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How Do You Know When the Price Is Right?

An eight-step process can help you make better decisions.

Pricing is managers' biggest marketing headache. It's where they feel the most pressure to perform and the least certain that they are doing a good job. The pressure is intensified because, for the most part, managers believe that they don't have control over price: It is dictated by the market. Moreover, pricing is often seen as a difficult area in which to set objectives and measure results. Ask managers to define the objective for the company's manufacturing function, and they will cite a concrete goal, such as output and cost, Ask for a measure of productivity, and they will refer to cycle times. But pricing is difficult to pin down. High unit sales and increased market share sound promising but they may in fact mean that a price is too low. And forgone profits do not appear on anyone's scorecard. Indeed, judging pricing quality from outcomes reported on financial statements is perilous business.

Yet getting closer to the "right" price can have a tremendous impact. Even slight improvements can yield significant results. For example, for a company with 8% profit margins, a 1% improvement in price realization- assuming a steady unit sales volume-would boost the company's margin dollars by 12.5% [1] For that reason, even one step toward better pricing can be worth a lot.

To improve a company's pricing capability, managers should begin by focusing on the process, not on the outcome. The first question to ask is not, what should the price be? But rather, have we addressed all the considerations that will determine the correct price? Pricing is not simply a matter of getting one key thing right. Proper pricing comes from carefully and consistently managing a myriad of issues.

Based on observation and participation in setting prices in a wide variety of situations, I have identified two broad qualities of any effective pricing process and a "to do" list for improving that process. Not every point will apply to every business, and some managers will need to supplement the checklist with other actions that pertain to their specific situation. But in general, by using these criteria as a guide, managers will begin to set prices that earn the company measurably greater returns, and they will gain control over the pricing function.

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Robert J. Dolan is the Edward W. Carter Professor of Business Administration at the Harvard Business Schoold in Boston, Massachusetts. His most recent book is Managing the New Product Development Process (Addison вЂ"Wesely, 1993). He is currently writing a book on pricing strategy with Hermann Simon. It will be published by the Free Press in 1996.

Strategy and Coordination

All successful pricing efforts share two qualities: The policy complements the company's overall marketing strategy, and the process is coordinated and holistic.

Marketing Strategy

A company's pricing policy sends a message to the market- it gives customers an important sense of a company's philosophy. Consider Saturn Corporation (a wholly owned subsidiary of General Motors). The company wants to let consumers know that it is friendly and easy to do business with. Part of this concept is conveyed through initiatives such as inviting customers to the factory to see where the cars are made and sponsoring evenings at the dealership that combine a social event with training on car maintenance. But Saturn's pricing policy sends a strong message as well. Can a friendly, trusting relationship be established with customers if a salesperson uses all the negotiating ploys in the book to try to separate them from that last $100. Of course not. Saturn has a "no hassle, no haggle" policy (one price, no negotiations) which removes the possibility of adversarial discussions between dealer and potential customer. Customers have an easier time buying a car knowing that the next person in the door won't negotiate a better deal.

The pricing policy for Swatch watches illustrates the same point. The company's overall message is that a watch can be more than just functional; it can be fun as well- so much fun, in fact, that a customer ought to own several. The company's price, $40 for a basic model, has not changed in ten years. As Franco Bosisio, the head of the Swatch design lab, noted in William Taylor's interview "Message and Muscle: An Interview with Swatch Titan Nicholas Hayek" (HBR, March-April 1993): "Price has become a mirror for the other attributes we try to communicate.... A Swatch is not just affordable, it's approachable. Buying a Swatch is an easy decision to make, an easy decision to live with. It's provocative, but it doesn't make you think too much."

For Saturn and Swatch, the pricing policy flows directly from the overall marketing strategy. This consistency, or even synergy, of price and the rest of the marketing mix is a critical requirement for success.

Coordination

There are typically many participants in the pricing process: Accounting provides cost estimates; marketing communicates the pricing strategy; sales provides specific customer input; production sets supply boundaries and finance establishes the requirements for the entire company's monetary health. Input from diverse sources is necessary. However, problems arise when the philosophy of wide participation is carried over to the price-setting process without strong coordinating mechanisms. For example, if the marketing department sets list prices, the salespeople negotiate discounts in the field, the legal department adjusts prices if necessary to prevent violation of laws or contractual agreements, and the people filling orders negotiate price adjustments for delays in shipment, everybody's best intentions usually end up bringing about less than the best results. In fact, the company may actually lose money on some orders, and some specialty items positioned to earn high margins may end up returning margins in the commodity range.

Such was the case at a major truck manufacturer. Marketing set list prices that were essentially meaningless because so many other functions then adjusted those prices for their own purposes. While salespeople chased volume incentives by offering the largest discounts they were allowed, finance and accounting were charged with making sure the company covered its variable