The price of anything is the foregone alternative: "proactive pricing strategies come from visionary companies that understand and rely on the economic value they bring to customers. They separate value from benefits.".

• Author: Lucke, Tom
• Position: Business & Finance

MANY COMPANIES miss significant opportunities to maximize revenue and profits due to dysfunctional pricing strategies such as ad-hoc discounting, poorly executed price increase announcements, mismanagement of competitive pricing interactions, and bundling of products to "sweeten the deal." Reactive and shortsighted, these strategies have the effect of accelerating the commoditization of markets, driving down industry price levels, and reducing profits for everyone. More progressive companies take a different position. They leverage a clear understanding of the economic significance they bring to customers in value-based pricing strategies that proactively manage market dynamics and contribute millions to the bottom fine.

One survey suggests that 70% of product managers indicate their biggest challenge in new product pricing is how to understand and quantify the value their products and services deriver to customers. When companies grossly overestimate or underestimate the value of their products, they tend to price benefits instead of value. Accordingly, understanding the economic value a product brings to different customer segments is an essential ingredient to launching new products.

A recent example is a medical device manufacturer that developed a visualization tool that could speed up certain clinical tests as much as tenfold. When the product was introduced to the market, it was praised highly by customers and the press, both of whom recognized the power of the innovation. Despite the kudos, sales fell far short of expectations a few months after launch. An extensive analysis combined with depth interviews--conversations that provide insight into how a product or service impacts the customer's business model and the value it creates--revealed different segments of the market realized significantly different value from the product. For instance, pharmaceutical customers saved enormous amounts of money by reducing the labor required to run thousands of testing procedures per month, while university segments found the productivity improvements actually destroyed value because they reduced the amount of time students had to learn the testing procedures.

Moreover, economic value must be understood in relation to the value delivered by competitors, because customers are comparing competitive offerings when making a purchase. Armed with this data (i.e., the economic value the product brings to customers and the price of the next best competitive offer), companies can begin to develop a credible pricing approach to help drive and sustain volume and margin growth.

Many firms fail to focus on economic value because they tend to have an overreliance on traditional marketing research techniques such as focus groups, surveys, and conjoint studies that are unable to answer one critical question: How will my product drive revenue or reduce costs for customers? Focus groups are helpful to understand the types of benefits a product might deliver to customers; surveys can provide validation for how those benefits vary across customer segments; and conjoint studies can provide statistically significant results for how much customers are willing to pay for a new product. However, the most effective way to assess the value a product brings to customers is through depth interviews, which enable an understanding of the customer's business model and how the product helps cut costs and drive revenue. Armed with intimate knowledge of how a product affects the customer's business, it is possible...