Pricing structure: How To Make More Profitable Pricing Decisions
A major development in Australian business in 2018 has been developing a pricing structure to collect more revenue across different customer and price segments. Legacy pricing structures are risking earnings in increasingly transparent B2B and B2c industries. Businesses employ procurement teams to check the consistencies and validity of your price lists. Customers begin to lose trust in your brand and demand discounts as compensation when they see price inconsistencies. Or worse still, they switch to the competition if they feel they’ve been overcharged.
Developing the right pricing structure for your business helps you to organise your prices so that you can generate more revenue and margin without losing customers or sacrificing volume. Leading businesses are de-linking ownership of physical assets from the value it creates to lower overheads and improve supply efficiencies. A static, cost based pricing structure is fast becoming a pricing convention of the past.
In this article, we will explain what is a pricing structure, and offer examples of different types of pricing structure in airlines, hotels, energy and B2B industrial. We will also show you how to develop a sophisticated pricing structure for your business that takes into account industry nuances – namely a pricing structure that generates more revenue without losing volume or customers. We will then move on to discuss the role of pricing professionals and revenue management in developing an appropriate pricing department structure for your business.
What is a pricing structure?
In general, the pattern of an businesses’s 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). This means you need your SKU prices to be aligned. All 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 price anchors in the product category.
A sophisticated pricing structure varies not just the price, but also adjusts the offer or the criteria to qualify for it. Which means you can charge different prices to different customers and for different applications when you have more flexibility in your pricing structure.
Prior to 2005, most businesses didn’t really have a robust pricing structure. They did not consider the price relativities between SKU prices or the logical relativities between category and product hierarchies. Many sales teams negotiated different prices for the same line item (i.e., interactive pricing or haggle price) and there were limited metrics to compare across different customer groups. More often than not, businesses without a well thought through pricing structure lost margin by excessively discounting because their SKU prices were all over the place.
For a long time, it was common practice to let sales negotiate all prices to customers. Having limited or no pricing structure in place made it easier for the sales teams to charge different prices to different customers for the same SKU. However, over time, markets became more complex. Channels became more fragmented, and procurement teams started to question why they were being charged more than other businesses for the same thing.
Executive teams around the country started to become aware that something was not quite right with their pricing. Some realised quicker than others that they needed a more robust pricing structure in place to organise their prices and data. Their industry was becoming more transparent. Customers knew what they were charging and were comparing their prices. Boards were concerned about the quality of teams daily price decision making. In particular, the impact poor pricing practices was having on reputation, brand and bottom line profitability.
Many businesses still believe a price structure restricts their ability to adjust prices
There is a misconception that a pricing structure doesn’t give you the flexibility you need to negotiate prices with your 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.
For example, fuel may have one price when purchased during the week in a metro region and another when purchased in a rural area. These numerous prices for fuel are part of the pattern of the business’ pricing structure.
Different types of pricing structures
In the past, businesses have attempted to remain competitive by growing scale at lower margins. However, nowadays, markets have become globalised with low cost entrants, platform based businesses and lean / agile operating models. The rise of the procurement buying function has also brought wide scale change in how business operate and justify their prices. We now see that a key role of procurement teams is to challenge legacy pricing structures, discount practices and conventional relationship based selling.
All of these elements (above) have put substantial pressures on margins. A simple cost plus price structure as seen inor copy the competition approach to pricing is no longer enough to stay ahead of the competition. Many leading businesses realise this and have been consistently trialling new and better approaches, pricing structures and revenue models in order to align their pricing structures with their future strategic intentions.
Airlines pricing teams have long employed a segmented price structure, similar to a hotel pricing structure, which enables them to maximise the revenue they can earn from different customers based on capacity utilisation and yield management.
Fuels, commodities, rental car, tourism, retail, industrial supplies, heavy machinery businesses have also established pricing teams in their business to develop segmented pricing structures and even price-offer constructs for value add services as well as traditional product portfolios. The aim to influence customers to pay a price aligned with the value they place on product or service (perceived value). A great way to educate customers on value at use and value at risk concepts.
