Pricing More Strategically
Many companies observe that their pricing process could use some improvement. This need for improvement is frequently attributed to a variety of factors, including lack of strategic pricing expertise and lack of clear ownership of the pricing function. A recent Product Executive Forum (PEF) brought together a diverse group of product leaders to explore this topic.
Ownership & Skill Building
Without a doubt, pricing is a team sport and also a key skill all product teams must establish. The team, however, requires a quarterback or team captain to drive a successful outcome. In many companies – typically, as they mature – this work is led by a Product Manager. As the nominal leader of the pricing process, the product manager has these responsibilities:
Establish a Value-Based Business Model or Models
Develop Pricing Models and Tiers
Check pricing against market and competitive data
Create Unit-of-One and Product Line Margin Analysis
The product team will typically contribute the following functions to the pricing process:
| Function | Inputs to Pricing | Outputs from Pricing |
|---|---|---|
| Sales | Customer, Competitive information, Sales Targets | List Pricing, Bundles, Discount Authority, Value Propositions |
| Customer Success & UX | Access to Customers, User Research on Pricing/Value | Value Propositions |
| Finance | Historical Financial Information, Cost Data, Sales Targets | Margin Analysis, Sales Forecast Inputs |
| (Product) Marketing | Market Data/Trends, Competitive Information |
Value Proposition |
Some companies rely on a pricing Subject Matter Expert (SME) or outside consultant who can augment the Product team until the skills are built with accompanying policies and procedures.
Triangulating Within A Square
Numerous conceptual models and methods exist to help organizations determine the value and price of a product, service, solution, or bundle. Many of these models are quite helpful and regardless of which framework you choose, implementation is key. A simple mental model is that a product’s price must be triangulated based on four dimensions:
Value – Price is based on revenue or cost saving to customers differentiated across market segments. This is typically expressed in an ROI or NPV analysis. A good example is automating the process of coding a medical record, which is a complex process that marries thousands of potential diagnoses with the procedure used to fix, repair, or cure a patient. There are almost uncountable number of rules and regulations that govern such coding. Tools that can automate or speed coding with rules or AI can provide measurable value in the form of faster physician reimbursement (revenue cycle), more accurate coding (fewer penalties), and less manual intervention (less cost). Modeling value to the customer and pricing this automated coding process is a value-based pricing exercise.
Cost – The cost of your product or service will typically set a pricing floor. Knowing it explicitly is critical to making decisions and establishing guard rails for margin. As one illustration, hosting services (e.g. data center, Amazon Web Services) in the tech industry are considered a commodity. Pricing the setup of a VPN or a backup server for a customer much over cost will raise eyebrows. Assuming these services cannot be provided in a self-service model, some labor is required to turn them on and maintain them. Focusing on a cost-based pricing model delivered with efficient services will ensure the captured margins do not dilute the overall product line.
Competition – Market substitutes offered by competitors can often limit pricing flexibility. The world of medical transcription, where audio files of patient/doctor visits are recorded and transcribed to text for the physician’s medical record is a highly competitive market. Automation can lower cost, and therefore pricing, but the reality is that the market price is driven in many cases by competitors offering a fraction of a penny lower cost per minute of transcription. This competitive pricing puts pressure on margins, driving them below target (#2 above). This is a good example of the ‘triangulation’ that occurs in pricing. In this case, cost and competition intersect and both must be considered. If competition is driving prices below the cost plus margin target, it is time for innovation through Product Management!
Portfolio – When the product is a member of a product family, pricing of a new offering needs to fit rationally within. For example, in the cardiac patient monitoring market, where hospital staff monitor a patient’s heart, blood pressure, oxygen saturation, and other parameters, individual cardiac monitors can vary in price from a few thousand dollars to tens of thousands of dollars. This span of monitoring offerings in market meets the needs of low acuity and high acuity hospital beds as well as operating rooms and neonatal ICUs. Pricing a new product being introduced into the line-up needs to be rationalized based on value, cost, competition, and fit within the overall portfolio. A poor job of pricing can result in cannibalization of sales of other products in the family.
Pricing is a discipline. It is strategic. It requires consideration, research, effort, and expertise. The PEF discussed this topic at length concluding that establishing and proving the value of a product or service – through price – to the customer is the single biggest challenge facing product managers. It is also a subject of countless consulting engagements, books, and sleepless nights for company executives. We’ll dig deeper into the topic of pricing in future posts.
This post was jointly written by Scott Sbihli, member of the BPMA Executive Board and Vice President of Product Management at HealthEdge, and Larry Kerstein.