Selecting a Suitable Pricing Baseline

Selecting a Suitable Pricing Baseline

This article is a response to  “When Cost-Plus Pricing is a Good Idea” by Professor Dholakia, Professor of Marketing at Rice University’s Jesse H. Jones Graduate School of Business, and the second in a two part response series written by Navetti’s pricing experts.

The question Should one base prices on customer value, competition or cost? is an oft debated topic. In the world of pricing, there are many schools of thought around this issue and arguments for the benefits and downsides of each baseline can be made convincingly. Because of this, sometimes a quite pragmatic approach on selecting the pricing baseline will help.

In this article, we explore the approaches that can be taken in practical baseline selection in different contexts and situations, and will then use this to build a decision framework for navigating the sea of pricing methodology selection.

Price foundation

The decision on what elements you should base your prices on is one of the most important steps in the price setting process. The decision should be driven by the goals that are set for the product, where consideration needs to be given whether it is a new product or if you are resetting the goals of an old product.

Price Window

Figure 1 Illustration of price window in relation to anchor points

When thinking about the price basis or anchor points for the price, it is helpful to illustrate them in a simple manner, so that they become tangible and easy to visualize. One tool for this is to use an illustration of the price window.

With a price window, it is possible to illustrate concretely what elements need to be considered in setting the price foundation. In practice, one can achieve decent and even good results when focusing on one of the elements only. But by doing so, there is also usually a lot left to chance in the pricing equation. At the other end, of course it would be excellent if every element in the pricing structure can be accurately modelled but doing so for each and every product in the assortment is often an unachievable target. A good and more practical recommendation for calculating the right price is therefore to be aware of all the elements and make a conscious decision about which of them are those that need to be modelled in detail and which can be used on a more general level. As a next step, we will take a look at each price basis and check what kind of considerations can be made when selecting either of them as the main baseline.

Customer value and willingness to pay

Taking customer value, or rather customer-perceived value, as the baseline is a very powerful starting point, and some of the most successful pricing approaches have been done from this angle. The inherent difficulty is to quantify the customer value, as it is not something that is set but represents whatever the customers think it is at any given time. This means that most likely there is no single value to represent customer value, but it is something that changes over time and for each customer.

However, this should not be a deterrence from modelling customer value. There are many good books on the tools and techniques regarding this, for example “Dollarizing differentiation value” by Stephen Liozu. These resources can be used as a guide on how to build your own quantification model.

At the same time, there are a few possible pitfalls in using customer value as pricing baseline that need to be considered. One is making the value analysis from an internal perspective using broad assumptions on customer thinking, which do not always correspond to the actual customer perspective, which can lead to grossly over- or under-estimated customer value figures. Even so, selecting customer value as the strongest pricing baseline is a must for products with high sales and margin creation goals, where the effort and investments needed to investigate customer value perceptions can be easily justified.

Market price

If the market price level is used as the main baseline for price setting, a key challenge is to correctly assess each product’s position and the differentiation value provided compared to the other market alternatives. It is also important for the pricing model’s accuracy and usefulness to make the evaluation as objectively as possible. One possible solution for verifying the results is to make a competitive value survey for the target industry in order to validate the internal vs external value perceptions. A market price baseline is a good starting point in situations where price comparisons are easy to make and commonly performed and is especially relevant for product segments that customers use to create an overall price level benchmark or impression for the full product range.

Cost

Using cost as the baseline for pricing is very resource effective, as in most cases the cost for a product sold is known. Therefore, it is easy to set up a relationship between cost and price. There are, however, a few obvious, and some not so obvious, potential pitfalls when using cost as a pricing baseline. The most common objection to cost-based pricing is that it does not reflect neither customer value nor market price levels. It could also be argued that when cost is selected as the pricing baseline, the pricing decision, or at least a part of it, is outsourced to the suppliers. And can they really be trusted with this? Do they know how to price the products right?

