a. Make pricing a part of regular discussion in all sales meetings, and force it on the agenda of financial meetings
i. Pricing is not part of financial meetings, and price issues are
raised in sales meetings only if our prices are believed to be too high by the sales teams.
b. Pricing should be made a topic on everyone’s mind, and it should be turned into a continuous process rather than an annual check- up.
i. A more systematic approach should be taken.
4.6 Summary of pricing analysis
During the current state analysis, I have learned that Hero is a good example of a com- pany that has unwillingly shifted to customer-driven pricing from something that was orig- inally cost-plus pricing that was attempted to change to value-based pricing. The pricing strategy and the consequences of implementing customer-driven pricing do not support the market trends. It has also caused strategically wrong customer groups to have high- est prices, while Hero wishes the these groups would work as efficient distribution chan- nels. This is partly because some groups accept any prices, as long as they are able to sell the products forward. They do not however know how much Hero sells directly to customers, or even care if they can sell some other brand products to their customers.
The prices seem to be at the hands of sales representatives and no pricing team has been set up that is responsible for pricing across the company. Financial team is not involved in pricing, and no one is fully responsible for pricing. Changes to prices are made hastily without proper data collection procedures and data on competitors or prices is not stored anywhere. Additionally, different sales representatives give different prices to the same customer, if the customer happened to ask from two different representa- tives. Lastly, pricing is complicated due to multiple different price lists with multiple dif- ferent discount levels, and even though some guidelines have been defined on dis- counts, they are not followed. During the literature review I found no evidence that sup- port the use of multiple price lists despite the company beliefs that it makes it harder for competitors to understand the price level.
5 Building the pricing strategy
5.1 Reflection to literature and current state analysis
The findings from the literature review as well as the current state analysis suggest that Hero would benefit from a revised pricing strategy. The currently overall strategy of Hero is not supported by the pricing strategy; pricing is illogical and left completely in the hands of sales representatives. If a company unwillingly moves to apply customer-driven pric- ing, it is unlikely that best profits are generated. Currently at Hero, no one is responsible for pricing or held accountable for the results of it. A pricing strategy has not been de- fined, but instead customer-driven pricing is applied. This is likely a natural cause of giving sales representatives the freedom to price as they see best. Values provided to customers are evaluated, but this does not reflect on the prices applied. Large discrep- ancies in the logic of pricing between different customers and customer groups also cause awkward situations for sales that often result in discounting the prices. This all is compensated by price increases based on raw material costs, but increases are not nec- essarily carried out to all customers, and thus, price variations between customers in- crease even more. The customers buying at the lowest price typically receive smaller increases to prices, if any, while the smaller customers, who buy at the highest prices receive highest increases. This causes the large customers to win more projects as the smaller customers cannot compete. From profit perspective, this further escalates the problem of earning money for Hero; the share of sales of bigger customers (lowest prices) increases, while the share of sales of smaller customers (higher prices) de- creases. Hero needs a revised pricing strategy that will support the overall strategy of the company and helps to maximise profit.
5.2 Basis for new pricing strategy
Several factors should be borne in mind when developing a new pricing strategy. First is that the industry has long traditions that affect the ways of doing business. As an exam- ple, Group 3 have typically had the lowest prices in the industry for at least two decades.
This is mainly due to the fact that they were one of the largest customer groups for most suppliers until around 2009, when the market started to decline. It is worth mentioning that they have always had professional purchasers in their organisation. Professional purchasers are likely to receive better prices than people who purchase goods only part-
time, such as a CEO of a company. Changing industry-wide traditions is seldom easy.
The second factor to bear in mind is that the new pricing strategy should support the strategy defined for distribution channels. In other words, this means that Group 1 must have a place in the chain, and pricing must support this. The third factor is that prices do not remain secret. Customers within the same customer group often have a clue of each other’s purchase prices, and occasionally this information travels even across customer groups. The fourth factor is the importance of large customers to production costs. As the industry has suffered from decreasing volumes for a decade, over-capacity exists in most product groups, and as Hero benefits from economies of scale in most of their products, effects of volume cannot be neglected in creation of the new strategy. The last factor relates to the trends in the industry. Even though we cannot predict the future, we can estimate the development of the industry in the short-term (less than ten years). No research support growth of the industry in the products that Hero sells, while it is not expected to decline either. However, it is likely that there will be changes in share of business between different customer groups. The development is expected to continue in the same direction as it has since 2010; share of Group 2 will grow, while the share of Group 1 and Group 3 will decrease.
5.2.1 Strategic choice of distribution channels
Distribution channels play an important role in the way Hero does business. Hero does not wish to do business directly with end users; hence intermediaries are required. Hero also does not have the capacity take care of all (about 2,000 registered companies) Group 2 in Finland. There are fewer companies in Group 4 and Group 3, but the total number of different companies that can be considered buying customers or potentially buying customers is about 3,000 different companies. Thus, Group 1 must play a part in the distribution chain. Also, as fewer companies in Group 3 and Group 4 are willing to assemble the product, Group 2 should fit in between Hero and Group 3 and Group 4.
