Lesson from Luxury Goods Pricing
In this gloomy economy there are pockets of unreal abundance where the sun continues to shine brightly. Consumers are reining in spending as the tightening credit puts pressure on prices of products and services. Yet producers of luxury brands continue to hold the line. And profit. There must be a lesson here for the rest of us.
European brands Hermes, and Gucci Tod’s all published earnings that topped or met market expectations on the back of impressive double-digit sales growth in the first half. This performance is striking coming against a strong euro that has hurt many European exporters amid rampant inflation in raw-material costs. And Hermes, whose handbags start at 1200 Euros (US$1750) but fetch up to 50,000 Euros, said there were shortages for certain items, such as crocodile-skin handbags, particularly in Asia. In fact, Chanel, is planning a 20% price increase starting Nov 1, 2008. For context, the Chanel Classic Caviar Jumbo Flap Bag that typically retails for $2850 will go up by $570.
Volkswagen-owned, Bentley, is staying away from “forcing sales of new cars up” while demand is low. According to UK’s Society of Motor Manufacturers and Traders, Bentley has sold less than 1400 new cars so far this year, down 23% compared to last year. September was particularly bad, with sales plummeting 48% year-on-year. Despite the slowdown, they are telling their network of dealers to offer used cars at competitive prices as a way of keeping the brand healthy during the downturn.
All these brands consistently pursue a luxury pricing strategy, which means high markups and limited availability. For instance, Louis Vuitton commonly shortened to LV competes with Gucci, Versace, Prada and other luxury brands but pricing strategy follows horizontal differentiation. They recognize that different consumers have distinct preferences for lifestyle reasons, brand and product attributes. Since bags are also a crucial product for them in retailing, LV offers different leathers in many styles and colors. They protect their brand fiercely and spend a lot of money and legal effort in going after knock-offs. LV, like most luxury brands, never has sales or discounts even during Christmas time for fear it would devalue the brand.
It is amusing to discuss pricing of luxury products and easy to not take the conversation seriously. So what should firms, say industrial manufacturers, do differently? As a Bentley spokesperson remarked and, perhaps, explained for all luxury goods manufacturers, the integrity and exclusivity of the brand are their two most potent assets. For companies that fall easily in the commodity trap, even during economic boom, the lesson is to differentiate and protect your brands. As for consumers who desire luxury but cannot afford it, do what I do, spend a dollar on a Powerball ticket every six months. The chance of hitting the jackpot is certainly greater than the possibility of getting lower prices from some the luxury brands any time soon.
Who Owns Pricing?
The Pricing Czar is dead. He lies in state with other forgettable organizational models propounded by consultants and academics. The idea behind this model, an all-powerful person could enforce unquestionable discipline, simply does not fit with human nature. Historically, people have given in to autocracy but have always revolted against it to find themselves in better or worse shape. Companies play out their own version of the Russian revolution where heads roll, thankfully, without the blood and gore. As a new pricing manager, I had once aspired for czar-hood to centralize the pricing function for my employer. Thanks to painful experiences and good as well as bad advice, I learned that an institutional “democracy” is the only prudent but not the easiest path for a pricing professional. The ongoing challenge for pricers is how to organize multiple functions and layers into successful pricing institutions.
One reason pricing processes in a company are complex is that they involve almost everyone in the company, or at least that is what everyone in the company thinks. Having varied groups with different views and incentives, sets the stage for pricing processes to be different across different companies depending on where the pricing function is located and to who it reports – pricing, finance, sales, or product management. Since pricing involves the customer, it involves the front-line groups, sales and customer service. Then there is marketing, which itself is a big and diverse group including marketing communications, brand managers, product managers, and marketing managers. Moreover, the senior managers invariably tend to lean on the decision process when the prospective customer is large or even potentially large. IT is involved as a support role because they create and/or maintain the enabling systems and reporting. Also involved is the pricing administration group and possibly, a multi-function pricing strategy group. The clout and effectiveness of the pricing function depends on where the pricing group is within marketing, sales, finance, and strategy or if it is a standalone group and with a clear control role. Many companies demarcate pricing strategy from tactics by having marketing own list price and sales own the discounts and hence the net price to customers. Oversight or control of realized prices is the responsibility of the pricing or finance group. While this explains roles at a high level, most price-related actions generate emotion because roles and responsibilities remain unclear and get constantly re-defined in the what-who-when of action plans.