All energy markets have been massively disrupted
Renewable energy is becoming much more efficient than ever before. Consumption of energy is decreasing overall as the world in general becomes more efficient (i.e, home, heating, cooling systems, cares etc). Energy usage from New York’s bulk electric system is expected to decline over the next year, and peak demand – a critical element to reliable system planning – is expected to decline by 0.13% per year through 2018.
Production of energy is easier too. We don’t have to work so hard to get energy. Electricity plants are closing down or producing less energy. Wind turbines and solar panels are generating more and more power for us. What’s more, people want to buy renewable because it is cleaner and potentially cheaper than traditional energy. The new problem now is energy storage, operational complexity and distribution. Giving people the energy they want, when they want it and at the right levels.
How to create a pricing structure?
Below listed are just a few key steps you need to consider as you create a value based pricing structure for your business or embark on a price structure analysis:
- Understand how value is created for different customer segments. Do this by estimating how much value different combination of benefits could represent to customers, and then test your assumptions and estimates with your customers (marketing survey, customer value discovery, sales CRM, won loss stats).
- 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).
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
Check if your pricing structure is commercially viable
- Choose from in low risk 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..).
Overall, to create a pricing structure, you need to first determine which features and services your business should have on it’s official price list. 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. Above listed a just a few of the key steps.
In practice, there’ll be multiple segments, varying in sizes, and multiple products to align, optimise and potentially bundle. Maximising margin contribution requires building a spreadsheet model or using optimisation models. 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? All these questions need to be addressed.
A key benefit of having a pricing team on board is that they have the know-how
A world class pricing team can accomplish price segmentation with fixed prices using a tied pricing structure. This gives you the flexibility of the interactive pricing approach we discussed earlier, but with the rigour and accuracy required to enhance profit without losing volume or customers.
Using a fixed price price structure based on simple cost price formula for all your customers would, however, necessarily over or under price a large proportion of your customers. A world class pricing team would know this and perhaps introduce bundling to facilitate more profitable, value based pricing to each segment without forgoing value or exceeding costs.
Strategically unbundle value when necessary
For other segments, they may strategically unbundle value if a bundle in a particular segment is undermining rather than enhancing profits. They would determine the right offer and price for the offer based on detailed competitive and customer intelligence. They would avoid a potentially fatal price-offer structure which would leak margin and impact profits and configure a new price-offer structure that boosts profitable revenue growth in competitive markets.
What is the role of the price management function?
Pricing management roles are wide and varied in their remit and span of influence across the organisation. As you see from the above, their focus can be quite technical in nature and focus on developing a sophisticated price architecture for a business. Other pricing functions have great strategic importance whilst others are required only to manage the pricing administration of the business, such as: 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 and/or the business’ maturity to undertake revenue and margin improvement programs.
Strategic price setting
More Australian based ASX and Fortune 500 companies have undertaken pricing improvement projects than ever before. These pricing initiatives have taken the form of diagnostic studies, price structure re-development, major analytics and optimisation projects and changes to pricing governance, price setting and policies.
Some pricing initiatives are conducted in response to legislation such as Sarbanes Oxley while others are risk mitigation programs authorised by company boards to de-risk earnings.
Marketing plan pricing structure example
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 structures and discount mechanisms raises important questions:
- Who should the pricing function report to?
- What responsibilities should the pricing function hold?
- What skills and qualifications does a pricing manager need to develop a pricing structure?
- Who owns pricing?
- What is the pricing team accountable for versus sales and marketing teams? Is 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.
Examples of different approaches to pricing structure development?
The answer to developing a lucrative pricing structure that also fits legal requirements can be found through a detailed assessment of the company business model and industry dynamics. This includes: the pricing structure and revenue model and the types of interactions needed between each functional area of sales, marketing, finance and operations.