Figure 17. The business model of Hero (Figure 9)
There are two types of Group 2 companies to be considered when it comes to pricing.
There are small companies in Group 2 and large companies in Group 2. The line be- tween small and large can be drawn roughly at one million euros revenue, or it could be based on potential purchase volume. The large companies negotiate prices directly with Hero, while in contrast, the smaller ones typically negotiate with Group 1. However, Group 1 might still ‘through-invoice’ even the large companies in Group 2 and earn a couple of percentages commission on this. This is done to retain good relationships with the Group 1 and to transfer the credit risk. So, Group 1 know the purchase prices of both, large and small companies in Group 2. Group 2 then sell to Group 3, Group 4 or end users. In end users case, the price of Hero’s products is the least relevant. Lastly, to be considered in pricing are ‘volume customers’; the customers that buy in such quantities that are important for scaling production costs down. This customer may be of any cus- tomer type except Group 1.
To conclude, there are five customer groups to bear in mind when creating a pricing strategy:
1. Group 1 2. Large Group 2 3. Small Group 2 4. Group 3 and 4 5. Volume customers
Group 1 should be able to sell products to small Group 2 from stock. Group 1 should also be able to sell products to large Group 2 from stock, though in such circumstances the large Group 2 is likely ready to pay a slightly higher price as large Group 2 normally get direct deliveries from Hero regardless of who is the invoicing party. Group 3 and 4 rarely buy from Group 1’s stock, and also they are likely ready to pay slightly higher price if they do buy from Group 1’s stock. A typical reason for a large Group 2, Group 3 or 4 to buy from Group 1’s stock is that they need the product very quickly because losses are made without the product at hand; hence higher prices for the products are accepted.
Volume customers normally interact directly with Hero and avoid using intermediaries. If they however need something quickly, the price of the product is almost irrelevant as it means they are in true hurry. Volume customers typically keep certain product range in their own stock also.
The pricing from strategic distribution channel perspective is visualised below in Figure 18.
Figure 18. Strategic pricing from distribution channel perspective.
From strategic point of view, Figure 18 illustrates the acceptable price ranges for each customer group. Group 1, large Group 2 and small Group 2 should be able to sell to Group 3 and 4. Volume customers can be of any type; hence pricing can vary vastly.
Notable is however that no other customer group should fall below the lowest Group 1 price. In some cases of the biggest Group 2 or volume customers the price could be the same, but not lower than Group 1’s.
The reality is however not so simple, and I will cover this more deeply in the following sections. We have to consider the values provided and the competitors and their pricing power. Figure 18 merely represents a figure to match the distribution strategy.
If the expected market share development of each customer group is added into the image, it will appear as presented below in Figure 19.
Figure 19. Strategic pricing from distribution channel perspective (including expected devel- opment of market share)
Group 1 will keep losing market share as other customer groups wish to purchase directly from Hero. Large Group 2 are likely to continue growing and eating market share from small Group 2, and gaining from natural growth of the market as people become more reluctant to assemble by themselves. Small Group 2 are however expected to gain some portion of the change also, especially because Group 3 are likely to purchase more from them. Volume customers are expected grow due to heavy marketing expenditure and increases in sales force. The share of Group 3 is expected to decrease because the projects have a trend of getting smaller year by year.
Considering the expectations of market development, it is likely the business model of Hero will also start to form into a simplified model of Figure 17. Group 2 is expected to start playing a bigger role in the chain. Figure 20 illustrates a likely direction of how sales will occur and payment be made in the future.
Figure 20. Possible future business model of Hero
End users, Group 4 and Group 4 are all likely to purchase products mainly assembled, and if the pricing strategy of Hero will support it, also the goods will be sold by Group 2.
Group 1 will still play an important role as a distribution channel for the small Group 2 as the small Group 2 wish to keep their suppliers to minimum and often request flexible payment times as well as fast delivery from Group 1’s stock.
5.2.2 Competition
Competition has effect on pricing. Especially in the products of the first department of the company the competition is fierce as the product qualities are more regulated. The minimum standards set for products have in most products become the exact aimed quality of the product. All major players in Finland have fought heavily for market share by lowering margins and product quality. This has led to very similar products in each supplier’s assortment. The differences in brand valuation are not significant either; hence differentiation is difficult. In the products of the second department the situation is differ- ent as Hero is the only local producer. This gives Hero a clear advantage in pricing due to a much better known brand than of its competitors. The biggest competitor is mainly selling to Group 3, so if the prediction of Group 2 gaining more market share is correct, Hero is likely to gain more market share in those markets also.
When considering pricing, the competitors should first be thoroughly analysed, including their strengths and weaknesses and possible future actions. This includes their pricing but also their delivery times and other service quality. The new pricing strategy should contain a numeric value used to assess the effect of competition in each product group and customer group. Without a numeric value, Hero will easily shift to a customer-driven pricing strategy again as the fear for competition will become too strong.
