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McKinsey - The Power of Pricing

McKinsey - The Power of Pricing

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Published by L'Hassani

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Published by: L'Hassani on May 03, 2009
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05/11/2011

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TERRYALLEN
 
pricing
 The power of 
t few moments
since the end of World War II has downward pressureon prices been so great. Some of it stems from cyclical factors—suchas sluggish economic growth in the Western economies and Japan—thathave reined in consumer spending. There are newer sources as well: thevastly increased purchasing power of retailers, such as Wal-Mart, which cantherefore pressure suppliers; the Internet, which adds to the transparency of markets by making it easier to compare prices; and the role of China andother burgeoning industrial powers whose low labor costs have driven downprices for manufactured goods. The one-two punch of cyclical and newerfactors has eroded corporate pricing power and forced frustrated managersto look in every direction for ways to hold the line.In such an environment, managers might think it mad to talk about raisingprices. Yet nothing could be further from the truth. We are not talking aboutraising prices across the board; quite often, the most effective path is to getprices right for one customer, one transaction at a time, and to capture moreof the price that you already, in theory, charge. In this sense, there is roomfor price increases or at least price stability even in today’s difficult markets.
27
Michael V. Marn, Eric V. Roegner, and Craig C. Zawada
Transaction pricing is the key to surviving the current downturn—andto flourishing when conditions improve.
 A
 
Such an approach to pricing—transaction pricing, one of the three levels of price management (
see
sidebar “Pricing at three levels”)was first describedten years ago.
1
The idea was to figure out the real price you charged cus-tomers after accounting for a host of discounts, allowances, rebates, andother deductions. Only then could you determine how much money, if any,you were making and whether you were charging the right price for eachcustomer and transaction.A simple but powerful tool—the pocket price waterfall, which shows howmuch revenue companies really keep from each of their transactions—helpsthem diagnose and capture opportunities in transaction pricing. In this arti-cle, we revisit that tool to see how it has held up through dramatic changesin the way businesses work and in the broader economy. Our experienceserving hundreds of companies on pricing issues shows that the pocket pricewaterfall still effectively helps identify transaction-pricing opportunities.
28
THE McKINSEY QUARTERLY
2003 NUMBER 1
Transaction pricing is one of three levels ofprice management. Although distinct, eachlevel is related to the others, and action at anyone level could easily affect the others as well.Businesses trying to obtain a price advantage—that is, to make superior pricing a source of dis-tinctive performance—must master all three ofthese levels.
Industry price level.
The broadest view of pric-ing comes at the industry price level, where man-agers must understand how supply, demand,costs, regulations, and other high-level factorsinteract and affect overall prices. Companies thatexcel at this level avoid unnecessary downwardpressure on prices and often emerge as industryprice leaders.
Product/market strategy level.
The primaryissue at this second level is pricing a product orservice relative to the competition. To do so,companies must understand how customers per-ceive all offerings on the market and, most par-ticularly, which attributes—product as well asservice and intangible attributes—drive purchasedecisions. With this knowledge, companies canset visible list prices that accurately reflect thecompetitive strengths (or weaknesses) of theirofferings.
Transaction level.
The focus of transactionpricing is to decide the exact price for eachtransaction—starting with the list price anddetermining which discounts, allowances, pay-ment terms, bonuses, and other incentivesshould be applied. For a majority of companies,the management of transaction pricing is themost detailed, time-consuming, systems-intensive, and energy-intensive task involved ingaining a price advantage.
Pricing at three levels
1
See
Michael V. Marn and Robert L. Rosiello, “Managing price, gaining profit,”
Harvard Business Review
,September–October 1992, pp. 84–93.

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