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The Price Is Right – so why are you still getting it wrong

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Astonishing discrepancies in the cost of insurance policies for new vs existing customers is a subject that made big news in the UK last year. Contrary to the expectation that long-term customers might be rewarded for their loyalty, they were actually being charged more. And it had nothing to do with them making claims. In response to the negative publicity, insurance companies are now taking action to redress the issue. However, the thing that really stands out for me is the mystery of why nobody, as yet, has apparently explained WHY existing customers were being charged more than new ones?

Different pricing for identical products is by no means restricted to insurance. It’s common in many sectors, with reasons such as promotional campaigns, seasonal factors, demand variances, product lifecycle and market dynamics cited as the basis. Despite the diversity of these drivers, they are usually all categorised as “differences in market conditions”. Which means that when the time comes to ask probing questions, the answers are buried beyond retrieval.

Ignorance is a risky business

There is a saying that “Ignorance is bliss”. But when it comes to understanding why you’re charging different prices to different customers, ignorance is a dangerous information gap. Price variance is a potentially destructive force which can promote uncertainty and distrust among customers, skew behaviour and understanding of your markets, create unhelpful internal competition and prevent you from achieving revenue objectives.

Fuelling instability

For example, if your customers are aware of unexplained price discrepancies, they lose trust in your business and try to beat the system by purchasing from outside their local market or altering their customer profile. This skews your figures and fuels undesirable internal competition which destabilises your pricing strategy.

Avoiding this requires being open and honest with customers about pricing differentials. But you can’t do that until you fully understand them yourself.

Jeopardising business objectives

Another example comes from a global manufacturer I was working for during the aftermath of the 2008 financial crisis. In response to returning one of their worst ever financial results, they decided they needed to increase prices by 8% across the board. (They were one of an exceptional breed of business for whom this was an option!) However they failed to actually achieve this, realising a rise of just 3% in some markets and 5% in others, with none succeeding in meeting the 8% goal.

This failure was put down to “differences in market conditions”, with nobody being able to cite the facts that explained the discrepancies. The response of “Because the market dynamics are so complex, that’s all we could do” was rolled out and, guess what… it was accepted as an excuse.

Our investigations revealed the failure was partly down to a lack of understanding of how the prices were constructed. Simply raising prices by 8% across the board would seem the obvious solution. However, localised price sensitivities meant this was not a viable option. The way to get around it would have been to increase prices by differing percentages based on volume contribution, in a way which would add up to an overall 8% improvement. But without full insights into the underlying cost drivers, such a calculation was impossible.

Accepted ignorance

This accepted ignorance of price differential understanding is a strange phenomenon. Arbitrary reasoning such as “We only produced 1,000 units today due to differences in production conditions” or “We only delivered 50 truck-loads today due to differences in logistical conditions” would never be accepted in any other area. So why let it pass when there’s a failure to achieve revenue objectives? In other areas, the immediate response to such excuses would be WHY? What specific factors prevented us from producing or delivering the volumes we should have been?

Assumption is not enough

In my experience, many pricing policies are based solely on gut feeling, industry knowledge or other non-measurable aspects as to what a particular market will support. This is all worthwhile stuff. But it’s not enough. If you want to maintain good customer relationships and achieve the revenue goals your business needs, you need to get a grip on pricing makeup.

This starts with putting all your actual FACTS on the table, where you can use them as input for reasoned decision making. So you can understand the real factors that lead to price variance, such as volume or LTA agreements, specification differences and freight fees.

Deriving standards from a sea of variables

When we undertook this exercise with the aforementioned manufacturing client, we had a eureka moment when we realised that, in cases such as theirs, a pricing standard is completely absent. And that makes it impossible to measure price variance. Our analysis clearly showed that, due to the variance factors mentioned above, one price doesn’t fit all. The solution is to identify a calculated range based on historical data combined with predicted market conditions, and use this range as the standard.

A high level view of the approach to doing this is depicted in the illustration below. The historical, transactional data (Bottom Up) is combined with the business’s medium-term strategic intent (Top Down).

Top down-bottom up pricing

Once all this data was available and organised (extracted from validated source locations, with agreement on the percentage weighting each factor should contribute to price setting), we were then able to measure price variance, in real time, rigorously and impartially.

An Operating System (regular review structure) was built that brought together all the people who influence price (Product Managers, Pricing teams, those responsible for negotiations) and used their experience to set the right prices (based on the standards).

The outcome of this project was a positive transformation in financial results, which was a great example of what can be achieved when Data-Driven Leadership is used to derive fact-based decisions and enable focus on determining standards.

Come on down!

Using R&G’s Data-Driven Leadership and Operating System approach, you can make sure The Price Is Right every time in your business.

While we have attempted to provide a simple and logical explanation of how to get pricing right, most businesses operate in complex environments which require specialised solutions. This includes creating a data infrastructure and designing an Operating System for monitoring and controlling price variance at frequent intervals.

To see R&G’s thinking in relation to both of these points, please refer to:  Data Driven Leadership by Keith Bestwick –  in which an example from the Food & Beverage industry, which is transferable to other industries, is described.  Also see – https://www.rnggc.com/idex/for information about our IDEX Operating System.

Sam Clarke is a Senior Business Process Consultant for R&G UK

 

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