RSM Resources

A decade ago, marketers seeking to set price points for products and services had a relatively simple choice: adopt a "low-cost" model designed to undercut competitors or take a "value-added" approach to justify a higher price for perceived quality differences.

Today, however, many experts say Internet marketing, global competition and increased commoditization are creating an uncomfortable pricing"squeeze play" on midsized companies. In fact, 21 percent of respondents in a recent Merrill Lynch survey of senior executives said that pricing pressures would be a major issue for their companies in 2006. That’s double the percentage of leaders who agreed with that statement just a year ago. And 40 percent of executives said pricing would be a major tool for addressing competition in 2006, compared with 35 percent a year earlier.

"There has been a fundamental shift in pricing power along the value chain for U.S. companies," says equity analyst Robin Wehbe in an investment advisory for State Street Global Advisors. "This shift has been caused by changes in business models and the world economy, and it will determine industry conditions for the foreseeable future."

The shift, or squeeze play, affects pricing as follows. A few years ago, a large producer of raw materials could simply pass along any increased costs to the next link in the value chain, such as a midsized manufacturer or service provider. That company, in turn, could recover its costs by increasing prices to retail or reseller outlets that often didn’t have the sales volume or buying power to push back.

Today, however, U.S. companies in the middle of the value chain face pressure on two fronts. On the producer side, there’s the exponential growth of manufacturing in countries such as India and China, fueled largely by low-cost capital and labor. That growth is driving up the cost of raw materials for all producers. On the consumer side, the rise of big-box stores such as Wal-Mart — coupled with a sharp rise in online shopping options — has given retailers unprecedented power to keep prices low. That leaves midsized manufacturers with little or no ability to pass along rising input costs.

While experts generally agree on how the pricing squeeze has evolved, they have differing views on how businesses should respond. For example, R. Sam Bowers, president of the Service Sales Institute in Charlotte, N.C., believes that the march to commoditization is unstoppable and that so-called "value pricing" is no longer viable. Instead, he advocates that companies consistently seek ways to remove cost from their businesses so that they can aggressively compete on price.

"You still need a quality service or product to even get in the game, and you still need to look for innovative ways to solve customer problems and needs," Bowers wrote in a white paper for Vistage International, a midsized-business information resource group. "But when that customer makes a decision to buy, you must stop playing the value-added game. All that does is increase your costs and lower your profit."

Establishing a price-value relationship
Doug Gilliss, president of Negotiation Strategies International, a California-based business strategy consulting firm, takes a more mainstream view.

"The bottom line is this: You cannot beat the giants on cost, and you cannot usually beat the little guys on customization," he says. "When it comes to pricing, the key to establishing value is not to focus on what you sell — but on how you sell it."

When faced with constant demands from customers to lower prices, Gilliss is adamant that companies can maintain comfortable margins by taking four basic steps, including:

Differentiation. Even in market segments that view products or services as commodities, it is possible to create enough differentiation to justify value pricing, Gilliss says. For example, he pointed to a midsized manufacturer of water heaters that made a good product, but was losing a price war with cheaper competitors. Looking for an edge, the company discovered that the average water heater failed either in its first year of use, or after 15 or more years of service. Armed with that information, the firm extended its warranty to 10 years — double the length competitors offered — and reintroduced the product line under a private label. That bet allowed the company to command a higher price by offering new consumer benefits with little or no added cost.

Narrowing the market niche. When faced with tightening margins, many companies will take steps to expand their markets, often through "line extensions" that can actually damage brand image and profitability. A better approach, Gilliss says,is to ask company leaders, employees and customers to help define the company's strongest market segment — whether real or potential. After identifying that niche, take steps to ramp up production or service offerings in that arena. Then a company can showcase its best work —and command premium pricing.

"There’s a long history of U.S.companies that have screwed up by trying to own a bigger spectrum of the market rather than really isolating what they do well in order to drive a higher net profit," Gilliss says.

Clarifying the value proposition.In an era when buyers are bombarded by constant media and marketing messages, the basic elements of salesmanship often get lost. One key mistake: using long, complicated justifications for higher pricing when a simple and concise illustration of value would carry the day. In a recent consultation, Gilliss recalled how a company’s marketing officials proudly displayed a 28-page product proposal designed to support a price increase. After asking the staff how many had actually read it cover to cover, the revised proposal was whittled to three pages.

Focusing on the customer’s customer. This stage requires a company to step away from its own vested interests and evaluate how the product or service it sells can help the customer make more money with its clients. Gilliss suggested taking time to engage customers on their downstream concerns, with an eye toward identifying where the company can help anticipate or fulfill those needs. Firms that do a good job in this area can then define specific value-added products and services that help improve the customer’s profitability.That, in turn, can justify increased pricing.

"Remember, it’s your job to educate the customer on how to make money with the goods and products you sell," Gilliss says. "If you expect them to figure it out on their own, it won’t happen."

By determining the rightapproach for your business, you can make pricing decisions that willhelp your company enhance both profitability and new businessdevelopment.