For example, the pricing structure of a hotel will be quite different to that of a medical technologies company that has public and private hospital customers and government mandated pricing and reimbursement programs. Likewise, the pricing structure would be different again for an industrial equipment and engineering company that derives much of its revenue from winning bids and tenders and renewing high value and volume contracts.
In this last instance, the pricing structure review process would cover off areas such as:
- rebates mechanisms,
- go to market strategies,
- won-loss sales
- and tracking distribution centres and branches.
The pricing team focuses on building proof of concept
They must collaborate with a wide range of customers, stakeholders and procurement functions in between. They would generate pricing insights from market research. Analyse big data sources to set up a price data architecture. Identify price realisations across a number of categories, SKUs and outliers.
The pricing team would also need to determine the company’s economic value to each customer profile, and the different wants and expectations of their suppliers. They also work closely with sales, marketing and the supply chain. There is always an imperative to accelerate business plans with a 6, 9, 12 month outlook. You can’t take 1 to 3 years to develop a pricing structure. By this time, a pricing structure for business plan will be outdated. You need to be take an agile approach, and tweak and adjust as you go.
Pricing structure for business plan
There is no one size fits all answer to either developing the right pricing plans or designing a pricing structure for business plan. But what is clear is that a world class pricing team will certainly help you iron through the complexities and solve difficult commercial challenge faster than other functions in your business.
Not all pricing teams are the same
An effective pricing function must be designed to address the dynamics and complexities of each business. They must drive the business forward. Many businesses make the mistakes of positioning the pricing function within whichever group or department initially championed the pricing project. This is a decision driven by who wants to do it, rather than who should be doing it. This arbitrary approach to setting up a pricing function affects the quality and impact of your pricing structure.
Pricing department structure
When the pricing function is not thought out or designed to fit the business, its purpose and effort can be diminished. Especially by well-intentioned but harmful pricing bureaucracy. Endless reports and analysis that do not get read or acted upon, don’t make you money.
Even effective teams can be been rendered ineffective when there is a lack of buy-in. It is difficult for a pricing team to achieve results when key stakeholders do not support them. It can be a mistake to view pricing as a matter for the pricing team alone. Many executive get complacent about pricing simply because a team is in place. You need a consistent focus on pricing even when you have established a pricing team to set and manage your prices.
If your business is facing margin pressure, a well-designed pricing function can generate at least $1.0-2.0M EBIT in 12 months for every $100M of addressable revenue
If it has been set up correctly, the pricing function can develop a customised pricing structure and architecture. One which should provide returns of more than 500% within 12 months.
If the pricing team is not set up correctly. Or the business chooses to spread resources from sales, finance and marketing to cover pricing work. It is much more difficult to develop a segmented pricing structure.
Taylor Wells finds 70% of Australian businesses lack the requisite pricing knowledge, skills and pricing capability
Our testing on price setting skills indicates this skills gaps includes the ability to develop a tiered pricing structure. We find without the right level of requisite pricing skills and capability, teams struggle to design and develop a customise pricing structure appropriate for a changing business model and industry.
From commodity items through to high value-add medical technology devices, teams continue to stumble over the following challenges:
- Undefined value drivers – they don’t know what value they generate for their customers with their products and services leading them to either undercharge or overcharge for them
- Management misalignment – they have multiple conflicting viewpoints on how to manage pricing across the business
- Reliance on discounting to win business – the sales team use tactical discounts to close customers instead of selling value
- Negotiating with procurement – they get negotiated down on invoice prices by sophisticated procurement techniques
Additional margin challenges to consider..
