One fine old pricing guru affectionately known as Yoda would routinely say, “Pricing is the only part of marketing that is not an expense.” Putting it mathematically:
Revenue = ∑ Prices 1:n
Essentially, the management of pricing is the management of revenues. In other words, price management is not about tweaking the price variable to incrementally increase revenues. It is rather about the whole of revenues.
But price is not only about revenues. Price is also the single biggest driver of profitability. Among the top 50 Tech and Services companies, a 1% improvement in price capture translates into as much as a 7% increase in profitability. Compare that to a 1% increase in volume, which results in as little as a 1% increase in profits. Another way to look at is that price capture is as much as 7X more powerful than volume growth in driving profitability.
Now to completely set the stage, I have one more ingredient to add to my witch’s brew: Price Optimization. Revenues and profits optimize at different price levels, leading to a fundamental question in business strategy. Do you want to sell more stuff or make more money? Because of how costs behave in most cases, revenues optimize at a lower price point than profits. To make this concrete for you, in one case of service plans, research revealed that revenues optimized at a $2,250 price and profits optimized at $2,700. At the higher $2,700 price, you sacrificed 11% of revenues, but were rewarded handsomely with a 29% increase in margin. Like I said, do you want to sell more stuff or make more money? That’s your choice.
So why don’t we want price management to report to sales? Because when pricing reports to sales, the business strategy question is not asked and the answer defaults to “sell more stuff”. Think of how sales is evaluated and rewarded. It is revenues, right? Look back at my optimization example. When pricing reports to sales, the natural inclination is to drive toward the revenue maximizing price, i.e. the lower price point that results in lost margins.
Bottom line is that price management needs to be independent of sales. Price is a strategic management decision, and needs to serve the dual masters of revenue and profit. Our number one principle of price management states that “sales and customers must be forced to acknowledge and pay for value delivered.”