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

The Importance of a Vision

The Importance of a Vision

This strange, but apparently now normal, hot summer of Europe is almost over – at least in Sweden! Now it is more like the “traditional” summer that I’m used to have here in the Nordics, meaning a moderate to chilly temperature with some cloudy days and a few drops of rain here and there.

In February I held a training session at our Development Centre in Skopje, and last week I once again had the opportunity to arrange some team training. (The cold weather in the Nordics had nothing to do with my escape to warmer climes, but I wasn’t objecting.)

The reason I share these updates about our training sessions publicly is because we have a lot of people working tirelessly behind the scenes in ClientCare to ensure that our clients’ experience with us is always a good one. Transparency is important to us, as is your understanding of our processes and the effort made to deliver what we promise.

Our training session last week started with a re-cap of the most important highlights from the last gathering, including training regarding our procedure, how we communicate with our clients through different channels, as well as risk awareness of working with live data (i.e. the data in your production environment). We then went through the information regarding the new processes and improvements that have been recently implemented in our procedures at ClientCare.

Afterwards, we did a group activity to highlight the importance of team work as well as clear communication in the team. We as a team practiced how a clear communication can contribute to efficiency and the speed of performing a task. As the results of the activity, we also learned how trust between team members could be one of the fundamentals for a team to function well; and that in a team no one takes the credit or the blame individually; it is the team, as an entity, who is responsible for results and performance.

Our training session last week also had one additional type of workshop – one to define the mission for Navetti ClientCare™.

We believe every service team needs both a vision and mission. Or better to say, every efficient service team needs them. Vision acts like a compass for a service team in every moment and every situation, that shows everyone in the team which direction they should aim for. This is at least the way Jeff Toister of Toister Performance Solutions describes it. Mission, on the other hand, works as a roadmap for a service team, so the individuals never get lost or go astray in their daily work and interactions with clients.

The journey of defining the mission for our team started about five months ago when we distributed an electronical survey to the whole company to collect insights and opinions. With that in mind, we continued our training session by workshopping the definition of the mission for our team. It was important that every single one of us on the ClientCare team participated in defining our mission. That way we all believe in it and work towards it.

The mission is still a work in progress, with much to do before we can communicate the results publicly, but we are almost there; and you will soon also be informed how Navetti and the ClientCare team vision a good and virtuous service.

I look forward to sharing our new vision and mission once it is ready for you.

Enjoy the rest of your summers and brace yourselves for hopefully a “traditional” winter. After all, as fans of Game of Thrones like to say, “Winter is coming!”, albeit slowly! 😊

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Arsham Mazaheri
Head of ClientCare

+46 (0) 70 032 63 79

arsham.mazaheri@navetti.com

The Hidden Costs of Cost-Plus Pricing

The Hidden Costs of Cost-Plus Pricing

In his article “When Cost-Plus Pricing is a Good Idea” Professor Dholakia, Professor of Marketing at Rice University’s Jesse H. Jones Graduate School of Business, makes a solid argument for why cost-plus pricing is a viable pricing strategy, and why it can be better than the current trend of customer value-based pricing strategies. He advocates three main reasons:

  1. It is easy to calculate, implement and justify
  2. It does not exploit market imbalances
  3. It helps support a low-cost strategy

Let me therefore start by saying that I do agree with him that cost-plus pricing can be a viable strategy in some situations. However, modern pricing strategy, and the software used to support the strategy, has to balance at least three different C-factors in determining the ”right price”: Cost, Customer value and Competitive situation. Relying on cost only has some obvious disadvantages, where the most important include the inherent lack of customer focus and non-consideration of competitive offers. But even the advantages outlined by Professor Dholakia are not as clear as they might seem. Let’s examine each one of them in more detail.

Is a cost-plus strategy easy to calculate, implement and justify?