For pricing professionals who care for process improvement, turf battles should not be an agenda item. Instead, they should gain influence as “community organizers” who proactively look into pricing issues, identifying root causes, and supporting and getting support from different groups by showing evidence how they can gain from it. This sounds utopian yet quite practical within the scope of a full-time job. Even tenured employees in established organizations can map pricing processes and analyze data to understand pricing issues. My book, Six Sigma Pricing, has a tool-kit on how to frame issues and overcome them without alienating colleagues and customers. Collaborative actions to achieve shared goals align people with business strategies and pricing execution. The Pricing Czar is dead. Long live the Pricing Organizer!
Massive Scope Minute Decisions
“Massive scope minute decisions”, the NBC commentator aptly described the heart-warming tai chi display at the opening ceremony of the Beijing Olympics. 2008 dancers leapt, swirled, and landed perfectly every time as each performer simply coordinated movements with their immediate neighbor. How come corporations can’t act with the same simplicity and precision especially when they need to protect their earnings and cash flows? According to a recent global survey done by McKinsey & Co., 34% of companies facing [product] innovation and 44% of those facing a pricing change found out about the competitor’s move when it was announced or actually hit the market. An additional 20% of the respondents facing a pricing change didn’t find out until it had been in the marketplace for at least one or two reporting cycles[1]. This situation needs to be and can be corrected by improving processes and internal coordination for gathering competitive price intelligence.
While researching pricing increases related to raw material inflation, I noticed an interesting pattern at Continental AG, the leading global tire company, which seems to be treading (no pun intended) very carefully. Since mid-2007, the price of petroleum crude, a key raw material for the tire industry, has doubled and the company had no choice but to raise prices. Here is the schedule of their price actions announced over one year along with my observations[2]:
a) Europe: No price increases in any segment throughout 2007
b) North America: 6% in passenger and light trucks only effective Oct 2007 (Notice no large trucks!)
c) Europe: 3% in summer tires only effective Jan 2008 (Limited scope – deferring to summer in snowy Jan)
d) Europe: 3-4% in car tires only effective Jun 2008, (Notice no trucks)
e) North America: 8% in OE truck tires only effective Aug 2008
(Notice no cars)
Apparently, Continental sliced and diced markets for execution by segment, season, and geography based on known or perceived customer and competitor-related risks. Assuming this strategy addressed raw material inflation, what should they and other companies do to realize their price increases to full extent?
Companies should monitor discount activity for any sporadic increases at appropriate levels of granularity – market, brand, product line, sales territory etc. Higher than usual discounts following a price increase typically suggest, a) sales people are holding back, b)customers are pushing back, or c) the competition is being opportunistic. During my early years in pricing at a global airline, I learned the necessity of following competitive changes not just for price and booking levels but also frequency of service, routes served, type of plane, and passenger capacity. By organizing public data and feedback from frontline employees, managers can spot trends in competitive price actions. For instance, managers can gauge competitive threat by monitoring the level of consistency in price execution over time which helps validate their own company’s discounting practices. Such market intelligence supports price realization efforts and helps prevent price-related customer attrition without giving too much away.
Let’s never forget the 4×100 meter men’s relay at the Beijing Olympics. The US men’s team was a favorite to win a medal but got disqualified in the prelims for dropping the baton. Actually, this was the fifth instance for the US men’s team to drop the stick in the last 12 global championships. The root cause is that the US athletes do not practice enough as a team. So it was “not bad luck but bad execution”.[3] Somehow, it always comes down to coordination and simple processes whether it is performing at the Olympics or in the corporate world.
Notes:
1. The McKinsey Quarterly, How Companies Respond to Competitors: A McKinsey Global Survey, April 2008
2. Company announcements in Europe and North America over one year
3. Comment by USA Track and Field CEO Doug Logan
Gentle, Responsive and Effective Organizations
It is July 4th – Independence Day for the United States. It just feels right to talk about uniting employees for the greater good of their companies. The sizzle of barbecues is somewhat subdued this year with the number of jobless exceeding 8.5 million in the United States. As thousands more worry about pink slips, stress levels and finger-pointing within companies are on the rise. In tough times, the foundational character and strength of an organization is put to test. As a pricing professional, I can never forget the angst of having to follow lackluster decisions made without the right analysis or due process. I have witnessed major gains lost to complacency and individual interests. I have also watched conscientious employees dive into impossible problems acting like patriots serving the mother country. How can companies empower and enable their employees to think about the good of their company aside from stock options and big salaries?
