Key Takeaways
- A strong pricing structure creates logical price points, tiers, and fences that help businesses capture more value without sacrificing volume or margin.
- Move beyond cost-plus pricing by aligning prices with customer value, willingness to pay, and market conditions.
- Use customer segmentation, price fences, and trials to create pricing flexibility without adding unnecessary complexity.
- Regularly test and refine bundles, offers, and price points to identify profitable opportunities across customer segments.
- Clear market positioning is essential for professional services firms to build a pricing structure that reflects the value they deliver.
A pricing structure is the way a business organises prices across its products, services, customer segments and offers. A well-designed pricing structure creates logical price points, tiers and pricing rules that help businesses capture customer value while protecting volume and margins.
Many businesses, however, have pricing structures that have evolved over time rather than been deliberately designed. This can result in inconsistent price points, excessive discounting, limited pricing flexibility and unnecessary complexity. Redesigning the structure can help businesses align prices more closely with customer value, willingness to pay and changing market conditions.
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Since COVID, many Australian businesses have faced greater pricing pressure and changing customer expectations. Yet many existing pricing structures still rely on broad cost-plus logic, inconsistent price points and limited fences or tiers to distinguish value across products and customer segments.
This article explains what a pricing structure is, how different industries use pricing structures, and how to develop one that supports profitable growth.
You’ll learn how to:
- Understand the role of price points, tiers, fences and customer segments in a pricing structure.
- Use industry examples to identify different approaches to pricing structure design, including B2C airline pricing, electricity and B2B industrial pricing.
- Develop and redesign a pricing structure based on customer value, willingness to pay, market conditions and commercial viability.
- Identify the pricing capabilities and team roles needed to manage complex pricing structure redesign work.
A poorly designed pricing structure can create inconsistent prices, excessive discounting, unnecessary complexity and margin leakage.
As customer behaviour, markets and business models change, businesses need pricing structures that provide flexibility while maintaining clear relationships between prices and value.
By the end of this article, you’ll understand what a pricing structure is, what makes one effective, and how to redesign it to improve profitability.
How to Create a Pricing Structure in 5 Steps
Creating a pricing structure starts with understanding how different customers value your products or services. The goal is to create enough flexibility to reflect differences in willingness to pay without making the structure unnecessarily complex.
The five steps are:
- Understand value across customer segments. Estimate the value different combinations of benefits represent to customers, then test those assumptions using customer research, CRM data and won-loss information.
- Develop price and buyer fences. Use criteria such as purchase timing and quantity to allow different customers to qualify for different price levels without making the structure unnecessarily rigid.
- Check commercial viability. Test the structure with lower-risk customer segments and assess whether additional offers generate enough incremental profit to justify their cost and complexity.
- Unbundle value when necessary. If a bundle is reducing rather than improving profitability, reconsider the offer and test a new price-offer structure.
- Align features and services with the market. Compare bundled and unbundled options and assess what generates the most money, remains practical and benefits the customer base.
These steps provide the foundation for the more detailed pricing structure analysis and industry examples discussed throughout the article.
Table of Contents:
I. What Is a Pricing Structure?
II. How to Create a Pricing Structure
III. Pricing Structure for Professional Services
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What is a Pricing Structure?
A pricing structure is the way a business organises its prices across products, services, brands, categories and customer segments. It provides the framework for determining how different price points relate to one another and how customers qualify for different prices or offers.
A well-designed pricing structure connects pricing strategy with the products and services a business sells. It can include price points, tiers, bundles, discounts, price fences and pricing metrics that help a business respond to differences in customer value and willingness to pay.
What Makes a Good Pricing Structure?
A good pricing structure creates logical relationships between price points. This is known as price relativity. Products within a category are often interrelated, so their prices should also follow a logical relationship. This means SKU price points should be ranked and grouped using clear pricing rules, with each price positioned appropriately relative to other products in the same hierarchy.
