Three Levels of Pricing

Pricing at the macro, strategic, and transactional levels

Within the field of pricing, there is a wide variety of things to analyze and work on. If you reach the point of thinking “I would like improve pricing for my business” and you start to read around on the topic, it’s easy to become overwhelmed.

As in other things, breaking it down into pieces helps. A good way to break down the world of pricing into manageable pieces about is one I’ve adapted slightly from the classic book The Pricing Advantage. This approach breaks the field of pricing down into three layers.

The first layer is the Macro layer. This has to do with pricing effects on the entire market in which you operate.

If there are key commodities which are used in your products, are they increasing or decreasing in price? Do you use steel, aluminum, tungsten, resin, oil? If so, the changed in that commodity will affect the entire market, both you and competitors. If you follow those changes closely, you can keep up with the market and protect your margins. If you ignore them until others move, you may always be one step behind.

What is the overall supply versus demand in your industry? Are you flooded with competition, driving prices down? Has a key competitor recently gone out of business, making your product scarce and thus more valuable?

What are the general economic factors affecting you and your competitors? Are the wages you pay your employees going up? Is regulation increasing? What is happening with energy costs? Have tariffs affected you or your competition?

As you think about all of these factors, you should think both about how they affect your company and how they affect your company relative to your competitors. If the cost of labor is going up rapidly, but you have a business model in which you use labor less than your competitors, you might want to increase your prices somewhat because your competition will be forced to do likewise by their higher labor consumption. If you increase your prices, but do so less than your competitors who have more labor intensive processes, you might be able to both increase your margins and improve your competitive price position at the same time.

Generally speaking, you should not have to think about these macro factors every week or every month. You should spend some serious time thinking about what factors affect your business, and make a plan for how changed in these factors will affect your prices. Then, as macro changes happen, make your price changes according to the plan. You might need to reassess the plan once a year or so in order to make sure that your assumptions still hold true, and you should monitor the results to see if your actions are having the results you expect, but with a good model you should not have to think about your macro pricing often.

The second layer is the Strategic layer. Whereas the Macro layer has to do with effects on the entire market, both you and your competitors, the Strategic layer has to do with what strategy you are setting for your products and how customers value them versus your competitors.

Are you a premium provider, offering more value than your competitors and charging a higher price as a result? If so, how are you conveying that extra value to your customers through your marketing and your sales process so that customers realize that your products or services are worth the price — in fact a bargain versus the “cheaper” products that provide less value?

Are there specific aspects of your product or service differentiation which deliver that extra value, and which you should focus your price on? For instance, perhaps you are able to deliver your products or services much faster than your competitors, finishing a project in days that would take others weeks. If so, perhaps you should have scaled pricing based on speed, charging customers 2x, 3x, or more for priority turn-arounds.

Do you provide higher reliability or a much better experience than your competitors? Could you adopt a product-as-a-service pricing model and charge based on the reliability rather than on a per-product basis? GE famously switched from selling jet engines to making lease agreements which charged the airline per mile flown to benefit from their high reliability. Or perhaps you need to build a model to quantify for customers how much better your product is and thus why your price position is justified.

Are there certain products that you are offering as a convenience rather than as the lowest price option? Do you provide a one-stop-shop when to save money customers would have to go to a dozen or more different vendors? If so, how much more can you charge for that convenience versus those numerous smaller suppliers?

Or are you a disruptive low price market entrant, using a slim cost model to steal business away from established competitors with a good-enough product which is significantly cheaper than the alternatives?

As you consider all this, the outcome should be setting prices and pricing rules such as how much (or if) you will discount, whether you will charge for shipping, rush orders, etc.

These decisions you make should reflect the strategy you have set for your pricing based on the value you believe you are delivering to customers.

If you are in the position of already having a number of products with prices out in the market, but not having arrived at those prices through conscious pricing strategy decisions, then you should work through a pricing review in which you establish what your strategy is and then adjust your prices, discounts, etc. in order to match that strategy.

Making a change is often more challenging than starting fresh, because both your own employees and your customers are used to your current pricing and practices, and if you are making a change it is necessary to very clearly communicate the reason for it and how it reflects the value you are delivering to your customers.

The final layer is the Transactional layer of pricing. This is where your strategy is actually implemented with customers and turns into dollars and cents.

Transactional pricing involves all of the day-to-day pricing decisions your company makes in making sales. If you have a retail type operation, this means the prices and promotions you offer on a daily basis on your website or in your stores. If you work through sales reps who have discount authority or you make quotes or bids in response to big orders, this involves what price you actually charge for your products on real orders after all the steps in the pricing waterfall to pocket price.

The key with transactional pricing is to make sure that you are actually executing on the pricing strategy that you set.

If you said that your product presents a higher value and should be sold 20% above the price of your competitors, are your salespeople actually selling at that price or are they discounting down to match competition?

If your value is in speed of delivery, are you successfully charging more for rush orders than for standard ones?

Are there steps in the pricing waterfall where you are making decisions that simply do not make financial sense, such as offering a 3% discount for early payment when your cost of money is just 0.8% over the course of the normal 30-day payment period?

Let’s do a brief review as we conclude.

We might think of the Macro level of pricing as answering the question: What is going on out in the market as a whole and how should if affect my pricing?

Your decisions at the Strategic level of pricing answer the question: What value am I delivering to customers compared to my competitors and what price does that mean I should set?

And as you assess your Transactional level of pricing, you are asking yourself: Am I actually pricing the way that I said that I would?

As you refine your company’s pricing, you’ll need to both analyze your company at these three levels and also develop the tools and practices to implement your decisions and make sure that the company is following through on those decisions.