Pricing Done Right: The Pricing Framework Proven Successful by the World's Most Profitable Companies (Bloomberg Financial)

by Tim J. Smith

Prices are determined by the customer’s viewpoint of value, not the firm’s viewpoint of costs.

Our research has found that leading firms price according to the customer’s willingness to pay, not the firm’s costs to produce.

Serving customer needs profitably is in keeping with the value-based philosophy of profitable pricing. It puts the customer as the key stakeholder in the firm. As for shareholder returns, employment security, or social responsibility, they are the result of a good strategy but not the strategy in and of itself.

Business strategy is the way in which a firm chooses to differentiate itself from its competitors

in a way that results in serving its customers’ needs more profitably than its competitors.

Economic profits are much more difficult to earn than simple accounting profits. Economic profits imply that the firm is earning a higher return on capital deployed in comparison to all other investment opportunities.

To earn economic profits, the firm must, in some way, be better than its competitors. It must have some form of a competitive advantage that enables it to serve its chosen customers more profitably than its competitors do.

In leading firms, strategic pricing reflects their business strategy.

When firms seek to serve customer needs profitably, they usually think in terms of offerings and markets. The choices of which markets to serve, and more specifically, the customer segments within those markets, are strategic choices. Similarly, the offering to deliver and variations in the offering and its price are strategic choices.

Endogenous marketing factors are those over which the firm has direct control. Exogenous marketing factors are issues that are largely outside of the firm’s direct control but have a strong impact on the potential to serve customers profitably with an offering.

Endogenous marketing factors

are the typical marketing mix issues: product, place, promotion, and price.

The exogenous marketing factors have been commonly classified into six different issues, the first of which is obvious to nearly every executive at all times: the competitive environment.

They are known as the technological, political and legal, economic, demographic, and social and cultural environments.

The technological environment

For example, the creation of ride-sharing platforms like Uber and Lyft could not have occurred outside of the technological development and ubiquity of smartphones.

The political and legal environment

Health care reform, FAA drone rulings, net neutrality, and many other political hot-topic issues directly impact the potential for businesses to serve customers.

The economic environment is most noticeable when a company considers cross border trading, but it is also a key factor when considering business cycles and customer demands.

Demography, which is largely predictable, greatly influences market demands.

the social and cultural environment, which influences tastes, needs, interactions, and much more.

Price acts as a wedge determining which customers will be attracted to the offer and which will not.

Aggregating customers by what they value and what they are willing to pay is a form of market segmentation.

A simple segmentation frame in relation to pricing is to classify potential customers as either utility buyers or price buyers.

The easiest market segmentation variables to observe are demographics

in consumer markets and firmographics

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Somewhat more difficult-to-observe market segmentation variables include lifestyles and psychographics.

Lifestyles and psychographics strongly influence how customers evaluate offers and, therefore, what they value and their willingness to pay.

A well-considered market segmentation and, more importantly, a deliberate choice by the firm about which market segments it will serve with its offering will define the firm’s customer strategy.

In every market, a firm faces competition, even if the competition is “do nothing.” To attract and retain customers from competitors, the firm must offer its customers a better value—at least for the customers in its chosen target segment.

In the broader sense of customer outcomes, competition includes any other means the customer can take to achieve the same or a similar set of goals.

cases, executives need to create a still broader definition of competition by not just considering who is competing for their customers, but by considering the entire value chain in which they operate.

Head-on price competition is often bloody with diminished

profits for all parties.

The alternative to direct competition is to identify some means of being better for the chosen target market.

being better requires being different.

the firm must have some differentiating strength compared to its competitors, which is called a competitive advantage.

To achieve a widening of the gap between the benefits customers gain and the costs to deliver those benefits, the resource-based view of the firm indicates that the firm must have some resource or capability that enables the development of the competitive advantage. Moreover, for the competitive advantage to be sustainable, even if for only a short while, the resources or capability that delivers the competitive advantage must be exclusive and inimitable.

consideration. Eventually most forms of competitive advantage are competed around—that is, competitors develop routes to deliver similar benefits to customers without relying on that same source of competitive advantage

This is the nature of creative destruction, first raised by the Austrian economist Joseph Schumpeter in 1942 (Schumpeter 2008). Through the creativity of businesses serving customer needs, existing businesses and institutions are replaced—that is, destroyed—with the new means, firms, and institutions that meet those customer needs more efficiently.

No firm arrives in the market fully formed. Rather, there are early developments that lead to the creation of the firm in its current form.

No two corporations are exactly alike nor can they follow the same path, hence the uniqueness naturally develops from the path dependency of the firm.

Resources and capabilities developed along a specific corporate development path will deliver a competitive advantage to some customers in the market and not to others. Some customers will highly value the output generated by a specific set of corporate resources. Others will not.

This insight drives the importance of fully understanding a firm’s true market segment—

To attract customers in the face of competition, the firm’s goal is to identify an alternative means to enable its customers to reach their goals profitably.

Choosing which resources to develop and how to deploy those resources is a core strategic decision that drives the importance of executive strategic choices.

Executives choose what the firm offers, what markets it pursues, which segments in those

markets it will target, how the offering will be differentiated in those markets, which efforts it will undertake to manage costs, and yes, the price it will accept for its offerings in the market.

In making those choices, executives should start with the assumption that their competitors are just as smart as they are but different. Competitors can and will copy the firm if they see it as being in their best interest. Over time, some competitors will have had the same opportunities as the firm had, but they will have made ...