The relationships between SKU prices are part of price relativity. In a good pricing structure, relationships between SKUs can help identify appropriate product and price groupings. Each price point should be calculated and positioned logically within its category and in relation to other products in the overall pricing structure.
Relationships between SKU prices can be organised around an anchor product within the overall product category. The anchor product acts as a reference point for price setting within the category, helping establish the price level and guide the positioning of related SKUs.
A sophisticated pricing structure varies not only the price, but also the offer and the criteria customers must meet to qualify for it.
Applying pricing rules and criteria to a pricing structure is based on pricing logic, including price relativity, price fences and detailed price data analytics. Fences are an important aspect of a pricing structure because they help prevent a business from cannibalising its own products and brands. Fences and tiers also help businesses distinguish price levels across categories and match the right price point with the right product.
Price tiers are another important way of organising a pricing structure. Price tiers enable a business to organise products and prices into a good-better-best structure and can also be used to differentiate customer groups. Both fences and tiers are important for optimisation and segmentation. Without them, pricing can become inconsistent, with random or scattered price points creating unnecessary complexity.
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Prior to 2005, most businesses didn’t really have a robust pricing structure.
Even to the present day, many companies operate without a robust pricing structure and list price strategy in place. We would estimate that:
- Around 60% of corporate pricing structures do not have logical price relativities between SKU prices or product categories.
- Over 70% of product hierarchies are too flat (i.e., one or two tiers)
- nd over 50% to 70% of pricing data structures in leading corporations are largely unusable or incompatible with price optimisation software.
More often than not, businesses without a well-thought-through pricing structure lose margin through excessive discounting or poorly enforced cost-plus pricing. SKU prices are commonly all over the place and/or many sales teams prefer to negotiate different prices for the same line item (i.e., interactive pricing or haggle price) rather than organise their prices into a good pricing structure.
For example, it is not uncommon for sales teams to distrust their existing price lists and pricing structures and ‘go off list’ to set customer invoice prices themselves, otherwise known as discretion pricing.
Many businesses still believe a pricing structure restricts their ability to adjust prices
There is a common misconception that a pricing structure doesn’t give sales teams the flexibility they need to negotiate prices with customers. This is not necessarily the case. A segmented or tiered pricing structure is a great way for sales teams to charge different prices to different customers and for different amounts without over-charging or underselling an item or bundle.
Different types of pricing structures
Airline pricing teams have long employed a segmented price structure similar to a hotel pricing structure. A segmented pricing structure enables airlines to maximise the revenue they can earn from different customers based on capacity utilisation and yield management.
The pricing structure for an industrial equipment and engineering company, conversely, derives much of its revenue from winning bids and tenders and renewing high-value and volume contracts.
In this instance, the pricing structure analysis process would cover areas such as:
- discounting
- rebate mechanisms
- go-to-market strategies
- won-loss analysis
- tracking distribution centres and branches
Fuels, commodities, rental car, tourism, retail, and even some industrial supplies and heavy machinery businesses (like John Deere, Hilti and Caterpillar) have for a long time now used a segmented pricing structure for their “value-add” services as well as traditional product portfolios.
A key benefit of a segmented pricing structure is that it encourages customers to pay a price aligned with the value (perceived value) that different customer groups place on a product or service, using concepts such as value at use and value at risk.
Electricity Pricing Structure Example
Wholesale electricity pricing structures provide another example of how pricing structures can be redesigned. Typically, an electricity pricing structure is designed around complex cost structures. These include their operating costs, including the fuels used by power plants to meet the demand for electricity. However, another important fence typically applied in most electricity businesses’ pricing structure is time. A time fence in a pricing structure is used by electricity businesses to encourage customers to buy in off-peak hours or when the business needs to balance or utilise capacity or prevent outages.
However, because most energy operations still exist within a system-wide wholesale market, price signals tend to be aggregated and pricing is still fundamentally fixed. This often limits price-setting because customer invoice pricing tends to be fixed too with only off-peak pricing exceptions.
