Chapter 3
Which Contexts Matter to You?
Con′-text, n. Parts that precede or follow … and fixits meaning.
Con-tex′-ture, n. Act, mode of weaving together; structure; fabric … composition.
—THE CONCISE OXFORD DICTIONARY (4TH EDITION)
Which contexts matter to your pricing? That question requires some careful analysis of your product and buyers, frequently resulting in some surprises.
One such surprise came from a supplier to Wall Street trading desks. That supplier’s sales team had been working hard to reach the “decision makers” directly and to avoid the buying organization. A survey of the sales force indicated that they ideally would present their offer to the head of trading and would work hard to avoid the vice president of purchasing. As it turned out though, this strategy was not ideal for achieving best price levels.
A look at the numbers showed that consistently when the buying decision was made by the head of trading, the client walked away with both a lower realized price and lower revenues. Why? The answer, as usual, lay in the decision context.
In a typical Wall Street environment, the head of trading is a powerful individual and apparently someone who is very familiar with the needs of the trading desks. Comparatively, the VP of purchasing is a lot less influential and is often removed from the operational needs of the trading desks. This means that when the VP of purchasing considers a price, he cannot afford to take the risk of saying no. Were he to cancel a service vital to the trading desks, without a seamless replacement, the consequences would be dire. Hence, the VP of purchasing could bark, but not bite.
In contrast, the head of trading was typically able to balance cost versus benefit because of his familiarity with the trading operations. Equally important, if he canceled a product or service, the complaints would flow to him and he could address them with less internal political risk. Finally, since he knew the needs more directly, he was more confident in cutting out less necessary service components. All this meant that the client would walk away poorer from the exchange.
The Effect of the Buying Decision on the Pricing Outcome
This is a clear example of context framing the buying decision, which in turn flows down to the pricing outcome. Further, the context also frames the ideal price structure. In the case of Wall Street trading departments, a good pricing structure worked to overcome the formidable defenses that the investment houses had erected so as to keep suppliers from encroaching on their treasure.
Trading organizations such as Goldman Sachs set up cost standards for their traders. A successful trader might bring that institution $35+ million a year in revenues—a lot of money. But each trader was limited to about a 10 percent expense ratio, from which came his or her base salary (small compared with bonus) and overheads such as floor space and benefits. This left about a $40,000 a year per trader target for other expenses, including purchases such as turrets, communications, training, data, and support. If you were a vendor who fell into one of the categories capped by this number, your price would be squeezed despite the huge margins enjoyed by Goldman—unless you refused to put your price in terms that allowed ready allocation of costs by a trader. An enterprise license independent of usage and crossing functional boundaries is difficult to allocate to each trader. Allocation can be done arbitrarily, but doing so often presents fairness issues (e.g., not every trader might use all the services and would complain) and is just more effort. So it was easier for the purchasing gatekeepers to allocate enterprise buys against entire departments. Fortunately department budgets did not have the same rigor as per-trader expense caps, hence pricing was less strongly resisted. Thus price structure, in this case the “unit” or measure of the service or product offered, helped liberate price level.
Thorough understanding of decision processes frequently does not happen in the course of normal sales activity. Yet it may be the only way to overcome contextual barriers to price.
The choice of purchase unit is an opportunity to have an impact on context and price, and it is often ignored. As described later in this book, most services or products can be sold in super-sets (bundles) or in partial sets (or “slices” or “intervals”) of ownership rights, and associated financing or warranties. Each of these choices should reflect the buyer decision process and frame of reference.
Frame of reference should include the channel context. For instance, a number of amusement park vendors have begun to charge more for tickets over the Internet than at the door. While this is different from what many consumers expect of the Internet, it makes a lot of sense. Most major amusement parks have found that visitors view their pricing in the context of the entire visit. In the case of a large amusement park, located in a major U.S. city, there is a wide range of visitors: local, in-state, from a long distance, and international. This means that for some visitors the travel costs are small—a trip on the local rapid transit system. For others, it means an expensive airfare, hotel, and incidentals.