If all products sold have the same characteristics, cost-plus as a percentage of purchase price might be an easy method. But in many cases the product portfolio is more complicated than that. Take for example the wines on a restaurant wine list. Many restaurants want to offer a selection, from low-cost/high-volume house wines to more premium first growth estate wines. However, adding a standard percentage rate to the purchase price of all wines would make the price of the premium wines prohibitively expensive, so many restaurants either use a combination of percentage and actual dollars (or euros, pounds, kronor etc.), or have different calculation models for different price ranges, to set the menu price. The same situation applies for most retailers and manufacturers, where there is a need to balance the pricing strategy for a smaller range of high volume/high inventory turn-over items – and usually fierce competition from a multitude of other companies with similar offers – with a large selection of low-volume/long-tail products where competition might be more limited.

Another classic example is the business where I have spent many years of my working life, i.e. marketing consultancy and communication agencies. Initially the standard remuneration method for an ad campaign was that the agency fee was calculated as a percentage of the media cost for the campaign. This worked reasonably well for a while, but increasingly there became to be a disconnect between two types of cost: the manpower and other resources used to plan, create and produce the communication activity, and the cost of the media channels used to deliver the communication to its audience. Increasingly, many agencies have therefore turned to the classic time-based/hourly-rate model, but even this simple cost-plus model is seriously flawed – as are most time-based models for expertise services.

The fundamental issue with time equals cost is that thinking time and experience are very difficult to allocate with precision. Manual labor, such as the time it takes to dig a hole, is reasonably straightforward to calculate on a cost basis, but how about the time it takes to come up with a good idea for a marketing message? If the team working on the project comes up with a great idea quickly, should this cost less than an equally talented team working longer on the same project before they find they right message? Or is a complicated idea, requiring more manhours to produce and execute, automatically better and worth more than a simple idea requiring fewer hours?

Another classic problem with cost-plus models, especially in manufacturing, is how to allocate the overhead costs. Should this be done on a pro-rata basis (i.e. where overhead cost are shared equally as a percentage factor), on a cost analysis basis (i.e. costs shared “fairly”, based on an analysis of resources used), a combination of these, or any other form? Hence, whilst “cost plus” is easy to say, it is actually often a lot harder to define and implement than what it might seem at first. And if it is hard to define the method used for calculating what would be called a cost-plus strategy, the consequence is that it will also be difficult to be totally transparent about how it is done, and how to communicate and justify the method.

Do other strategies exploit market imbalances?

Professor Dholakia uses the examples of, among others, Uber and Coca-Cola to argue against market-based pricing. However, the customer frustration – sometimes even rage – that ensued demonstrates that Uber and Coca-Cole did not practice customer-value based pricing at all, but rather a form of opportunistic pricing. Pricing based on perceived customer value recognizes the balance of needs between supplier and buyer, whereas opportunistic pricing means get as much as you can and do not worry about long-term relations or customer satisfaction levels.

Most consumers understand the laws of supply and demand, and appreciate that prices can vary, but only within certain socially acceptable limits. If there is a shortage of a commodity, whether it be because of production issues, increased demand, change in competition or other reasons, consumers accept that prices will rise – but only to a level where they feel they are not being taken advantage of. This is the implied social contract of reciprocity and fairness that we – and most social animals – base much of our relations on. What this revised price level is, and how quickly it changes, is something that a sophisticated modern pricing system can accommodate and help pricing managers stay on top of. And incidentally, the response from the customers of Uber and Coca-Cola showed clearly that these companies were not using a customer value-based strategy, as the customers quickly let the companies know that their products were not worth the money they wanted to charge.

Does cost-plus pricing support a low-cost strategy?

Professor Dholakia argues that if you want to be a low-price player that uses a cost leadership advantage in the market, it helps to use cost-plus pricing to convey this position. However, he seems to get (at least) two different strategies mixed up in his argument. On the one hand there is the strategic position of being the low-price leader in a market, and on the other there is the strategy of cost-plus pricing. They can be related, but he does not present evidence for neither the full relation nor the causality. In some situations, a low-price position comes with attributes such as lower service levels, reduced product range etc., as these are both means to achieve lower costs and ways of demonstrating that low cost comes at a price. Incidentally, it should also be noted that low cost is not the same as superior customer value. In fact, and this is a common semantic mistake that sometimes even professors can make, EVERY successful brand delivers superior customer value, as value is defined by “what I get” vs “what I pay”. Successful brands would not be successful and achieve sales growth if they did not deliver superior value for their customers, irrespective of at which price points they compete.