In the past couple of years, however, there has been a wide-scale disruption in the electricity market and the concept of optimising based on demand is being scientifically tested and trialled. In New York City, for example, local government and private businesses are working with consultants to design a smarter market. These changes are also changing perceptions of value in the energy market and more importantly, willingness to pay and price setting practices.
New York authorities are developing a new system, called “The Grid”. This new system will completely change current electricity pricing structures and revenue models, including how people perceive the value of energy.
The “Grid” will integrate the state’s increasing number of distributed energy sources into a dynamic centralised operational system. It will include wholesale energy and alternative sources.
Sources such as:
- power plants (wholesale market)
- solar rooftops
- battery storage
- household generators
- and virtual storage (renewable energy sources)
Together these power systems will constitute resources that can be used to help the state’s electric power system accommodate the swings in demand and supply that are part of the natural daily and seasonal cycle.
How Electricity Pricing Structures Can Become More Dynamic
It’s only a question of time, then, before all electricity pricing structures are highly dynamic and focused on the needs and values of consumers (value-based pricing).
A major driver for introducing dynamic pricing in the electricity and fuels market is that the cost to produce energy is decreasing. The cost of production will decrease even more with streamlined production and integration into a dynamic, centralised grid. It will not be commercially viable for authorities and private businesses to set customer pricing based on their costs anymore. The reason is that their cost positions will be too low and they won’t make enough margin.
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Implications for Pricing Structure Development
A centralised grid system will inevitably enable pricing and operations teams to identify more revenue and margin opportunities and operational inefficiencies than ever before:
- There will be significant supply efficiencies even in remote areas that are difficult to supply, as well as in metro areas that experience frequent “brownouts”.
- Electricity wholesalers will massively decrease their operational costs.
- Government and pricing teams will be able to monitor individual consumption of energy.
- Private businesses will find supplying energy to remote areas more appealing. This is because they’ll receive more money (not less) for doing so.
- Teams will have localised data to read pricing signals occurring across the grid in real time.
- Authorities and private businesses will be able to rapidly identify price realisation opportunities that are typically obscured by a system-wide wholesale market and aggregate data.
- Pricing structures will include regional capacity metrics allowing more granular customer-focused pricing.
And, of course, people will finally get the cleaner energy they want and even in remote locations.
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Detailed Steps for Creating a Pricing Structure
Redesigning a pricing structure for complex markets, like the energy example discussed above, will involve complex pricing work.
A segmented electricity pricing structure (like the one discussed above) has a vast array of price-offer configurations, price metrics, and fences. Each will be appropriate for addressing different reasons for the existence of value-based segments.
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Below are just a few key steps and tips you’ll need to consider as you’re creating a segmented, value-based pricing structure for products or services:
1. Understand how to create value for different customer segments
- Estimate how much value different combinations of benefits could represent to customers. Then test your assumptions using customer research, CRM data and won-loss analysis.
- Then, identify differences in the potential contribution that can be captured from different customer segments.
- Consider which price, performance-based and tie-in metrics are relevant for your business and industry.
- (Remember: Value received is sometimes not even related to differences in the quantity of the product bought. Research shows metrics tend to align most with how buyers experience value: ‘Value in Use’ and ‘Value at Risk’, rather than features and benefits.)
2. Develop appropriate price and buyer fences
- Think of fences as criteria customers must meet to qualify for a particular price or offer.
- Use purchase-time and purchase-quantity fences, such as volume discounts, order discounts, step discounts and two-part prices.
- Remember: You’ll need fences in your pricing structure to allow you to charge different customers different price levels for the same products and services using the same metrics. Fences actually give your pricing structure flexibility and sophistication (even though the term ‘fence’ suggests rigidity and restrictions).