Furthermore, the commercial models used by different parties across the supply chain can significantly differ. This means that even if the same product is supplied, the price will differ based on the cost differences in the business model and structures used. This is actually one of the most difficult questions to manage in cost-based pricing, i.e. how does one select the right cost? A good guide to this decision can be found in the classic pricing textbook by Thomas Nagle, “Strategy and Tactics of Pricing”. Cost-based pricing definitely has its uses and is the right way to go under correct circumstances. One such case is when there is a need for a very simplistic pricing model to be used for setting a vast amount of price points with minimum effort for low-value products which have supportive roles in the product portfolio. However, also in this type of situations, modern software tools can help create the same efficiency, but with a much more fine-tuned pricing approach.

Selecting the right pricing baseline

Given these options and considerations, what aspects should be considered when selecting the best alternative for defining the pricing baseline? Below is a simple and pragmatic framework that helps companies make these initial choices. The purpose here is not to give all the answers for your pricing strategy. Instead, this methodology can serve as a guidebook to help companies get started:

 

  • More anchor points are better. Selecting multiple price anchor points is always better than selecting only one. Simply having two anchor points instead of one greatly reduces the risk of making a pricing mistake due to bad input data.
  • Prioritize analytical resources. If the products to be priced play an important role in the total product portfolio, and hence there are high expectations on their performance, it is wise to invest more resources in research and analysis to develop the right pricing method and baseline selection.
  • Dig for data. What data is available and how can more data be gathered? What resources will this require? Don’t give up easily even if getting to use multiple anchor points seems more difficult.
  • Keep it simple. In the end you need to be able to communicate the justification of the price to your customers in simple terms. Consider how potentially complex calculations can be reduced to simple principles.

Kalle Aerikkala
Senior Consultant

+358 503 771 834

kalle.aerikkala@navetti.com

Boris Antonov
Pricing Consultant

+33 6 42 58 09 66

borislav.antonov@navetti.com

The benefit of having a Navetti PricePoint™ TEST environment

The benefit of having a Navetti PricePoint™ TEST environment

When you are dealing with software development and a continuous delivery concept, having a test environment is recommended based on the industry’s best practices. There are benefits and justifications for this which I will explain in the following section, but first let me explain what we at Navetti mean by a “test environment”.

A Test Environment for Navetti PricePoint™ is an environment that consists of the application and its connected database, and often includes the NAIS™ (Agile Integration Suite) and the integration to the other test ERP systems, the same way that the main NPP environment or Production environment (PROD), is set up. This is mainly because the Test Environment is supposed to work the same way as PROD, so the changes and new development can be tested in a safe and isolated environment before deploying the changes to the main environment.

Production and Test Environments

As part of our Change Management process, we at Navetti always perform quality assurance tests on what we develop or configure before releasing or deploying it, including in our own test and QA environments. This guarantees that the new functionalities and configurations that we are releasing are aligned with the core of the NPP platform the existing functionalities and configurations. Nonetheless, to make sure no surprises happen when we deploy the new development on your NPP environment with your configuration and your data, we use a test environment. When a new release is available, we deploy that first into your test environment, do a smoke test to make sure everything is operational from the application perspective, and then ask you to confirm that everything is working the way it should. Thereafter, and only then, we push the new release to the production environment, where you keep your live data. The test environment acts as a buffer to detect and prevent any possible development mishaps from entering the production environment.

Additionally, when a new member on your pricing team needs to be trained, they can use the test environment to learn your processes, with no concern of jeopardizing the live data. Even experienced users sometimes want to try out new functionalities or processes in a safe and isolated environment, without worrying about repercussions, or how to revert changes. Having a separated and isolated test environment is handy in these situations.

As you can see, there are multiple benefits to having a test environment for your NPP, which is why all our clients have at least two setups. You can of course have as many environments as you need for your business but having two as the minimum requirement is something we strongly recommend.

We also recommend refreshing the data in your test environment with close to real data (normally a copy from production data) at least every six months, to make sure the results of the tests are as realistic and reliable as possible.

If you don’t have a test environment yet, would like an additional environment for your NPP, or want to refresh the data in your test environment, please contact our Navetti ClientCare™ team (clientcare@navetti.com, or open a ticket in our ServiceDesk).

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Arsham Mazaheri
Head of ClientCare

+46 (0) 70 032 63 79

arsham.mazaheri@navetti.com