- Pricing complexity or inconsistency – their pricing structures are complicated and hard to manage leading to errors in pricing
- Cost Plus pricing culture – they set prices using a percentage mark up on costs unrelated to the actual value of the product or service to the customer
- Inability to implement a price increase – they try to take price rise but often let it get diluted with exceptions, rebates and additional discount offers
- Commodity mindset – the sale sand marketing teams believe they are an easily substituted product or service with limited pricing power
(ref. Pricing Insight – 8 margin challenges article)
All these issues place pressure on B2B and B2C businesses in highly competitive and disrupted industires. We recommend that you set up a pricing team with great care to help you overcome these hurdles. Consider performance optimisation for established pricing functions. Think about building a pricing centre of excellence to distribute pricing knowledge across the business. A pricing team should not be the only team that understands pricing.
Case study example: A pricing structure for services and products
An iconic Australian brand specialising in Automotive and glass repair services and products engaged Taylor Wells to find, hire and on-board a new pricing manager and strategic pricing analyst for their Home & Automotive Division. They were having challenges with their product pricing and pricing structure rate card. Large value customers (i.e., insurers) and smaller retail customers were pushing back on their pricing structure. They had no one internally with the level of pricing expertise to build a dynamic pricing structure and optimised rate card.
The business needed a segmented price structure based on value, with tiered quantity breaks and multiple fences and metrics. They had capacity restraints and ebbs and flows in demands which were mostly unexplained. Forecasting needed improvement and as there were limited analytics on capacity utilisation and yield management.
We helped this business develop and implemented a systematic 5 step recruitment model to build a pricing team with the right mix of skills to fix these problems. This model was designed to identify executives with technical pricing skills and analytical thinking required for a strategic price structure process. This included a technical pricing workshop to benchmark candidates on core pricing skills and domain knowledge.
We then compared and bench-marked individual pricing capability
We found a strategic pricing manager and technical pricing analyst with a mix of pricing skills to develop a pricing structure for the business. These pricing professionals were not just technical wizards. No. They naturally sought to educate stakeholders on the reason they were changing the pricing structure. They saw relationships and education as vital steps in the price structure process.
The new employees came into the business with the skills to develop a margin maximising price architecture for the Home and Automotive division. On-boarding was customised around their needs, and targeted pricing training with provided to fill gaps in knowledge quickly. They were both clear about the issues and challenges they would face along the way. Everyone on the executive and sales teams were fully informed about what the next steps were and what was expected from them.
Our hiring algorithm identified 256 suitable profiles based in Australia
We profiled and assessed 132 for the strategic pricing manager role and a further 124 for the supporting pricing analyst role.
Our talent assessment processes identified only 2 out of 132 pricing managers had the required pricing competency for this role. And, only 1 of these had the technical and softer skills we were looking for.
The net benefit of the recruitment program to this iconic automotive glass business was 2% margin improvement in under 12 months. A further margin expansion was made in the following 12 months. Operations, marketing and sales teams became heavily focused on pricing, value and margin. In 3 years, the business realised significant EBIT gains through rate card optimisation. They also developed a better price value management system, and competitive tender submissions. Their call centre is now training in value based selling.
Designing an optimal pricing structure for your business is clearly among the most difficult, but potentially rewarding, aspects of pricing strategy.
For companies launching offers with differentiated benefits, you need a new pricing structure.
For firms employing a business model with changing operations and different cost structures, you need to re-design your pricing structure to accomodate change and capitalise on new revenue opportunities.
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 a pricing team can do to improve profitability
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 require a depth of pricing skills and expertise. This includes capabilities like: creativity, lateral thinking, domain knowledge and innovation. You also want people with the ability to implement those principles with your industry.
The investment in a pricing structure is small relative to other marketing investments. But the payoff in a robust pricing structure is often very large.
A world class pricing team will help you de-risk earnings and drive profitability. They have the know-how and skills to develop a robust pricing structure that accomplishes your strategic goals without earnings risk.
Alternatively, if you would like to learn more about how to build a world-class pricing team for your business, download our complimentary e-book five ways to double EBIT or free pricing recruitment guides.
Don’t waste another dollar on the wrong pricing team strategy.
Arrange a confidential meeting.
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.