they are traditionally known as businesses that use revenue management dynamic pricing but that was more on the supply side, they’re using it to manage their supply. How much they should produce and allocate to their distributors etc. But now they’re using it to think closely about forecasting, consumer demands, and what drives people to buy so they can utilise revenue management to be more of a strategic lever. 

When you think of revenue management as almost if you could think of it today as maximising revenue from what you have today. We take an example again of an airline whereby people will accept the prices change based on criteria such as time of day, red-eye flights are cheaper they will accept that flying between two non-main airports might be cheaper and flying over a weekend may be discounted if you do a longer stay. They will use methods to price discriminate between the potential customer to make sure they get every potential dollar revenue out of those customers that they can. If there’s one seat for sale, if you sell it to tourists who may or may not want to go to a certain city versus the business person who has to get to that meeting on Monday at 9 am; the willingness to pay difference could be massive.  

This comes down to customer value drivers, understanding why people are buying. How they’re buying? How they’re buying from? Are they coming through your website? Are they coming through your call centre? What’s the urgency they need to buy? Things like that. 

Looking at revenue management in recent years, a huge amount of technology, computer programs, and analytical data have been applied to that. If you think as Joanna mentioned the number of potential value drivers for those customers it’s much too much for any person to keep in their head. But computer programs PROS as a famous example the number crunch thousand of potential even more. 

Yeah, they do that. But, they first look at segmentation to break this down. They break into what they call micro-segments which are fundamentally like different groups, which you can allocate groups of customers, and different groups of competitors. It’s breaking down the market so you can make it more manageable and you can review the value drivers more systematic way. Then you’ll find out that there’s a cross over between groups and other groups that are not.

Do you think things or great or do you sometimes think your pricing is all wrong? Is this a cold reading?

We ask what are the lead indicators as to whether your pricing is great or failing  - and why asking the question early can save a lot of problems down the line.

Pricing can be the canary in the mine - and it is always best to know early.

In today’s episode, we want to ask the question, How do you know when your business has a pricing problem?

It sounds like an easy question but actually, it’s quite difficult to detect you’ve got a pricing problem. Often business leaders think about pricing right at the very end and they don’t think it’s the problem, but it’s the cause of driver of a lot of other issues. I just wanted to discuss some of the things you should look out for or double-check you’ve got a problem or not. 

When we look at companies, a lot of companies assume they have a pricing problem but one of the best reasons to do this in advance is it’s a lead indicator of future business success. If your business is facing a pricing problem that will suggest that down the line there will be a financial impact, there will be a business success impacts and I think it’s almost a canary in the main concept where it gives you that lead indicator whether they’re at six months or a year in advance. 

Maybe you should always look out for and measure as part of a general financial rigour and check if you’re on the right track. So one of the things you probably should look out for is on the P&L, a very basic, is if your revenue is increasing but margins are declining this is a good sign but potentially you may have some pricing issues.

If you’re selling more and more but the pricing you haven’t reduced it at. This assumes that there’s no huge volume discounts or rebate strategies in play, but to sell more products you are having to discount and reduce your margins. Another aspect of this can be more of a people aspect talk to your sales team, see what they say.  

They might be complaining that there’s a lot of pricing pressure out there,  a lot of competition and they’ve got no choice but to discount a lot of the products even the high-value products more than they want to, it may be the case. It’s a simple sort of cost-plus pricing methodology that isn’t covering substantial price premiums that you could charge or it could be indeed something that you’re struggling to cover the cost of CapEx even though you see your sales teams selling lots of deals and lots of products but you’re just not getting returns there.

I think, especially for more capital-intensive industries whereby you need your business to be the return on investment has to certainly cover the cost of the capital otherwise you will eventually go broke. If you’re investing in a business that isn’t growing, doesn’t have pricing power sufficient to forecast or give you good confidence in ongoing profitable growth that will cover the investment; it’s a ticking time bomb. 

It’s good to think about your pricing power, so you’ll know what price-setting methodology you should use. But it’d be quite dangerous to apply value-based pricing in a margin constrained industry with limited pricing power, you need to think very carefully about your P&L and your price setting methodology. 