- Test different offers or options for select customer groups
3. Check if your pricing structure is commercially viable
- Choose low-risk customer segments (i.e., price trials, customer value discovery exercises and simulations). Make adjustments to your price and customer segmentation, as required based on the findings from your trials and tests.
- Analyse whether the “additional offer combination” costs more to administer than the incremental profit it would generate. Pay attention to differences in cost-to-serve. Is it easy to measure and enforce? Can you generate favourable positioning versus the competition with a tiered pricing structure?
- Aim to capture the best possible price from each segment while keeping the cost of selling and serving customers commercially viable.
- Refine the price-offer structure for different segments (generally, customers are self-selecting; if they don’t tell you what they want, they’ll certainly tell you what they don’t want).
4. Strategically unbundle value when necessary
- For other segments, strategically unbundle value if a bundle in a particular segment is undermining rather than enhancing profits. To do this, determine the right offer and price for the offer based on detailed competitive and customer intelligence.
- Then configure a new price-offer structure and test it with relevant customer segments.
- Leave room for customers to customise their offers by selecting the features and services they value most.
5. Make sure the features and services align with the market and customer base
- The end goal here is to evaluate bundling alternatives versus unbundled products and services.
- Evaluate which option generates the strongest commercial return, remains practical to administer and provides meaningful benefits to the target customer base.
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Implications
If you’re not sure how to build a pricing structure, consider appointing a pricing manager to help you. Pricing structure development requires specialised pricing expertise, particularly when businesses are redesigning complex product, service or customer-segment pricing.
But remember, if you go down this path, pricing management roles are wide and varied in their remit. Senior commercial pricing executives, for instance, tend to have great change management and strategy development skills. Some pricing team roles, conversely, are more technical and are better suited to pricing structure redesign work.
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Conclusion
In this article, we discussed how to create a pricing structure that reflects customer value and business differentiators rather than relying solely on cost. A well-designed pricing structure can help businesses improve price realisation and revenue across customer segments.
Price structure development is one of the most important pricing activities undertaken by a world-class pricing team to improve profitability. While designing an optimal pricing structure for services and products seems difficult, it’s also potentially the most rewarding aspect of pricing strategy.
For companies launching offers with differentiated benefits, you’ll need a new pricing structure.
For firms employing a business model with changing operations and different cost structures, you’ll need to redesign your pricing structure to accommodate change and capitalise on new revenue opportunities.
You need to think carefully about who you hire to do this type of detailed pricing work. Pricing structure development requires specialised pricing expertise and a strong understanding of customer value, segmentation and commercial data. Hire pricing managers and analysts with the right traits, such as lateral and vertical thinking capability.
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How Positioning Can Affect Your Pricing Structure for Services
Professional services firms need a pricing structure that reflects the value they deliver and the clients they are best positioned to serve. When positioning is unclear, firms can take on clients whose needs do not match their expertise, making it harder to communicate value and achieve appropriate prices. If you have found yourself in this situation, you may be working with clients you should never have taken on in the first place. This article will focus on how to align your business to create a solid pricing structure for services.
Business positioning is a term used to describe where your business stands against other players in the industry. It helps a business establish a clear identity and address a specific market need. A well-positioned business can help you remain distinguishable and resilient when markets get tough.
If your business positioning is unclear, it becomes harder to define the right clients, communicate value and build an effective pricing structure. You don’t want to end up with a weak client and market profile, as well as a swath of internal conflicts that arise due to clients you may be unfit to handle.
Likewise, it will be impossible to create a solid pricing structure for services without proper positioning and identity. Building a strategy framework starts with finding your firm’s identity and challenges first.
Professional firms can run into a number of challenges without clear client mixes, especially because typical corporate top-down approaches don’t work for this format. Service firms generally evolve pretty quickly, so it’s the professional’s job to deliver consistent skill and value.
However, clients can also greatly affect a professional’s growth and experience. So, it’s important to take on clients that match your existing expertise while also supporting the capabilities you want to develop
You need the Right Numbers for Pricing! 👍 Podcast Ep. 66!
