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11 Determinants of Pricing



Author: Frank Frohmann


Price optimization for business services (e.g., products such as game consoles, services such as air travel, digital services such as video streaming) must include 11 essential information. These can be symbolized by the "11C" of pricing. In essence, the following questions are involved (cf. Digital Pricing, Springer Gabler 2018):


1. Customer : What are customers willing to pay? What are the price elasticities of customers for our offerings (products, services, software, etc.)?


2. Competition: What are the prices of our competitors? How will competitors react to our measures?


3. Costs: What is the composition of our costs? What is the ratio of variable to fixed costs?


4. Capacity : What is the capacity situation in the industry? How high is the utilization of our production and service capacities?


5. Cycle stage: What stage of life cycle is our offer in?


6. Company targets: What is the strategy? And what are our goals?


7. Compliance: What is the legal framework for pricing in our industry?

8. Channel: Which sales channels do we use? What is their strategic relevance?


9. Country: In which countries are we actively selling? What pricing-relevant interdependencies exist between the individual countries?


10. Currency: How should exchange rate changes be represented in pricing?


11. Context: How does our price presentation affect customer perception? How can we change the context in which a price is presented? How can we consider findings on "nudging", "framing", etc. when optimizing prices?



About the Determinants in Detail

Customer

Price acceptance from the customer's point of view is a key factor influencing sales and profits.


Competition

Customer preference for a manufacturer or retailer depends on the prices offered by the competition. The tendency here: the lower the competitor prices, the lower our own pricing potential. However, there are numerous examples of companies in various industries that largely avoid price competition based on a differentiation strategy.


Costs

The level and structure of costs determine the company's pricing leeway.

Capacity: The utilization of production facilities or service readiness has a direct impact on pricing. The intensity of price competition results from the relationship between supply capacity and demand. In the case of overcapacity, price is increasingly used to control capacity utilization. The strong correlation between capacity utilization and price levels is particularly true in commodity industries. In the case of homogeneous mass products, the market price is primarily determined by the relationship between supply and demand. Raw materials (crude oil, cement, steel, iron ore), electricity, certain basic chemicals and many other product categories are among these commodities.


Cycle stage

The variation of prices over the product life cycle is one of the decisive levers for corporate success. Pricing strategies and levels differ fundamentally for the four phases: introduction, growth, maturity, and degeneration. Market penetration can be controlled by the company. For example, a low launch price can accelerate the diffusion process. Digitization fuels the speed of market developments. One example illustrates the dynamics: the classic telephone took a total of 75 years to reach a penetration of 100 million users. In the case of Facebook and WhatsApp, the time required to conquer the same number of users was reduced to four and two years respectively.


The changing pricing potential over the lifecycle can be described by the concept of "pricing power." Pricing power describes the potential of a company to enforce price increases (Simon and Fassnacht 2016, p. 26). A company's pricing power is one of the key leading indicators of long-term success ( (Ramanujam & Tacke, 2016). The ability to enforce prices varies over the lifecycle of offerings. High pricing power - and the resulting profit potential from price changes - tends to arise in the following situations:

– Innovative offers

– High market share (dominating market position)

– High customer benefit

– Complex offer with low pricing transparency

– Scarce capacities

– Superior brand image


The pricing power of offerings tends to increase from launch through the growth phase and reaches its peak in the maturity lifecycle phase. Thereafter, the price penetration potential generally declines again. Market share is of prominent importance within the criteria. In connection with the lifecycle phases, investment in market share is critical to success, especially for digital offerings. In many digital sectors, quickly achieving critical mass is a prerequisite for reaping the value created through higher prices in later lifecycle phases.


Company targets

The basic equation Profit = Quantity × Price - Cost illustrates the direct relationship between price and profit. All consequences resulting from a price action are condensed in profit as the ultimate target.


Compliance The opportunities and risks of price management are determined by legal details, especially in digitalized industries. Some examples: Technology companies such as Amazon migrating to the financial sector must observe the regulatory requirements of the banking sector. Legal restrictions are also relevant in the highly profitable cloud computing business. For example, Amazon is not authorized to directly analyses the content of companies' stored data. In other sectors, legal requirements apply to digitized price publication (e.g., gas stations) as well as restrictions on the potential of bundling (e.g., software). The following also play a significant role: the fundamental price regulation (e.g., retail, gastronomy) for maintaining price truth and price clarity in the interests of the consumer, and gender equality in the context of gender pricing (e.g., in the cosmetics industry).


