Marketers should reconsider pricing and think behaviourally

22nd Jun 2009

Prices are the key marketing variable to consider in a tight economy but just as marketers are readily embracing behavioural targeting in their digital channels, they need to use behavioural principles to set price structure in a customer-centric way, says Rod Street.

Price structures are often taken for granted, especially in many B2B companies. I remember working with one firm a few years ago where, when they raised their wholesale price by 6%, their realised prices might go up by 2-3% but they could not be sure in advance by how much prices would actually rise!
This is not seen as unusual by many companies. Yet, this lack of precision often means that businesses price essentially in line with their input price inflation - i.e. cost plus – rather than with a real focus on how price shapes customer behaviour. This can happen even when companies go through a sophisticated annual planning process.
The chief customer officer needs to change this approach by reconsidering price structure. Just as marketers are readily embracing behavioural targeting in their digital channels to improve profitability and the customer experience, leading companies are revisiting their price structures with similar behavioural principles in mind.
It can be very attractive. A more customer-centric approach allows price to fulfil its economic role – shaping behaviour to allocate resources effectively – and may offer a ‘win-win’ to both sides of the transaction offering growth and value.
Pricing powerfully shapes behaviour
Behavioural pricing looks at how the structure of charges aligns the interests and opportunities of supplier and customers. For example, with airlines, we have all become aware of the ‘auction’ style pricing that the likes of Easyjet and Ryanair introduced – allowing the seat price to reflect the value of immediate supply and demand. However, we have perhaps not yet paid quite so much attention to their other pricing innovations.
They have unbundled many other aspects of ‘price’ to align customer behaviour and supplier economics: queuing, checked luggage, pre-assigned seats, card payments, printing your boarding pass, sitting together. All are priced separately and now shape consumer behaviour. If well executed, this sort of approach enables customers to match their needs and the supplier’s offer much more closely. At the same time, this can benefit the supplier too, enabling much better control over the profitability and growth of the business.
Without this philosophy the low cost airlines would never have taken off [sic]. However, this approach is not by any means restricted to travel and transport. In other industries it has allowed customer and supplier to choose their value and eliminate unnecessary costs in the supply chain - something that is good for both sides!
For instance, companies like P&G and Unilever have already adopted this with retailers. Their trade terms structure helps them better manage the margin pressure generated by the buying power of the mega-retailers. Their prices only enable customers to access best terms if they work with them in the optimum way – prices allow for full trucks, layers and pallets, payment terms, joint business plans and information sharing, promotional features, order efficiency and forecasting.
Other structures apply in leading automotive supply companies, chemicals businesses and in the telecommunications industry. In each, though, companies look to create structures that ‘reward’ efficient behaviour from customers and charge for that which generates cost and disruption. The best are roundly customer-centric in focus too.
Aligning behaviours with opportunity
This approach offers significant profit, growth and service enhancement opportunities for suppliers and their customers by aligning behaviours with opportunity and cost drivers, improving control and encouraging information sharing. The benefits can be substantial and it can improve the structural position of supplier and customer in the industry. This approach and its supporting operating model allowed the low cost airlines to achieve a 9% point operating cost difference over full service airlines. The result has been a market share growth engine and robust defence to the vagaries of the airlines industry.
In consumer goods companies, it has helped generate one-off revenue growth of 3-4% and even larger immediate cost/margin benefits, which have also been sustainable. On the customer side, the benefits can be equally attractive, so long as customers work with the supplier to optimise their buying terms - hence the behavioural aspect! Through this, pricing can become much more effective for all parties.
However, this is a major change for most businesses that must be managed with great care to avoid upset to customers and profit erosion rather than improvement. The keys to success are:

1. A well administered price process
Recheck your current process. A large number of prices below ‘floor’ guides, discrepancies on account profitability and significant invoice disputes are all a good guide to process problems.

This can often be the case where on and off invoice deductions and retro payments can radically alter actual prices paid. An effective process is needed to manage this. The solution may be one of the newer software pricing tools for administration and authorisation to ensure deal pressures do not undermine policy and a proper control environment. Well controlled price files, authorisations and clear price setting processes are an essential foundation for change.
2. A clear understanding of your own, competitor and customer cost drivers
Understanding how customers view ‘prices’ is vital to identify a win-win approach to change. Detailed customer interviews, working with selected customers to understand how your product and service elements impact their business and picking the brains of your most knowledgeable customer-facing staff are the foundations for a customer centric structure.
When combined with an understanding of your own costs, this can be translated into a strong, logical framework, often offering unique advantages if you do your work well – from the cost advantages of full truck loads to O2’s targeted text bundles (focused on younger mobile users).
3. Model the new price structure
A good understanding of costs and customer responsiveness is needed to change price structures. The pricing elements and their levels can have a huge impact on profit and it is vital to model scenarios, sensitivities and transition. But this needs good data and insight.
New tools have emerged over the last few years that can help. Many companies already run sophisticated analytics to optimise prices – analysing the elasticity of demand to help set better prices. Combined with good customer and costs data, this can help derisk the change.
4. Communicate and sequence carefully
In making the change, good communication both internally and with customers is another foundation. Explaining, co-opting and negotiating is critical, as is choosing the sequence for engaging segments. In almost every case, it becomes important to tackle the difficult areas first or risk too many challenges to your profit position.
Addressing price elements and reviewing customer behaviour generated by current pricing opens up constructive new ways to partner with customers and generate total value chain savings. Most importantly, it will help to ensure that you end up with the customer behaviour that you would like to have - and with current market conditions, that can be worth even more.
Rod Street is partner at IBM Global Business Services. In over 20 years of consulting he has worked with the likes of Unilever, Nestle, Samsung, Philips and Glaxosmithkline, and is the author of the recently published book on customer experience across channels - The Multichannel Challenge.

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