A major development in Australian business in 2018-19 is re-designing a more sophisticated pricing structure to collect more revenue across different customer and price segments.

Many Australian businesses have been experiencing a series of pricing errors due to a legacy pricing structure, which is causing substantial margin erosion:

  • Customers are increasingly employing procurement teams to identify price inconsistencies.
  • Consumers are quick to demand discounts or credits as compensation for advertised pricing mistakes.
  • Sales teams are losing confidence in pricing structures because they are often complicated, hard to understand or misaligned to market expectations

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In this article, we will explain what a pricing structure is and how a good pricing structure can dramatically help your sales teams improve pricing decisions in the following ways:

  1. Real world industry examples, including different types of pricing structure in B2C airline flight ticket prices, electricity / energy and B2B industrial.
  2. A detailed checklist and tips on how to develop a sophisticated pricing structure for your business that takes into account industry nuances.
  3. An evaluation of pricing department structure and team role requirements for strategic pricing work like pricing structure redesign.

What is a pricing structure?

In general, the pattern of a business’ product prices is known as its price structure. A pricing structure is a construct which organises your prices across different products and categories so you avoid overcharging or undercharging your customers.

Quite often, various products are interrelated such as the price charged for one SKU (Stock Keeping Unit). All SKU prices however should be aligned.  Items should take into account the prices charged for other items sold by the business.

The interrelationships between SKU prices is called price relativity. Interrelationships between SKU prices are based on an anchor product in the overall product category.

A sophisticated pricing structure varies not just the price, but also adjusts the offer or the criteria to qualify for it. This gives the sales team the ability to charge different prices to different customers without over-pricing or undercharging their customers.

what is pricing structure

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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 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., 1 or two tiers)
  • And over 50 – 70% of price data architectures in leading corporate are largely unusable or incompatible with price optimisation software.

More often than not, businesses without a well thought through pricing structures lose margin by excessively discounting. SKU prices are commonly all over the place and/or many sales teams still prefer to negotiate different prices for the same line item (i.e., interactive pricing or haggle price).

A large majority of price structures are just too simplistic for complex markets and are generally cost focused and full or logic errors. Many use antiquated metrics and lack price controls, which make it very difficult for teams to compare prices across different customer groups.

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.

pricing structure insurance

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Many businesses still believe a price 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 customers. This is not really the case at all. A segmented 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

Airlines 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 last instance, the pricing structure analysis process would cover off areas such as:

  • discounting,
  • rebates mechanisms,
  • go to market strategies,
  • won-loss sales
  • and tracking distribution centres and branches.

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pricing structure airlines

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 price structure is that it encourages customers to pay a price aligned with the value different customer groups place on a product or service (perceived value) using concepts such as value at use and value at risk concepts.

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Electricity markets pricing structures and economics explained

Wholesale electricity pricing structures are another interesting example of pricing structures redesign. 

An electricity pricing structure has been typically designed around complex cost structures. Things like their cost of operations, including the fuels used by power plants to meet the demand for electricity. 

Price signals are generally aggregated because operations currently exist within a system-wide wholesale market.

Most electricity businesses use a finance driven pricing department to figure out the costs before they set prices  – generally using cost plus pricing methods and calculations. They also use temporal pricing models (i.e., dynamic pricing). However, dynamic pricing is largely implemented by energy businesses to encourage their customers to buy in off-peak hours to balance capacity utilisation, as opposed to optimise revenues.

For many years electricity / energy companies customer invoice pricing has been largely fixed with off peak pricing exceptions. In the past couple of years, however, there has been wide scale disruption in the electricity market. Including how electricity companies and government will charge for energy in the future.

In New York City, for instance, local government and private business are working with consultants to design a smarter market.

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),
  • sources 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.

B2C Electricity pricing will be dynamic

Like recent changes in fuel pricing (ref Caltex business strategy), Australian consumers will soon be introduced to dynamic pricing when they buy electricity.

It’s only a question of time 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.   When production is streamlined and consistent into a dynamic, centralised grid, the cost of production will decrease even more. It will not be commercially viable for authorities and private businesses to set customer pricing based on their costs anymore because their cost positions will be too low and they won’t make enough margin.  

Electricity markets pricing structures and economics

Customer value drivers will be of increasing interest to government authorities, think tanks and private investors

Information on why people want to buy cleaner energy, what they need and when and where they need it will be used to set invoice prices in the future. There’ll likely be a switch from cost based pricing to a value based pricing structure with multiple segments, tiers, fences.

As cleaner energy becomes more available to us, the grid will acquire energy from multiple, non-traditional renewable energy sources. When production gets easier and cheaper, authorities will gradually de-link ownership of the physical asset (i.e., the electricity plants) from the value it generates (i.e., energy) over time.  What’s more, business and investors alike will be encouraged to put more resources into storage facilities and distribution (rather than wholesale electricity production).

The current system-wide wholesale market looks like it’s only got a limited shelf life.

Of course, changing public will be another important factor to making the grid system work, including dynamic pricing.

Public support is essential to implementing dynamic pricing. Changing price metrics from per megawatt-per hour to capacity metrics will be a big change for people. As consumers, we’ve been trained to follow the cost of electricity and invoice prices have been fairly fixed – with increases associated to rising energy costs rather than consumption or location.  

It’s highly likely that we’re going to hear lots more about energy pricing, dynamic pricing and value based concepts in the media (and as legislation relaxes).