This context sets price sensitivity. To someone who has spent over a thousand dollars to travel, for example, to Atlanta, a $39 admission ticket appears small. To someone who has spent $4 on mass transit to get there, the $39 will receive more attention. In fact, distance and travel cost drive price, so an Internet purchase favored by out-of-town visitors should be higher than an in-person purchase.
Context of overall purchase amounts applies to large industrial negotiations also. In the course of a multi-hundred-million-dollar negotiation, the seller asked the buyer to cover a $100,000 cost item, and the buyer team (focused on the large-ticket items) casually agreed—a concession that in any other negotiation would have been inconceivable.
How Customer Concerns Influence the Buying Decision
So many things can represent factors that have an impact on price outcomes: contexts and drivers may include buyer title, choice of unit, geography, related expenses such as travel, and the size of the negotiation. The list goes on and on. Furthermore, we find that key drivers in one market turn out to not matter much in other markets. Bundling of oil field services and geophysical analysis matter, but bundling of steel types does not matter at all. Bundling of cable television and telephone service matters to market segments of modest means, but it actually destroys value in high income segments. Therefore, an examination of context and resulting drivers is required—of course, that is ostensibly the job of product and market management, not to mention sales.
Yet repeatedly many managers resist looking into the black box of the customer’s mind and buyer decision processes. Two examples:
First, the brilliant CEO of Bell Canada Mobility, and before that the savior of Ford Canada, Bob Ferchat was a seasoned CEO with a sterling management record. Yet Bob was frustrated by the total organizational resistance to a very pragmatic suggestion: learn about Bell Mobility’s best customers.
Since long-haul truckers were one of the most important segments served by Bell Mobility, Bob said that any employee who wanted to spend a few days riding with a trucking fleet was encouraged to do so and would be compensated for it. Much to Bob’s chagrin, none of Mobility’s 20,000 employees took up this offer. Not one employee wanted to understand first-hand the company’s best customer groups’ needs and how they made their buying decisions.
In the second example, a manufacturer of narrow body short-haul airframes noticed that one of their smaller airplanes was not selling well, and often buyers were going up one size even when they did not need the extra seat capacity (or expense). Investigation found that the larger airplane readily qualified for an investment tax credit, while the smaller airplane typically did not. When the difference in the buyer’s tax obligation was pointed out, product management said that it was “none of our business.” From a pricing point of view, it was exactly the manufacturer’s business.
Figure 3-1 Inside the customer’s mind; the “black box” of the customer’s decision process.
Thus, one step towards contextual pricing is to encourage your company to look inside the black box of the consumer’s mind, or the decision process of a business customer. Many questions important to pricing are not always asked, so the decision process remains dark and obscure.
As with all change, expect some resistance to a customer-centric pricing approach.
You may be wondering, even if your team recognizes that the buyer’s economics has an impact on your company’s sales success, how do you improve your team’s understanding of price context and price drivers? How do we identify potential drivers, and how do we test them? The answer is simple. We find that drivers and context are usually well-known to management, and certainly to customers. Asking management to document and discuss potential drivers is a good first step.1
Some degree of impartiality is required for the evaluation of drivers, however. For instance, in sales-oriented organizations, often the factors important to sales are given priority and a sales issue with minimal impact on pricing is given priority over an actual pricing issue that is destroying customer loyalty. At one company, sales management used the inquiry into contextual pricing to club customer service management over the head about some minor service issues, while the real issue provoking customer defections was pricing.
A generic list of potential contextual pricing drivers may be useful as you consider your pricing initiatives. This generic list has been organized by the four Ps of marketing:
Product. In addition to basing pricing on the familiar measures of performance and quality, spend more time looking at uses and competitor offers (including both tangibles and intangibles). Most important, don’t assume perfect information—what do potential buyers know? What do they not know? Over time?
Promotion. Sophisticated promotion and branding management is already worried about what the buyer thinks and what the buyer knows. The shortcoming is that often these insights are linked to messaging and ignore pricing. Branding is an effort to communicate and influence buyers, often through context; extend this discipline to pricing.