I think when we talk about looking at a business and seeing what doesn’t have a pricing problem, the flip side of that is the opposite of a pricing problem is having pricing power. Like Warren Buffet, probably the world’s famous investor he always talks about pricing power in businesses that he looks at. He looks at having protective moats and pricing power whereby that company can either maintain pricing or increase pricing over a short-medium term.

It’s funny that sometimes if you just look at the P&L to determine your pricing power you can think you don’t when you do. This is a sort of a mindset issue, we see a lot of companies that potentially have more pricing power than they think they do but they’re constraining the power of pricing because they’ve got a commodity mindset. There’s that sort of tricky line between looking too much at the P&L to determine pricing power and thinking psychologically about the culture of the business and trying to unlock both, the mindset and the P&L. 

We’re seeing proactive institutional investors, people like private equity. Classically, what they do is the buyer company take on debt and then they try to improve the company through either cost-cutting or improving the commercial focus. And pricing is becoming much more common in that area whereby streamline did the business system but also improve the commercial and pricing approach and pricing outcomes. 

Private Equity now staying in businesses much longer. They growing the business and they look at the pricing when they’re buying a company to see if there is indeed pricing pressure. Once they bought it, they want to grow their business and they’re introducing more sophisticated pricing techniques, value-based pricing, dynamic pricing, to ensure the return on investment. 

We’ll wrap it here today but what I’d like to finish on is that having a pricing problem is not always a bad thing, spotting a problem is the first step of fixing it. Knowing you have a problem that just tells you, you can improve. 

That’s right. When you think everything’s okay or you don’t have a check-in place to make sure things are on track. Ask those questions, look at the P&L, and look at the behaviour of your team to give you a sense of where you’re at with pricing and never underestimate your pricing power. Think about mindset, P&L and team behaviour. 

We know what you came for - it is a chat about value based pricing and what it really means.

Lots of people (from outside the pricing profession) have doubts about value based pricing - and whether it can be implemented in your business.

We give some simple examples that hopefully make it clear what it is all about.

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We want to cover something slightly more, maybe exciting or interesting. We want to cover, what is value-based pricing?

Value-based pricing, it’s a method that people are starting to use a bit more but there’s still quite an element of confusion about what it is.

To some extent, I almost say it’s a bit of a holy grail in the pricing community. A lot of people want to move towards it but they’re still certainly looking in the vast majority of companies there’s a reluctance or a misunderstanding or something holding people back.

Also, something that seems to be in the hands of consultants more than the business community but we’ll get on to that may be a later date.

So Joanna, what is value-based pricing? 

I supposed in theory, it’s a processing method whereby you set your prices based on what your customers perceive as valuable about your products and other people say setting prices based on your customer’s willingness to pay.

You could think of it as a customer purchasing a product or service at a price that they’re happy with. A price that they think is a fair reflection on the “ value “; the value whatever that may be that they are receiving so they don’t feel like paying too much. They don’t care about paying too little but they’re paying too much for the value that they are receiving. 

That’s the tricky part knowing where that best price, that sweet spot of pricing is for different customers because everybody knows we’re all different and we’re all willing to pay different amounts and I think this is where people may be businesses get a little bit sort of maybe confused or a bit reluctant to use it. Because it’s very difficult to know how many because there are thousands and millions of people out there prepared to pay different prices. So what’s the best way to control value-based pricing in a business?

In the last episode we touched on cost-plus pricing and we discussed one of the big pluses of that is it makes sense to many people certainly from a finance background it’s easy to understand.

Easy to use and apply.

Yes and I think this value-based approach it’s almost the polar opposite it sounds, I’ll be honest it sounds hard.

 In many ways, it’s not easy but it’s applying rigour and discipline to the price-setting process.  You need a set of rules, you can’t just dive into it. There’s a science, there’s mathematics, there’s economics, and psychology all involved in that which I think I’m making it sound even harder but I supposed you know to say it’s easy it’s not. 

I think for people who haven’t listened to the podcast you don’t know much about value-based pricing I think we’d like to give two examples that make it clear to you, how it works in the real world. For example, the first one I’ll give is the concept of rebadging cars. In the auto industry, certain factories manufactured cars and they come out of the production line and there’s a different badge stuck on them at the end. What we see is fundamentally the exact same car except a badge can be sold in the same markets at different prices. And, we’re not trying to trick the customer but the customer is actually putting a value on very different things, not just the car itself but items such as brand prestige perhaps financing packages; lots of different things.