Implication of the new grid system for pricing structure development

A centralised grid system will inevitably enable pricing and operations teams to identify lots 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 or metro areas that experience frequent “brown outs”
  • Electricity wholesalers will massively decrease their operational costs
  • Government and pricing teams will be able to monitor individual consumption of energy
  • Private business will find supplying energy to remote areas more appealing 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 business 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.

pricing structure for business plan

How to create a pricing structure?

Re-designing a pricing structure for complex markets, like the energies 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 metric and fences. Each will be appropriate for addressing different reasons for the existence of value-based segments.

Price signals will reward supply flexibility. Integrating the cost of carbon dioxide emissions into wholesale market prices will likely be used to incentivise competition from low-cost sources of carbon abatement, rather than a basis to set invoice prices (hopefully..).

Below listed are just a few key steps and tips you’ll need to consider as you’re re-creating a segmented, value based pricing structure for services or products:

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1.Understand how value is created for different customer segments

  • Do this by estimating how much value different combinations of benefits could represent to customers (pricing structure analysis). Then, test your assumptions and estimates with your customers (marketing survey, customer value discovery, sales CRM, won loss stats).
  • Then, identify differences in the potential contribution that an be captured from different customers 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 In Use” and “Value at Risk”, rather than features and benefits).

2.Develop appropriate price and buyer fences

  • Think about fences in your pricing structure as fixed criteria that customers must meet to qualify for a lower price or offer.
  • Consider using (as appropriate): time of purchase fences,purchase quantity fences as discount tactics (i.e., volume discounts, order discounts, step discounts, two-part prices).
  • Remember: You’ll need fences in your price 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, test, customer value discovery exercises, simulations). Make adjusts 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 then 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?
  • Capture the best possible price from each segment; making the sales at the lowest possible cost, or both. Re-align with your customers’ price response: direct feedback, sensitivity analyses and won-loss stats.
  • Refine price-offer structure for different segments (generally customers are self-selective. If they don’t tell you what they want, they’ll certainly tell you what they don’t want..).

 

How to build a pricing structure

4. Strategically unbundle value when necessary

  • For other segments,  you may have to 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 like crazy.
  • Remember: Leave room for customers to customise their own offers and which features and services to bundle into packages. As you refine and add to your pricing structure, you’ll find there are many different configurations you’ll need to consider to customise your price structure.

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5. Make sure the features and services your business focuses on reflects it’s mission statement and aligns with the values of its customer base

  • The end goal here is to evaluate bundling alternatives versus unbundled products and services.
  • What makes most money?
  • Is it practical?
  • Is it benefiting your customer base?

Each of these questions must be addressed as you re-design your pricing structure.

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If you’re still not clear about how to build a pricing structure, consider appointing a pricing manager to help you

Pricing structure redesign is not easy. It may be a good idea to get a bit more pricing expertise on the team to help you. A world class pricing organisational structure will make sure your on the right path to profitable revenue growth.

But remember, if you go down this path, pricing management roles are wide and varied in their remit and span of influence across the organisation. Some senior commercial pricing executives, for instance, get involved with change management and strategy development right at the outset of a major pricing transformation. Some pricing team job descriptions, however, lack the technical pricing skills and knowledge required for pricing structure redesign.

Mid level managers or analysts, conversely may be better at managing the pricing administration of the business rather than price structure development. Things like: setting up customer price files, processing rebates and producing margin reports.

To a large extent, the wide variation in pricing roles is strongly related to the level of understanding of pricing strategy.

This includes the business’ maturity to undertake revenue and margin improvement programs.  You need to think carefully about who you get to do all types of price work and know they can do what they say they can do.

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Pricing structure for business plan

The design and implementation of a pricing structure, as well as the substantial net benefit and risk associated to a poorly developed and implemented price structure raises important questions:

  1. Who should the pricing function report to?
  2. What responsibilities should the pricing function hold?
  3. What skills and qualifications does a pricing manager need to develop a pricing structure?
  4. Who owns pricing?
  5. What is the pricing team accountable for versus sales and marketing teams?
  6. Does our pricing architecture set up to meet or exceed budget?

All of these questions pose substantial challenges for the CEO and executive leadership team. Very few business have the answers.

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Conclusion

In this article, we discussed creating a pricing structure that aligns with your differentiates (i.e., the value generated) versus your cost structures. We showed how the principles of pricing structures discussed in this article, can serve as a guide to driving optimal revenues across segments.

Price structure development is one of the most important pricing activities to improve profitability. Get a world class pricing team in place to make sure you are doing it properly.

Designing an optimal pricing structure for services and products is clearly difficult. But 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 re-design your pricing structure to accommodate change and capitalise on new revenue opportunities.

We strongly advise you think carefully about who you hire to do this type of detailed pricing work. Pricing structure development is not something anyone can do.  The process of developing a pricing structure requires a depth of pricing expertise, unique traits, such as: lateral and vertical thinking capability.

If you would like to learn more about how to achieving world class pricing in your business, download our complimentary e-book five ways to double EBIT or free pricing guides.

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Did you know that…

How you set up and recruit strategic pricing managers and analysts is a key determinant of how fast you can accelerate earnings growth. With the right pricing team strategy and implementation in place, incremental earnings gains can begin to occur in less than 12 weeks. After 6-12 months, the team is often able to find additional earnings. They identify more complex and previously unrealised revenue and margin opportunities.

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