Price structure. Forms some of the most directly applicable context. A price structure powerfully communicates what context should be used by buyers: for Band-Aids, pricing by the box says, “Compare by the box,” and a fixed price often says, “Here it is, whether you use it or not.” Make sure the message is right.
Channel (“place”). This is often the core of contextual outcomes. Sales channels differ in effectiveness, ability to communicate, and ability to shape decision criteria. Pricing must weave the story most useful to channel, including the point of sale price strategy.
Graphically, Figure 3-2 shows some of the more frequently encountered contextual factors. Word size represents frequency of occurrence. This diagram may form a starting point for discussion, but sometimes markets march to their own drummer and the usual suspects are not the drivers of price.2
Figure 3-2 Proportional representation of common pricing contexts.
If the universe of potential contexts seems large, it is. The business world is big and diverse, and so is the world of contexts. They are not all primary, however, and the good news is that no company division faces more than a few primary contextual drivers.
The academic literature reinforces the many ways in which context matters, and perusing it reveals some proven contextual influences.3
Time. Most consumers will not pick the first offer presented, even if it is the best one.
Comparison of prices. Most consumers see price differences as a percentage of the base price and are less motivated by the same absolute dollar-price difference on a large purchase than they are on a smaller purchase.
Premium products. Adding a premium product to a product line enhances consumer perception of the product line, even if buyers choose not to purchase the premium tier.
Discounts. A discount works better when consumers have a clear understanding of the normal price.
Bargains. A higher list price minus a discount will sell better than a lower discount with a surcharge, even if the resulting prices are equal.
Nonprice fees. These can outperform explicit dollar fees in some circumstances, for example, “tokens.”
There may be no contextual commonality across your company divisions, but that is okay: focus and relative simplicity is of course why many companies divide their management into different business units.
The Other Side of the Mirror
So now we’ve seen context from a market perspective. An underpinning of contextual pricing is that unless you have a unique product, your company may need to pay attention to what the market wants. But what about the perspective from inside your company? Typically, business units must adapt to a range of customer and selling situations, and they do this by thinking in terms of the tasks to be performed. While there is some loss of fidelity to the market by doing this, such a task-oriented view is okay.
Some common contexts requiring different pricing capabilities (and, likely, different price points) are:
Large bids, generally involving negotiations
Standard product sales in moderate dollar contracts
Small and one-off sales
Special orders
Rush orders
Direct sales via proprietary channels
Sales to consortia
Sales through retail
Sales to competitors and resellers
Sales via bid
Sales to loyal and sole-source customers
Sales for marginal customers
Highly competitive sales
Add-on sales
Up-tiering
Pilot sales of new offers
Bundles
Direct to buyer versus intermediary
Preemptive (e.g., stock-up strategy) versus reactive
Complex choices versus clear choices or guided sales
Intended (by seller) use versus unintended use
Certain use by buyer versus contingency (e.g., insurance)
A complete list would be quite long. The list here covers a lot of ground, perhaps 70 percent of your company’s pricing situations.
Suppose you want to condense the list further. One way to condense contextual pricing factors is to lump them together according to how robust or fragile is your customer relationship. If you have—by reason of product, delivery, branding or pricing—a very strong appeal in a particular context, that should be handled very differently than if your offer is not compelling in a particular context. Therefore, one potential approach is to categorize your selling contexts by market strength.
One example of contextual price points, ordered by strength of customer relationships, that served a large consumer goods company selling through retail is illustrated in Figure 3-3 above.
Figure 3-3 Contextual price bases: example of five contextual price bases used by a large consumer goods company.
These five categories of contextual price pressure replaced a complex pricing formula and matrix, yet proved implementable across the market. The five explained price variation better than the existing segmentation; so this insight was incorporated into this company’s market strategy.
Often you can categorize your contextual baselines by reference to your market power (measurable, in some cases, as customer price sensitivity).