Levels of Practices
There are several levels of practices your firm may fall under. This is crucial to understand in order to position yourself properly and create an effective pricing structure for services. Keep in mind that these aren’t clear-cut, and some firms can span more than one of these categories. However, these serve as foundations for understanding your position.
Positioning can be shifted as needed since firms and client profiles are subject to change over time. Economic environments can also be a major influencer of where your firm sits at any given time.
Routine
Routine practices mainly specialise in, as the name suggests, routine problems. These can usually be dealt with through economical and quick services that have a low margin of error. Firms that handle routine practices usually have lower costs and margins, yet higher leverage.
Complex Procedure
Complex procedure practices typically deal with more complicated problems. Projects typically have several parts, and while these aren’t the most high-profile cases, they require a much more systematic approach than the routine level. Costs are still relatively low, with moderate to high leverage.
Expert
Expert practices require professionals with a lot more experience than the previous two levels. These issues are quite major and require years of expertise dealing with similar issues, as clients typically have none. Margins and costs are higher, with moderate leverage.
Deep Expertise
Deep expertise practices handle highly complex and high-value business issues, such as mergers or acquisitions. These firms deal with large company issues such as mergers or acquisitions. This requires years of experience, the most updated theory, plus the ability to creatively problem-solve unique and complex issues. Clients pay high prices for these firms’ ability to develop innovative solutions, and leverage is low.
Elements of a Pricing Structure For Services
Professional services generally use this formula for their pricing structures with adjustments based on their type of practice:
Profitability = Margin x Rate x Utilization x Leverage
Your margin includes profit divided by revenue. Rate equals your revenue divided by the time billed. Utilisation is your time billed divided by the number of professionals involved, while leverage is the number of professionals divided by the number of partners.
Deep expertise and expert practices use 50% margins, while complex practices use 35% to 50%, and routine levels use 20% to 35%.
Leverage is low for expert and deep expertise practices because senior professionals have to be at the forefront of cases, while professionals in routine practices can easily pass cases on to junior professionals, resulting in higher leverage.
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Implications of Incorrect Positioning on Your Pricing Structure for Services
As we have mentioned, taking on clients despite their mismatch to your skills and practice can lead to additional problems over time. These clients might expect you to carry out a different type of practice, which can create pressure and confusion.
This can also create a misunderstanding of value, giving your firm difficulties when the time comes to collect payments. Unclear positioning can give clients a vague perception of what your services are worth, which is hard to correct.
Incorrect positioning can often come from desperation for new clients, which leads to firms taking on clients that should be seeking lower level practices. It can also come from misplaced arrogance, which leads to firms taking on cases that should be going to higher-level practices.
Importance of Correct Positioning on Your Pricing Structure for Services
The importance of proper positioning is that you understand what your professionals are capable of and which clients will benefit your business the most. This will increase your value and clarify perceptions of how you are valued.
By doing so, you can leverage pricing properly, and not be short-changed for your services. The ability to command value is key to thriving as a professional service firm, no matter what the situation is.
As your firm evolves, you’ll also need to adapt your positioning. Understanding the different levels of firms can help you recognise when you need to rethink your positioning or your client profile.
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Bottom Line
Positioning is an important consideration when creating a pricing structure for professional services. Firms need to understand which clients they are best positioned to serve and how their expertise creates value for those clients.
Clear positioning also helps firms choose clients that fit their expertise, support profitable growth and reinforce the value of their services.
For a comprehensive view on building a great pricing team to prevent loss in revenue, download a complimentary whitepaper on How to Build Hiring Capability To Get The Best Pricing Team.
Are you a business in need of help to align your pricing strategy, people, and operations to deliver an immediate impact on profit?
If so, please call (+61) 2 9000 1115.
You can also email us at team@taylorwells.com.au if you have any further questions.
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