5.3 The new pricing strategy
It has become obvious Hero needs to forget about customer-driven pricing strategy, if something utilised unwillingly can even be called a strategy. During the literature review and current state analysis, I came to the conclusion a value-based pricing strategy would fit Hero the best. However, it will not work as simple as pricing products solely based on the value the customer receives. Other factors need to be borne in mind. Most im- portantly, a strategic choice of distribution channels has been made and the future de- velopment of market has been forecasted. These factors set boundaries for the value- based pricing strategy. Nagle et al. (2016) also support the approach of first determining the initial price ranges that match with the company’s overall targets and strategy.
We will use the basis of acceptable price level presented in Figure 18 when creating a new acceptable pricing levels (boundaries for pricing). Group 1 are used to low margins in professional business; stocked products can be sold at even 5 % margin, while non- stocked (direct delivery from manufacturer) products can be sold at even 0.5 % margin.
Group 2 can manage with small margins when selling to Group 3 as they can generate profit from services. Volume customers work directly with Hero with no intermediaries in between and they expect the cheapest prices in the market. However, some clients are very demanding in terms of service, such as delivery times, last minute changes or train- ings. This could be costly for Hero and the cost needs to be covered somehow, so it is possible such clients cannot be offered the cheapest prices, especially if the value of- fered to them is viewed significant. Figure 21 illustrates an idea of pricing that takes into account Hero’s idea of how distribution will work in the future (Figure 20) and how high margins each customer group requires in the distribution chain in order to be able to sell Hero products. Notable is that the suggestion in Figure 21 considers only professional sales. Products strictly aimed for consumers sales (DIY products) are not part of this as
they are mostly sold by Group 1 directly to consumers, and thus, no conflicts between different customer groups exist.
Figure 21. Acceptable price ranges per customer group
0 % represents the lowest price Hero gives to any customer, and each positive percent- age number on the left side of the figure represents the difference to the lowest price.
Averages are marked with red dash line. This gives us a frame for the pricing work. The purpose of these boundaries is to aid in the development of the future business model (Figure 20). If Hero keeps pricing products lower for Group 3 than for Group 2 for exam- ple, it will limit the Group 2’s ability to sell products assembled to Group 3, and thus, hinder the shift to the new business model. As the new model looks however the most likely option, the risk of Hero losing market share to its competitors would increase. The highest acceptable price level for volume customers has been adjusted from the original model as a difference of 30 % to lowest price could increase the risk of losing customers, if they found out about that high price difference to the cheapest buying customer. The minimum prices for Group 3 and 4 have also been slightly adjusted to ensure Group 2’s ability to sell products assembled to them. Only in cases where Group 3 self-assemble the products, should they buy close to the same prices as small Group 2.
The current situation of price ranges and averages is as presented below in Figure 22.
Figure 22. Current price ranges and averages per customer group.
The current situation does not support the strategy of Hero, but is a consequence of customer-driven pricing. Group 1 have an almost impossible task to sell products for- ward, while Group 2 also cannot sell products to Group 3 and 4. It seems clear a shift towards the suggested price ranges presented in Figure 21 should be made to better support the strategy of Hero and help to generate maximal profits.
5.3.1 Implementing value-based pricing strategy
Pricing solely on perceived received value for the customer is not possible in Hero’s case. The strategic choices related to distributing products affect pricing too much to take an individual customer approach where each customer would be offered the prices that match the perceived received value. Thus, I propose the frame presented in Figure 21 is used as basis for pricing and the effect of value offered is adjusted only within the price frame for each customer group. In best case scenario, products would be developed to match the customer needs at a cost they are ready to pay for the value received. Devel- oping a whole new product range is however a lengthy and costly process, and so is not a concern in this thesis. If we use the current product range, the aimed average price point for each customer group presented in Figure 21 should be used as starting point, when considering prices to be offered. Then the value offered to the client should be added to the price, and the effect of competition deducted from the price. The effect of competition should be considered by comparing the value the competitors can add, not the particular dimensions or weight or quality of the product. For example, a product may be identical in quality but the competitor may be incapable of delivering the value the
customer expects. It could be that their delivery times are too long, or they do not have sufficient technical consultancy, or they do not train the customer to sell the product. All in all, it could be that the competitor is missing or failing to provide something that con- verts into the customers’ profit. After all, desire to make profit is what drives most com- panies in their decision-making. In addition to the initial price range set by strategy, the value offered to the customer, and the effect of competitors, the cost of managing the customer should be considered to ensure all customers contribute positively to the over- all profitability.
An example of the new pricing strategy in practice that takes into account: the strategic price point, value offered, additional costs caused by the client, and the effect of compe- tition is presented below in Table 5. Also, the need for flexibility in pricing for sales rep- resentatives is added as 5 % to the table.