CHAPTER 1
MONETIZATION AS A PRIORITY
"The single most important decision in evaluating a business is pricing power.
If you've got the power to raise prices without losing business to a competitor, you've got a very good business.
And if you have to have a prayer session before raising the price by 10 percent, then you've got a terrible business."
Warren Buffett, President of Berkshire Hathaway
Pricing: The New Source of Competitive Advantage
The most successful companies - those with above-average profits - have discovered the new source of competitive edge: pricing and, along with it, the way they can capture the value they provide to their customers through innovative monetization approaches.
Despite being the main and strongest profit driver, in many companies, pricing still remains at the stage of mere potential. This does not enable full profit to be obtained, whilst in the worst of hypotheses an inadequate pricing model ends up by losing customers and with them revenues and profits.
We set prices: "As we always have done" or again: "Adding our margin to the base cost" - these are typical statements from the old world when sales were purely transactional. "I give you a product x and you give me y dollars" was the mantra then. In a context where demand outweighed supply, where customers' demands were unsophisticated, where competitors were more or less analogous and technology not widespread, this might have been a sustainable approach. Not today. The time has come for a change.
There are, however, also companies that realized the importance of pricing, but either lack a structured approach to optimize their monetization, simply ignore or miss out the many pricing levers that if activated could strongly improve their profits or do not have sufficient top management attention on this key topic. The most successful firms are those that have as their number one priority total comprehension of the value perceived by their customers, combined with innovative approaches to monetization.
One of the first things they are quite clear on, is that price is the main profit driver.
If we take the case of a company with fixed costs amounting to US$30 million, variable costs coming to $60, a sales turnover of 1 million units and a price equal to $100, we find ourselves with a profit of $10 million. If we now improve every profit driver by 1%, in the equation given by profit equal to price by quantity, or the revenue less the costs both fixed and variable, we have the following result: pricing, compared to all three of the other profit drivers, that is, fixed costs at 3%, quantity at 4% and variable costs at 6%, is the lever that makes the greatest impact: increasing profits by as much as 10% (see Table 1.1).
Firms with above-average profits grasped this mechanism some time ago: they know that pricing is not only the most powerful lever but also works the fastest. Whereas on the side of costs, improvements of even a mere 1% can require large investments and take a long time (e.g. for moving production plants to countries with low production costs, etc.), a 1% improvement in pricing can occur instantly and at zero cost (e.g. when digital pricing labels are changed on the retail shelves in just a few seconds and at zero cost).
Table 1.1: Impact of 1% on all profit drivers
Source: Adapted from Zatta Danilo et al. (2013), Price Management, Franco Angeli, p. 15.
Starting situation Improvement of 1% New profits Increase in profits Fixed costs $30,000,000 $29,700,000 10,300,000 3% Quantity 1,000,000 $1,010,000 10,400,000 4% Variable costs $60 $59.4 10,600,000 6% Price 100 $101 11,000,000
10% Once the power of pricing is understood, companies ask themselves which levers to activate to improve their monetization skills. The answer to this question is that there is not a single pricing lever, but several levers that can potentially be activated, as indicated in the Pricing Framework represented in Figure 1.1.1 These levers can be assigned to four categories.
The first is related to price strategy and contains several facets, like the revenue model, positioning, and differentiation. Moreover, the direction set by the company in relation to its monetization priorities is part of this first category: one of the issues addressed is the question whether the company would be prepared or reluctant to sacrifice market share to increase its profits. In the automotive industry, until a few years ago the answer to this question was a clear no: volume and market share ruled. Today, the view on this has changed quite drastically.
Figure 1.1: The Pricing Framework: from price strategy to price steering
Source: Courtesy of Horváth
The second category is about price setting. Price logic, portfolio pricing, and product and service pricing are key facets here. If we take price logic as an example we will find several possible approaches - from cost plus pricing to competitive pricing or value pricing - based on the pricing maturity of a company, as indicated in Figure 1.4.
Once the price strategy has been defined and prices are set, in the sales process we see prices moving from the initial list price to the final transactional price. This is the essence of the third category - called price implementation - with, for example, terms and conditions provided by the company to its resellers and distributions partners, execution and negotiation of prices. There are also companies selling directly or not selling via price lists, for example, operating in project business with very customized products or services - all these cases are contemplated in this third category as well.
Finally, companies need to monitor and ensure that the target profitability is reached at the end of the year. To ensure this, price steering is needed, as indicated in the last category, where price controlling, price analytics, and price reporting come into play.
To ensure that pricing becomes an integral part of the company and is properly embedded there is a supporting layer, called pricing enablers. A clearly structured pricing organization, defined pricing processes (e.g. related to yearly price reviews and increases), pricing IT systems, and pricing skills are all relevant enablers.
To show how many and diverse pricing levers companies can activate you can review the elements displayed as examples in Figure 1.2,2 where their typical profit impact is shown. These elements can vary from industry to industry and in terms of single elements and profit impact. However, the same key learning holds true for all industries: to become more profitable there is not only a single element to be activated on the revenue side. Several pricing levers can be optimized and the sum of the impact of each of them generates a substantial profit improvement.
Triggers of the Pricing Model Revolution
In the last years we observed companies changing their monetization approaches: the most profitable companies were capable of assessing where value was coming from in the eyes of their clients and adapt their monetization approaches accordingly, creating a sustainable competitive advantage.
The period of the 2020-2022 pandemic gave a further boost to change and digitization, opening up to pricing and new models of revenue - barriers that previously seemed impossible to force open.
Starting from the basis of this ground-breaking change in the way companies monetize the value they provide to their customers, there are particular elements that we have grouped into four groups: these are the accelerators, or triggers of the Pricing Model Revolution (Figure 1.3). They are changing and will increasingly change the way firms extract and will continue to extract value from the market.
Figure 1.2: Pricing Framework: key elements and profit impact
Source: Courtesy of Horváth
Figure 1.3: The four triggers of the Pricing Model Revolution
The technological innovation of the last few years is the first trigger: it has laid the bases for raising pricing to a new level: digitization, cloud computing, the Internet of Things (IoT), autonomous systems, robotic process automation (RPA), or augmented reality. New cloud applications or digital pricing are often the prerequisites for holistic, data-oriented price management.
Data science progress is the second trigger: there are new quantities and a quality of data that create completely new potentials for setting prices. Suffice it to think of the huge quantities of big data available and how this can provide real-time elasticity regarding individual products or optimal discounts thanks to artificial intelligence....