Organizational Acceptance of Contextual Pricing
Management today has an array of tools for identifying and evaluating the contexts for purchase decisions. Each can provide a richness of insight and means for lifting revenues, but often management hesitates to embrace implications. Why?
Outside some industries where pricing is a primary management activity (e.g., finance and travel), the unwillingness to draw conclusions from data seems to be motivated by a combination of fear and inertia.4
One cable television company delayed making major price decisions because it was waiting to build a multimillion-dollar data warehouse—despite having a rich inventory of customer surveys. Upon completion of the warehouse, the cable company then decided the data warehouse data was imperfect (surprise!) and therefore unsuitable for pricing decisions. After several consulting efforts cobbled together data from various sources, all fairly consistent in direction, the cable television company is still looking for more data to support the various evidence-based (but imperfect) strategy recommendations.
No pricing strategy is risk-free or based on airtight evidence. But neither is any sales strategy, any financial strategy, any product development plan, any branding strategy, and so on. Yet those imperfect plans seem to be implemented more often. Why? One possible answer is that in many industries, top managers have reached that position through sales, finance, or marketing. A former chief marketing officer for Dun & Bradstreet said she found evidence that their pricing was an issue. Forced to undertake a program to shore up revenues, however, she chose the tool that had brought her to the office: branding. Managers do not like to bet their careers on functional programs with which they and others are unfamiliar. This is possibly why there is sometimes tolerance for indefinite delay in addressing pricing.5
Context may make pricing principles familiar to company management teams because in many cases contextual logic can make the results intuitive. That is the hope, in any case. Context rejects simple mathematical measures such as elasticity, and rightly so. Instead, contextual logic requires a relentless focus on why and how decisions get made. That is often not known, but is a familiar question to those who address branding and sales issues.
Summary
The potential frames of reference have a striking amount of diversity. Yet when we consider specific cases, the context is relatively simple. In each case the process of ascertaining context is fairly similar: investigate the buyer decision process, through interviews, survey, or other means. The menu of contexts presented here may be a useful starting point.
Notes
1. If you ask, you are more likely to end up with too many potential contextual drivers rather than too few. The trick is that many are closely related, or colinear in statistical terms. For instance, as a B2B example, be aware that the “buying size of the customer” is often related to how long they have been a customer, which is related to how long the company has been in business, which is related to how senior the sales rep is on that account, to many other considerations. In other words, all these factors may be really measuring the same thing. Determining which related factor is primary often requires some statistical testing.
2. Going after the most common drivers of price is not always the most effective method in finding the real sources of pricing difference. When Captain Renault says “Round up the usual suspects” near the end of Casablanca, he’s letting the real culprit (played by Humphrey Bogart) go free. Do not let teams assume the usual contextual drivers are applicable—you may miss the real culprits.
3. Warning: on advice of counsel we are obligated to warn you that this may be the world’s most boring footnote. Linking price outcomes to mental processes has been well established in a slew of academic studies. A few examples: Kent B. Monroe and Joseph Chapman, “Framing Effects on Buyers’ Subjective Product Evaluations,” Advances in Consumer Research, vol. 14, 1987, pp. 193–197; Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, Summer 1985, pp. 199–214; Amos Tversky and Itamar Simonson, “Context-Dependent Preferences,” Management Science, vol. 39, no. 10, October 1993. But that research is more focused on price level and couponing, so it is a bit narrow for managerial use. A few authors take a broader view, and describe how to link price framing (“contextual”) insights to pricing practices. For a nicely written look at use of context see Benson P. Shapiro “What the Hell is Market Oriented?” Harvard Business Review, March 3, 2009.
4. Oddly, many managers seem to think that price decisions can be avoided and pricing issues addressed through other means. This course of action is similar to comedian Mitch Hedberg’s dental strategy: “I was going to get my teeth whitened, but instead I got a tan.”
5. In part we suspect that the ambivalence in coming to grips with pricing issues occurs because pricing can be unusually complex. That can be a reason managers refuse to move on pricing initiatives. “Why So Many People Can’t Make Decisions,” The Wall Street Journal, September 28, 2010, p. D1.