Channel

Digitization has led to a significant expansion of sales channels: including web stores, online marketplaces, platforms. In addition to online sales channels, there are indirect sales (via a distributor or dealer) and direct sales, - this makes price management across all channels much more challenging.


For certain customer groups & products, online stores have proven their worth (e.g., spare parts, simple products, customers with low service needs, additional products). Even with a rough division of channels into "online" and "offline", there are different options in pricing: no price differences, "best buy" model, price differentiation "offline" vs. "online". Depending on the industry and strategy, online channels can also be positioned higher in terms of price than stationary stores. The latter strategy was driven by Wal-Mart in 2018. This was due to 3 of the influencing factors already outlined above: Costs (higher logistic costs), Customers (convenience) and Company targets (traffic shift to the stationary channel).


Country Price variations depending on countries, regions or sales territories can be explained by a variety of parameters (including differences in competition, costs, or willingness to pay, tax influences). A particular challenge are flows of goods between countries that are not intended by the companies (reimports, grey imports). Parallel imports lead to profit losses through cannibalization, which can be actively countered by a price framework. A price corridor is a compromise solution between unit prices and independent country prices.


Currency

Exchange rate changes play a prominent role in the price management of global companies. Looking at the price potential between the upper and lower limits (figure 1), it can be stated: The greater the variable unit costs in relation to the maximum price, the greater the influence of exchange rate changes on the optimum price.


Context

The benefit and price perception of end users, customers and sales partners depends on the context (situation, location, price presentation, etc.). The price presentation is more important for the perception than the objective price level. Consequently, pricing must necessarily incorporate the latest findings in behavioural economics. The latest findings from brain research must be integrated both in price optimization and in the other challenges of the pricing process. Figure 1 illustrates that the various criteria act on two levels. The first tier outlines those criteria which directly influence the level of a price. The second tier comprises factors that have a moderating influence on the price level.


Conclusion

Professional price management requires the integration of all influencing factors outlined. Business mistakes are inevitable if individual factors are ignored.


The most common mistakes include:

• Considering costs, customers and/or competition in isolation

• Neglecting the legal framework

• Not setting clear target priorities

• Inconsistent pricing across sales regions and channels


The complexity shown in the diagram is further increased in the context of Dynamic Pricing. Dynamic pricing is a time-based approach to price optimization that incorporates a variety of additional criteria beyond the factors outlined: Temporal factors such as season, day of the week or time of day; contextual criteria such as location and weather; customer-related factors such as end device or "search agent" up to offer criteria such as perishability.


Particularly important:

1. Price optimization for business services (e.g., products such as game consoles, services such as air travel, digital services such as video streaming) outlined based on the 11 influencing factors is only one facet of price management!


2. Pricing processes consist of numerous challenges that have different significance depending on the sector (B2C, B2B, C2M, C2C), industry and company. Monetization ("value extraction") and value creation ("value generation") can be achieved equally with this management process.


3. Important entrepreneurial decisions are upstream of price determination: ✓ the definition of revenue sources (the revenue model). ✓ the definition of customer value (value-to-customer) as a central pillar of the business model.


4. In digital business models (platforms, marketplaces, ecosystems, etc.), price is no longer a reliable metric for competition. Two major reasons may be mentioned here: a) Many companies (like Google, Amazon, Alibaba or Tencent) cross-subsidize parts of their business. Not all business units have to contribute to the profit. Services are therefore often offered for free (Google) or below production costs (Amazon). b) In digital business models, customers can pay with an equivalent value other than money. For example, with awareness in the context of freemium models. Here, they accept advertising to be able to use the "free" component free of charge. But they can also pay with their data (as in the case of Facebook and Google).


5. This means that professional price management must go beyond the pure optimization of the pricing process and reflect the higher-level decisions on the business model and the revenue model (Frohmann, 2018).


6. Only a holistic view of all levels, including their sub-elements, enables companies to exploit revenue, profit, and value enhancement potential.




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1 Comment


Arup Guha
Arup Guha
Jul 02, 2023

Very well organized article, pleasure to read. Author knows his stuff.

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