I suppose here it’s the job of the business to work out segmentation. Value-based pricing becomes much simpler when you understand your market and you break it up into manageable sort of groups. You group your customers it was from that example you got the same product, it’s pretty much the same it’s just how your customer perceived that product which adds that additional price premium but just because you can add a price premium doesn’t mean you overcharge the customers. I think, very often value-based pricing is seen as an overcharging method but I think that’s incorrect.  Value-based pricing is adjusting prices to the market it’s actually creating fairer prices.

Another example I will give and I saw Joanna commented there she had a new handbag I don’t know about handbags but it appears to be an expensive one and I suppose in that context the cost of manufacturing the bag I don’t know does it even have anything to do with the price of selling. 

Well, again we’re going into psychology here why do people, why do women buy handbags? I suppose it comes down to things like prestige, which could be status, these are things called value drivers. And it’s a job of a pricer to find out what the unique value drivers are and from here set prices based on those types of qualities they’re not always tangible qualities, they’re intangible, psychological value drivers, it can be emotional value drivers and things like that they’re not just financial. 

We’ll finish up whereby we’ll say those items there’s more know on financial reasons that’s something that makes a lot of people certain in the finance profession you know a bit scared I think of value-based pricing but I’d also like to finish by saying I’m very glad that the value drivers driving expensive handbags luxury products don’t apply to me so I don’t purchase them.

Well, I think this also comes down to having a diverse team you do need different disciplines to get involved in the price-setting process so that you can ensure that you’re charging the right price for the product and using a range of different methodologies to ensure that the price is the correct one. 

In this episode of Pricing College - Aidan and Joanna discuss what cost plus pricing really is?

We do not focus on the weaknesses or potential negative impacts of cost plus pricing but introduce the topic.

Cost plus pricing can be as simple as adding a mark up or margin to your costs.

It can be as simple as buying an apple for a dollar and selling it for two dollars.

Cost plus pricing can be very appropriate for simple trading or arbitrage style businesses or for simple retail businesses.

Cost plus pricing tends to be popular with finance professionals as it is easily understood and gives the appearance of common sense and financial rigour.

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In today’s episode we want to cover that seemingly,  very simple question but something fundamental in pricing; What is cost-plus pricing?

A lot of businesses used cost-plus pricing. It’s a very common price-setting method and technique. We won’t go into a lot of detail about the weaknesses of cost-plus pricing but we will discuss what it is.

I think certainly the obvious flaws or problems potentially with cost-plus pricing is something we’ll cover in not one future episode but I assume many. But what we’ll cover today is the pluses of it, how it’s done, and why this is seemingly very efficient and make sense to so many people. 

I supposed in a very simple way it’s a mark-up on your cost; fixed and variable cost. 

Some people say a mark-up, other people try to capture a certain margin but fundamentally it means if you buy an apple for $1 you sell it for $2. You make a profit on each item you sell and at the end of the day, that’s a very sensible business. As you get more complex in business you may not want to make the same profit on every apple but, if you’re selling a thousand apples on average you want to make a profit on each one you sell 

Yes. If you’re pretty confident about your cost position then cost-plus makes sense. It’s just perhaps when markets change, it becomes a little bit more tricky but we won’t get into that right now. 

Fundamentally, cost-plus pricing makes sense in a very simple business that could be a trading business; An arbitrage style business when you buy a commodity and sell it with very limited value add. In that context, if you’re a price taker from purchasing it can make perfect sense. Especially if you have limited ability to influence the price you are selling it out. 

I supposed it’s not about a technique to use. It may be in a retail business as well. In a small retail business you've got relatively few products that you’re selling,  you know your cost. It’s not about approaching your first step into setting prices. 

I think also in this episode, we’d like to cover why is it so popular and why is it so accepted in the business community, and often if you talk to people who are not pricing professionals cost-plus pricing is what springs to mind. I’ll go first in this one because I am an accountant patriot previously and it does appeal to accountants and financial professionals who love looking at cost, P&L and balance sheets. 

