No. 61 IMD Faculty Capturing Value and Avoiding Commoditization Professor Stefan Michel through Pricing Excellence Research & Development want and how much they are willing to Michael Sorell pay for what they want Michelle Perrinjaquet 2. Economics: Understanding both the internal economics of the company and the economics of the market 3. Pricing management: Setting the right price and making sure that your discounting policy makes sense 4. Pricing psychology: Understanding that it is the customer’s perception of the price While organizations might think they that drives the behavior. understand competitive pricing, potential sales are often lost because of price One company that clearly knows how to competition. The challenge that most use customer insights to its advantage is businesses face is that they cannot afford Bossard, a Swiss-based fastening technology to adopt a lowest price strategy. To compete company that sells screws, nuts and bolts to successfully in today’s global business companies such as John Deere and Tesla. In environment, companies need to achieve a hugely competitive market, it realized that pricing excellence. the only way to stay alive was to capture more value and to price its products according to Google is the world champion of pricing how much they are worth to the customer. excellence. It is able to ascertain from its customers how much they are willing to pay Having discovered that its customers’ and adjusts its pricing to reflect this. This is employees were spending more time the essence of the pricing excellence model. manually lubricating screws than putting In April 2016, around 60 The ultimate goal is to uncover and capture machines together, Bossard teamed up executives attended an the value that is created for each customer. with a chemical company to find a way of IMD Discovery Event to producing fasteners with a lubricant already discuss pricing excellence To succeed in pricing excellence, companies applied, thereby capturing significant value from different perspectives need to develop a set of organizational for its customers compared with the next- and to explore recent case capabilities that are not discussed in books on best alternative. Although the lubricated studies from both B2B and pricing and not generally well known because screws are more expensive, the time- and B2C markets. no one is responsible for them. In order to cost-saving is such that customers are willing develop a pricing excellence culture, it is to pay the higher price. Discovery Events are exclusively crucial to understand these four capabilities: available to members of IMD’s Corporate Learning Network. To find With an operating margin that is about twice out more, go to www.imd.org/cln. 1. Customer data and insights: the industry average, Bossard has clearly Understanding what customers really leveraged its customer insights. © 2016 IMD – International Institute for Management Development. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the permission of IMD. Customer data and insights With all this on offer, it is not surprising that Zoots dry cleaning stores have many In order to capture more value, companies happy customers. The perceived benefits need to understand what their customers for the customer include self-esteem, really want and their willingness to status, hygiene (clean clothes); tax pay for it. One way customers reveal savings (financial savings), “saving the their willingness to pay is through self- planet” (environmentally friendly cleaning segmenting, i.e. they themselves choose solutions), control and time saving the high- or the low-price offer. (convenience, more free time), among others. All this adds up to a higher quality A good example is grocery coupons, which of life and a better family life. offer discounts on specific items for a certain period of time. Coupons are an excellent Pricing economics way for retailers to generate more traffic When the benefits and and sell inventory but more importantly, they According to economists, markets are values are not perceived allow customers to segment themselves governed by the law of supply and demand. by the customer and through their willingness to pay. Often If a company prices its product high, it will the attributes are shoppers cannot be bothered to search for sell less. If a company’s prices are low, it standardized, goods and redeem coupons, thereby effectively will sell more. These are the basics of the and services become choosing to pay the full price. supply and demand curve. Companies commoditized. never know what their demand curve is Most companies do not succeed in going to look like. generating good customer data and insights because greater emphasis is From a pricing excellence viewpoint, the put on product attributes rather than challenge is that the demand curve does on benefits. While attributes are easier not capture customers’ willingness to pay to focus on because they are tangible more. Although customers may be willing and measurable, customers do not buy to pay a premium over the market price, attributes – they want the benefits. For companies lose this value if they give a example, customers of Holcim – one of standard list price to all their customers. the world’s largest cement companies – They would need to have several prices in are not interested in cement, they want a the market at the same time representing street, a bridge or a tunnel. differences in value. The fundamental insight is going from The problem with this method is that focusing on attributes to benefits. When customers will observe the multiple identifying benefits, companies should look prices and choose price over value. To at ways to relieve (what does the customer overcome this, companies need to put hate doing?) and to enable (what does the a smart fence between customers who benefit enable the customer to do?). appreciate value and those who are just looking for a low price. This is one of Zoots, a dry cleaning service in New the most important strategies in pricing England, US offers a list of benefits as excellence – customers who are willing long as your arm. With 45 branches in 10 to pay for value should not be offered a different states, its business model is based low price. on making things simple for its customers. In addition to dry-cleaning and laundering, Pricing management its services include alterations, shoe repairs, draperies and upholstery. Not only does it When the benefits and values are not offer home delivery and pick up, but many perceived by the customer and the stores also offer a drive-through service with attributes are standardized, goods and treats for kids and pets. For busy clients, services become commoditized. According a 24-hour drop-off and pick- up service is to Professor Michel, “Commoditization is available with automated machines and a bad word. It is procurement’s weapon to lockers accessible with a credit card. make you lower your prices.” Page 2 www.imd.org insights@IMD One way to achieve pricing excellence Another aspect of pricing psychology is the through pricing management is to “price carrier” i.e. what you put the price reduce harmful discounts. According to tag on. This is important because it is not Professor Michel, there are only two types always possible to put the price on the value of discounts: “stupid” ones and smart you are creating for the customer. For some ones. By eliminating the “stupid” ones, customers, for example, an important part companies can increase their margin of the McDonald’s experience is the play Pricing management is by an average of 1%. The problem is that area it provides for the kids and the free perception management. in many cases, the harmful discounts Wi-Fi, but the fast-food chain only charges have become part of the organizational its customers for food and beverages. culture making it difficult to identify and eliminate them. Another example is Nespresso, which has changed the price carrier from a kilo If you offer a discount, you need to make of coffee to a cup of coffee. Nespresso it more difficult for customer. Airline tickets aficionados, for example, are happy to pay are a good example. While most airlines €0.60 for a capsule, i.e. an incredible €140 offer discounts, these usually come at a per kilo of coffee. The price carrier decision price, for example requiring the consumer is a fundamental part of pricing excellence. to fly during off-peak hours or only being available on certain days of the week. Frequent dilemmas in pricing Flights are offered at incredibly low prices to excellence begin with but gradually increase in price as time goes on. Since passengers are often In many companies, the full potential not able to book flights months in advance, of value-based pricing is not exploited they are forced to pay the full price for last- because different stakeholders have minute bookings, luggage, etc. Another competing objectives, inevitably leading example of “willingness to pay.” to pricing dilemmas. Participants identified some of the dilemmas they have Pricing psychology experienced in their own organizations: • Short term vs. long-term customer There is a tendency to believe that it is management the price that drives consumer behavior, • Discount vs. cash flow but it is in fact the customer’s perception of the price that drives their behavior. • Price consistency vs. make the sale Therefore, pricing management is also • Profit per SKU vs. profit per customer perception management; it is important to • Internal vs. external forces know how people perceive price. • Profit vs. mission The price carrier decision A good illustration of this is a customer • Everyday low prices vs.