- Author: Bevan Callaghan
- Posted: November 2, 2020
CFOs Need to Play an Active Part in Pricing Strategy
By Bevan Callaghan
Pricing is a fundamental component of how you do business. Price makes up one of the four ‘P’s of the marketing mix (alongside product, place and promotion), and is the lever that has the most direct impact on bottom line. However, research suggests that pricing strategy is not given detailed attention in many firms. As leaders in the business and gatekeepers to the financial information about products and firm performance, CFOs and senior finance personnel should play an active role in your company’s pricing strategy.
Key to pricing strategy is the approach taken to pricing different products and for individual segments. Pricing approach typically falls into three buckets: cost-based, competition-based or customer value-based. Cost-based involves calculating all costs of the unit, an allocation of overheads and adding a margin: it is the most widely used approach and is straightforward to understand and calculate. Competition-based pricing takes a market orientated approach while value-based pricing seeks to use willingness to pay, or differential over next best alternative to determine the amount customers pay. The latter is the only approach which seeks to maximise the price based on the benefit customers gain from the product.
It is important to note that these pricing approaches are not mutually exclusive. Indeed, it is beneficial to take elements for each approach – being market informed is critical and cost-based pricing calculations can provide the lower limit for the minimum amount you need to charge under any approach.
Another consideration is the pricing model, which seeks to describe how you engage with customers to agree the price and collect money for them. For example, is there a fixed price list or a negotiated price based on volume? Do you have bundled or unbundled offerings, and does the customer have a perpetual licence to consume the product, or is it a rent or pay-per-use scheme?
Decisions on the approach and model need to be integrated within the organisation and fostered by a culture and set-up that supports execution of the pricing strategy. Few firms have the luxury of a dedicated pricing department, so a cross functional committee comprising (for example) Sales, Finance, Marketing and Product may be needed to collect data and establish the pricing framework.
In setting the strategy, elements such as sales rewards schemes must be considered and complimentary to overall objectives. For example, are bonuses / commissions based on volume or margin made by sales executives? If the sales team is volume orientated, then there may be a rush of discounting at the end of the month or quarter in order to hit targets. Whilst these frameworks can be set by the pricing committee/department, Finance has a responsibility to monitor the data and interpret results so that the firm can have certainty that decisions on pricing and incentives are driving positive outcomes for the bottom line.
The pricing strategy should be clear on the segmentation and pricing objectives for each segment. Segmentation is most successful when it is based on needs, rather than simply dividing up the market geographically or based on demographics. By engaging with your customers and understanding their pain points, product use situations and jobs-to-be-done, the product offering can be much more effectively targeted. This is a product management function but warrants understanding because it follows that pricing can and should be separate for each of these segments. This is the most effective means to ensure that money is not being left on the table by treating customer homogeneously.
This article is an introduction into pricing strategy but the message for finance is clear: you should be actively involved and challenging the business decision making on pricing, making this an ongoing process in the organisation. If leadership is lacking then the CFO can step in, but input should come from representatives across the business in order to ensure a coordinated strategy. Finance can also play a significant role in assessing metrics that show success or failure of the pricing strategy (e.g. margin calculations and impact of discounting) as well as supporting innovations in the pricing model (e.g. demonstrating the impact of buy vs lease pricing schemes through considerations for interest and depreciation on the P&L and balance sheet).
The decisions on pricing approach and pricing model will dictate the data needed and the shape of the pricing framework across the business. The key is to ensure that these decisions are deliberate, and the firms is working towards outcomes that can be monitored with accountability. Like with all other processes across the business, develop the ability to make changes and drive improvement that is understood and supported across the business.
Author Bevan Callaghan. Bevan has worked in a diverse range of organisations and industries around the world including Contact Energy, Air New Zealand, the Office of Rail & Road in London and is currently based in Dublin at Global Payments Inc. This article was based on research done for an MSc in Product Management; the dissertation was titled An exploration of value-based pricing in software service companies. For further information contact Bevan Callaghan ([email protected]) or consult the research of Andreas Hinterhuber, Stephan Liozu, and Sonja Lehmann & Peter Buxmann.