10 Feb 2003  Research & Ideas

Commodity Busters: Be a Price Maker, Not a Price Taker

Too many businesses are price takers, not price makers. That means they are willing to lower prices to capture market share or to sign up a marquee customer. But Harvard Business School professor Benson P. Shapiro says don't let your ego get in the way of good business sense. Here are seven steps toward naming your own price.

 

Business is about making money, not measuring macho. The scrap heap of business disasters is littered with managers whose ego drive overwhelmed good business sense.

Founder and former chief executive Ray Noorda had a wonderful business in network software supplier Novell—until he became obsessed with beating Microsoft. His battle was futile. He left the company as Novell began a long downward slide. The fighter pilot mentality of several U.S. airlines led to a price war in which billions of dollars were lost. Even in small protected niche markets such as retail security systems, in which the two primary competitors, Checkpoint and Sensormatic, went at each other mercilessly, unbridled competition can be destructive.

Sensible business managers focus primarily on their own success, not on creating failure for their competitors. Despite intense competition in business, one can win without destroying or even harming the competitor. The focus must be on your own success.

Smart competitors don't try to beat their adversaries; they avoid direct competitors and instead maximize profits. The astute manager wants to establish a set of quasi "local monopolies" protected from competitive as well as customer pressure. This demands confidence, not bravado; astute analysis not raw aggression; and requires careful, empathetic focus on the other players in the marketplace.

Competitors, in an attempt to gain market share or market position, often succumb and thus destroy the profitability of whole markets.
— Benson P. Shapiro

Make your price

This is perhaps most true in pricing, a particularly vexing challenge in today's hypercompetitive marketplace. Major customers exert enormous pressure to force suppliers to cut prices. The consolidation of purchases and purchasers adds to the pressure. Competitors, in an attempt to gain market share or market position, often succumb and thus destroy the profitability of whole markets. But, with careful thought and precise execution, managers can be price makers, not price takers.

There are seven requirements to becoming a price maker. Each step is crucial. Failure to take any one will put your company on the slippery slope to being a price taker.

Step 1: Create customer value. There are two parts to the creation of customer value. You must provide a reason for the customer to do business with you. Focusing on the four core customer values of convenience, availability, product or service functionality, and relationship, creates a reason for the customer to buy.

But, you also must eliminate reasons for the customer not to purchase. Various adjunct services, for example, often described as the steps in the order cycle, can cause serious problems for customers and create a strong reason not to purchase. Confusing or inaccurate billing causes customer annoyance. Simply eliminating the reasons for someone not to purchase, however, does not create a reason for them to buy. It is necessary to provide a positive attraction for your product or service, as well as to remove the inhibitors to purchasing.

The most successful companies follow this two-pronged strategy of providing a reason for the customer to buy, while eliminating annoying problems in the order cycle. Whether it is Microsoft or Wal-Mart, the balanced approach works best. Wal-mart, for example, stresses its low everyday prices, which gives the customer a reason to buy, while simultaneously providing supportive services from the greeter at the store's entrance to the cashier at its exit.

Step 2: Choose your customers. The corollary to providing customer value is to choose customers or purchase situations where the value is recognized. Managers are beginning to understand that it is impossible to provide a meaningful reason to purchase and outstanding service to all customers in all purchase situations. It is absolutely necessary to fit your capabilities to your customers' needs and to match your customers to your capabilities. You must focus your capabilities where they will mean the most to the customer. The real secret to being a price maker is to walk away from business if you cannot provide superior value.

Happy customers whose expectations are met tend to dwell less on price.
— Benson P. Shapiro

Focus only on the market segments, defined by customer set or purchase situation, to which you can bring superior perceived value. It is important to understand that both the perception and the reality are important. Some customers really have no interest in your special capabilities. Avoid those customers. You must also avoid prospects who cannot perceive your superior value. Simply put, schizophrenia is terminal in business. Your company must stand for a unique value provided to a unique set of customers or purchase situations.

Step 3: Be different. While many managers talk about uniqueness, when the going gets tough, they attempt to imitate their competitors. To be a price maker, be different! The difference can be in the nature of the customer value created, the way it is created, or for whom it is created. The more different you are, the greater your opportunity to set your own price. A commodity is defined as "undifferentiated." You must be different.

Gore, the very successful manufacturer of Goretex, provides unique product functionality. Other successful companies focus on a unique business model, which is the way in which they create value. They create value more cheaply, such as Wal-Mart, or provide better service such as The Four Seasons hotels. Still other successful companies choose to appeal to a different set of customers or set of purchase situations than their competitors. Progressive Insurance built a wonderful business by selecting relatively low-risk customers from among generally high-risk motorcyclists.

Step 4: Keep it simple. Don't shoot yourself in the foot by mismanaging your own product or service line. Many companies offer so many variations with minor differences that customers are encouraged to trade down to lower margin merchandise or services, or just become so confused that they won't buy. It is difficult enough to compete with others; do not compete with yourself! By and large, simple product lines and service offerings have proven the easiest to manage, and in the long run, the most profitable to offer.

Step Five: Determine customer value. Develop a way to charge for each customer transaction based on either the quality or the quantity of value you provide. Each transaction provides the opportunity to price relative to customer value. To do this, you must focus on the basis of your pricing. For example, when the Xerox machine was introduced, it was neither sold nor leased on a time basis. Instead, a lease meter was installed in each machine to count the number of copies. This enabled Xerox to charge heavy users, who found greater value in the machine, more than it charged light users. The original basis for pricing telephone service, including both a fixed monthly charge and a usage charge, represents the same kind of thinking. The person who chose to price advertising services as 15 percent of the media buy, instead of by time and materials, created an enormous amount of profit for advertising agencies.

Often services, and to a lesser extent products, can be priced not just by quantity, but also according to the performance or quality provided. Thus, a computer consultant might be paid based on meeting certain quality benchmarks, or as a percentage of cost savings. Or, a contractor might be paid more for finishing a job early. There are many variations to performance-based pricing including penalty clauses. But, the idea is always the same. Base your price on the value the customer receives.

Many people who are able to follow the first five requirements find the last two particularly difficult. The first five have an intellectual tone. They involve careful analysis, and detailed conceptual frameworks. But, requirement number six makes clear that execution is absolutely critical.

Step 6: Deliver on your promise. If you do not deliver on your promise, your customer will have a good reason to negotiate, focusing on price. Happy customers whose expectations are met tend to dwell less on price, and to generally behave better. For example, there is a great deal of evidence that satisfied customers pay more rapidly than dissatisfied ones. Ask any accounts receivable manager.

Step 7: Be courageous. The final requirement is the simplest, but the most difficult. In large transactions, customers will emphasize price negotiation. During the process, it will be tempting to cut price to keep the customer or to gain market share. But, if you erode the integrity of your price book, you become a price taker, not a price maker. For example, if you set a price, and announce that it is not negotiable, you must not negotiate. Once you begin to negotiate, you can't be a fixed price company.

Each of the first six steps requires courage. Providing real value to the customer requires courage. Choosing certain customers or purchase situations, and consciously walking away from others, requires a much higher degree of courage. Being different requires the most courage. Courage to overcome the fear of being different is in short supply, but is highly rewarded. The very difference will enable you to be a price maker, not a price taker.

Copyright (c) 1997 Benson P. Shapiro. All rights reserved. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means-electronic, mechanical, photocopying, recording, or otherwise-without the permission of Harvard Business School or Professor Benson P. Shapiro.