In many regards, I think it’s used because it was the first pricing method that ever existed. Makes 99% of the businesses use cost-plus pricing. That’s what people are used to and maybe it’s used because it’s a tradition; a management convention, and some people don’t know that there are other things out there too. I don’t know. Aidan, you’re the accountant, what do you think? 

Thanks for reminding me and I supposed in accountancy people, there is a real dedication to numbers and the seeming solidity that numbers give. So if I see your grills, the CFO wants to know why decisions are being made and basing things on a cost-plus method gives a solidity that makes it seem sensible. Certainly to people who do not have a marketing sales approach or mindset and of course without trying to bash certain professions here. Certain professions are more focused on you know value marketing sales and others; and yeah I think that’s fundamentally it. 

What appears to be quite a rigorous logical approach, is that what you’re saying?

It’s the appearance of a rigorous approach whether that makes sense or not I don’t think matters but, I think we’re straying into some negative territory which I think we leave for a future episode. 

It’s good to find out where this convention started and why people are so dependent on it and I don’t think that’s a negative

In this episode of Pricing College - Aidan and Joanna discuss where pricing is actually set by companies in 2020.

Most smaller companies - i.e. with revenue below $100m per annum do not have dedicated pricing teams - and this is perfectly understandable.

Pricing is often set somewhere such as finance, marketing, the sales team or sales reps, merchandising or commercial departments.

Whilst none of these approaches are automatically wrong - we ask - do you know where pricing is set?

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Following from the last introductory episode on what is pricing, we want to discuss in 2020, Where is the pricing function in most companies?  Where is the pricing set?

Well, A lot of companies don't even have a pricing function. Pricing still can be set anywhere around the business, commonly we see prices being set by sales teams. A lot of prices are also set by finance, possibly marketing, and in retail businesses we've seen prices set in merchandise by category managers, and even merchandise managers. A handful of businesses do have an actual dedicated pricing function. 

We need to state that realistically most companies certainly smaller companies probably won't have a dedicated pricing function. And that's perfectly fine, but when you're starting on a journey of examining your pricing, working out whether you're doing a good or bad job, just even asking the questions to start with, who sets the prices? It’s not always as easy and answers as you might expect.

To have a dedicated pricing function, you're talking about a business with revenues over 100 million-plus so yes, you're right Aidan. If you're a small business, you can't invest in a pricing team but you can invest in your understanding of pricing, educating yourself on some of the skills and the tools that big businesses use. That is why we're having this podcast for everybody.

To begin with, Where in your company prices are set? The next question is, why are they being set in that way? And then a third question will be, are these people incentivised to do it correctly? to help the company? or are they confident? and are they interested? Those are deeper questions that will obviously require more thought but just even asking the first question in your company, who sets the price?

Often we've seen in businesses that do have a dedicated pricing function. But the real pricing manager may not be the pricing manager, it might be the sales manager, the finance director.  Pricing does touch on a lot of disciplines, it crosses many different teams, but you kind of mean a centralised hub of the pricing team to manage not control pricing but, managing pricing.  So that everybody knows where they're at and where they need to go. 

I always think the mark of a good pricing manager or even not requiring that job description but the person in charge of pricing, the need to work with other departments is key to understand what the company does, the operations, the value provided to customers, who the customers are, and work with the marketing department.  There's no point in launching a marketing campaign if you're not tracking the dollars coming back. It's someone who works with, whether there is a dedicated resource or whether they're a shared resource among departments or whoever they report to. They need to be aware that there are so many stakeholders in the company that they have to work with and understand. 

One of the best pricing managers aren’t just like spreadsheet technicians, they get out from behind their desk, and they work with stakeholders to improve skills, educate people on price, listen to key challenges, and try to find practical solutions to businesses problems and connects different teams to the market. 

I think we will end this podcast today with a question to you the listeners. In your company, who sets the pricing?

There's no right or wrong answer here if you haven't got it.  It does depend on the maturity of the business if you haven't got pricing formalised pricing discipline or process set. Then discretionary pricing is very commonplace, but you can take steps and learn new skills to improve that process no matter who you are.