Professor Dholakia uses Costco as an example to make his point, as they use – and communicate – a cost-plus strategy to support their role as a price leader. But a sample of one is not the same as evidence that cost-plus is a better pricing strategy, or even necessary, for a company that wants to be perceived as a price leader. This can easily be shown by using another example of a well-known company that pursues a price leadership strategy through low operational costs, but which does not talk about a cost-plus strategy. IKEA is a global home furnishings success with its “democratic design” philosophy and its desire to make good design affordable and available to all. One of its ways to prove its operational cost leadership is its clear strategy of “if the customer does some of the work they get to keep the savings”, demonstrated by elements such as its flatpack design and open warehouse store structure. Another detail is its focus on “the first item we design in a new product is the price tag”, i.e. how its designers always look for ways of keeping costs down without compromising on quality or performance. In other words, IKEA communicates very clearly how the company is a cost, and low price, leader, but it does so without using a cost-plus pricing strategy.

In summary, it is clear that cost plus has its role as a pricing strategy in a number of instances, for example for complementary products or where the real customer-perceived value might be difficult to assess, due to low volumes, special buying conditions, or otherwise. And more importantly, cost should of course always be considered in every pricing strategy, in order to find the right balance between cost, customer-perceived value and the competitive structure for each product and for the total portfolio. But even when a cost-plus pricing strategy is used, one should be careful about what the real advantages are, and what alternative strategies exist.

Mats Rönne
Marketing

mats.ronne@navetti.com

Business as Usual

Business as Usual

By now I assume all of you know the news:

Vendavo acquired Navetti

The news is short but powerful: Intelligence Pricing made simple

 

Vendavo Acquires Navetti

 

I personally believe that when two the leading providers of intelligence pricing platforms in the market join forces, only good can come of it.

 

Navetti and Vendavo

 

Both Vendavo and Navetti have worked to generate resources that shed light on what this new partnership will look like, including an official announcement video and a webinar, to answer the questions that current users of PricePoint™ may have had. In short we, now as a single and united entity, have even more competence and resources than before, under one single roof, to support you in your pricing activities.

If there is one message I want to highlight for our clients at this point, it is the message that was communicated by our CEO, Andreas Westling, during our 2018 User Conference: “Business as usual”

 

Business as Usual

 

We will continue with the same improvement plans that we had for our SaaS environments (our cloud-based solution) before the acquisition. As a matter of fact, we have recently recruited a dedicated database administrator, Ranjana, and she has already started the improvement processes to our servers that will ensure we not only maintain the same level of performance as we grow, but also continuously improve performance in the long run.

We are currently taking advantage of the slow summer months, when the load on our servers is at its lowest, to do some housekeeping activities. We have started upgrading our SQL server, full defragmentation and re-indexing of our databases, regrouping them for daily backup process, re-evaluating and rescheduling the daily backup times to have the least interfere with normal user experience, and much more. We are convinced that the combination of these activities will excel the performance of our SaaS solution in long run. You may notice some interruption or sluggishness in your PricePoint tool during this summer as we are performing all these activities, but we promise to do our best to minimize those effects, as well as to inform you regarding any upcoming interruption.

So, rest assured that ClientCare will continue to do our “business as usual”. We will continue to provide the services and support to the users of PricePoint™ as we have up until this point, using the same tools and communicating through the same channels as before, including the Navetti Service Desk, Navetti Knowledge Center, and your Navetti Account Responsible, and we look forward to bringing you a larger, exciting array of solutions thanks to our new partners.

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Arsham Mazaheri
Head of ClientCare

+46 (0) 70 032 63 79

arsham.mazaheri@navetti.com