Pricing is a key factor in business innovation. Strategic pricing involves aligning the pricing strategy with corporate strategy. The price must be chosen carefully after considering various scenarios and possible implications. Is the price attractive enough to capture the mass of target buyers? Can the company make the offering at the target cost and still earn a healthy profit margin? Can the company profit at a price that is affordable to the target buyers?
Strategic pricing is a key component of Blue Ocean Strategy pioneered by Chan Kim and Renee Mauborgne. To have strong revenue flowing, the strategic price must be set. This procedure will ensure that consumers will want to buy and will have the compelling ability to achieve it. It is fundamental, from the start, to know the price that will bring mass of target consumers. The strategic price defined must not only attract customers but also retain them. The reputation must be earned since day one and rapidly spread by networked society. That is important to avoid imitations and turn the blue ocean in red ocean. The price corridor of the mass is a tool to facilitate the discovery of the right price to attract mass of buyers. The great challenge to define the strategic price is to understand the price sensibility of those people (buyers) when comparing completely different products/services offered outside the group of traditional competitors.
“With an understanding of the right strategic sequence and of how to assess blue ocean ideas along the key criteria in that sequence, you dramatically reduce business model risk. The starting point is buyer utility. Is there a compelling reason for the mass of people to buy it? Absent this, there is no blue ocean potential to begin with. When you clear the exceptional utility bar, you advance to the second step: setting the right strategic price. Is your offering priced to attract the mass of target buyers so that they have a compelling ability to pay for your offering? These first two steps ensure that you create a leap in net buyer value. Securing the profit side brings us to the third element: cost. Can you produce your offering at the target price and still earn a healthy profit margin? The last step is to address adoption hurdles. The formulation of blue ocean strategy is complete only when you can address adoption hurdles in the beginning to ensure successful actualization of your idea.” — W. Chan Kim and Renee Mauborgne
In a competitive market, cost plus pricing does not work. Costs must be controlled so that profits can be generated at the price the market can take. At the same time, in the process of cost cutting, the company should not reduce utility, i.e. the value customers perceive in the product or service.
To hit the cost target, companies can look at various options. They can streamline operations and introduce cost innovations from manufacturing to distribution by addressing relevant questions. Can the currently used raw materials be replaced by unconventional, less expensive ones? Can high-cost, low-value added activities in the value chain be reduced or outsourced? Can the physical location of the product or service be shifted from prime real estate locations to lower-cost locations? Can the number of parts or steps used in production be truncated by changing the way things are made? Can activities be digitized or automated?
As goods become more knowledge intensive, product development costs rather than manufacturing costs start dominating. So achieving high volumes quickly has become the need of the hour. Moreover, to a buyer, the value of a product or service increases as more people start using it. As a result of this phenomenon, called network externalities, either millions of units are sold at once, or nothing at all. So it is increasingly important to know from the start what price will quickly capture the mass market. That is why strategic planning is gaining in importance.
The main challenge in strategic pricing is to understand the price sensitivity of those people who will be comparing the new product or service with a host of products which on the surface look different, but offer the same benefits to the customers. So companies must list competing products and services that fall into two categories: those that take different forms but perform the same function, and those that take different forms and functions but fulfill the broad objective. The exact price will be guided by two principal factors – the extent of patents or copyrights protection and the ease of imitation.
Sometimes, there may be little scope to cut costs but there could be scope to come up with an innovative pricing model. Take telecom service companies. In developing countries, public call offices in rural areas, by eliminating fixed monthly rentals, significantly reduce the price of the service. Another pricing innovation is small packs. Offering products or services in small quantities makes them more affordable to the masses.
Short Case Study:
Toys “R” Us rapidly opened a nationwide chain of retail stores and pursued a cost-leadership strategy to outperform its rivals and consolidate a previously fragmented industry. Originally, its low cost strategy relied on efficient materials management techniques and low levels of customer service. As the company grew in size, it also decided to add more products, which raised inventory expenses. However, new rivals like Wal-Mart and Target saw the profitability of the toy market and began to focus more attention on toys. Toy “R” Us had lost its cost advantage and couldn’t drop prices to the levels that the big discounters could. In response, Toys “R” Us concentrated on lowering costs further through the use of IT and a reduction in the number of items sold. They also created other types of stores, which focus on different customer segments and try to differentiate in addition to following cost leadership. It also went online, partnering with Amazon.com in offering toys online.
Hint: Toys “R” Us used pricing games to attack its competitors in the toy industry, driving several of its major rivals out of business. Successful pursuit of that strategy was enabled by the firm’s very low expenses–it could cut prices and still be profitable. However, the firm became complacent, and soon found that other, stronger firms were using its own strategy. This case demonstrates the difficulty of competing on a price basis, namely, that there will always be someone who can find a way to drive down costs further. Cost advantages are often based on factors, such as economies of scale, which can be duplicated by powerful rivals.