Several years ago, I heard about the motto of Ritz-Carlton Hotel. “We are ladies and gentlemen serving ladies and gentlemen”, is an age-old credo at the Ritz which has helped them adopt and share best practices across all levels of employees worldwide. While it may sound like a corporate myth, Ritz lives its motto guided by 20 Basics which are truly fundamental ideas. Here are a few:
#7. To create pride and joy in the workplace, all employees have the right to be involved in the planning of the work that affects them.
#8. “Each employee will continuously identify defects throughout the Hotel.”
#20. Never lose a guest. Instant guest pacification is the responsibility of each employee. Whoever receives a complaint will own it, resolve it to the guest’s satisfaction and record it.
The Ritz-Carlton hotel chain has one of the highest employee and guest satisfaction rates in the hospitality industry. They have also won the Malcolm Baldridge award more than once. I will let you guess if this bolsters their luxury image, top-line and bottom-line. Any corporation can choose to be like the Ritz by instilling among employees a sense of pride in continuous improvement and genuine courtesy towards their colleagues and customers.
The Tide is Going Out
“When the tide goes out, we find out who’s been swimming without a bathing suit,” wrote Warren Buffet to his shareholders about the housing crunch rooted in the credit debacle that continues to batter the US as well as the global economy. If one picked a mere two examples out of dozens of known blunders, managers in any industry can draw lessons to preempt such outcomes. Countrywide Financial Corp.’s Fast and Easy mortgage program resulted in a $893 million loss in the first quarter alone because of overly optimistic underwriting without due diligence[1]. Société Générale, the venerated 144-year old French institution, has lost €4.9 billion[2] to rogue trading[3] resulting from process controls so weak that a relatively junior employee could evaporate all this wealth.
The discipline in transaction pricing in most companies follows, to varying degrees, the dynamics of Fast and Easy underwriting (which is also a pricing process). Sales teams when pushed to generate volume turn around to push for short-cuts in how business is conducted with customers. Sound familiar? While a few ill-advised (out-of-spec or badly specified) pricing transactions go unnoticed or ignored, in a repetitive process such actions represent the tip of the proverbial iceberg that brought down the Titanic in waters as frigid as our current economy – inflation in a recessionary environment. Therefore, senior managers charged with safeguarding earnings need to closely monitor their company’s pricing processes as well as cause and effects of their actions.
Many companies are pro-actively reviewing their pricing strategies in light of the shrinking economy. Nowadays, my conversations with business leaders focus on the importance of quality of pricing operations to ensure successful execution of pricing tactics as well as strategies. Announcing price increases to cover fuel or raw material cost inflation is risky if such actions are hardly practical due to weak internal processes. Why invite the ire of customers and undue attention from competitors when stakes are so high! Smart companies who align their pricing operations with strategies for the economic downturn will enjoy competitive advantage. In any case, no conscientious manager who cares for her customers and shareholders deserves ruin or embarrassment when the tide goes out.
References
1. The Wall Street Journal, Countrywide Loss Focuses Attention on Underwriting
2. The Herald Tribune, Report Pinpoints Faults at Société Générale
3. The Wall Street Journal, The Loss Where No One Looked
Pricing Strategy and Pricing Operations
Pricing activities affect or are executed by different people in a company where a shared understanding of purpose is as critical as the lifeline of the company itself. It is surprising how many business leaders believe that the price of a product or service is just math done by or one or two people as a result of a simple work flow. When business leaders do not understand the complexity of their pricing function, they not only compromise careers of their pricing professionals but also unintentionally drive away from profit.
It is true that the price of a product for a customer is derived from a list price or MSRP after factoring in discounts, concessions, incentives, rebates or credits depending on the industry. But the process of deriving a price point can be complex because often different functions manage pricing at a strategic or operational level. Pricing strategy is outward looking and refers to the company’s choice of positioning itself with respect to their competitors based on product attributes, quality, and brand etc. Whereas, pricing operations involve mainly internal processes for modifying list prices and control processes to ensure compliance to pricing guidelines at the transaction level.
Six Sigma Pricing is applicable to pricing operations and not for designing or choosing pricing strategies. Clearly defined pricing processes that are well-understood throughout the organization bring greater success in implementing the chosen pricing strategy. Nowadays, whenever I read about the possible slowdown in our economy, I recollect from Robert Phillips’ book (Pricing and Revenue Optimization, Stanford, 2005), “Pricing decisions are becoming increasingly tactical and operational rather than strategic.” Six Sigma Pricing can help companies stay on the path of profitability regardless of the business climate.
Make Your New Year Pricing Resolutions Stick
On this last day of 2007, I am ready with my list of resolutions for the new year just like everyone else. I plan to spend more quality time with my family and live healthy with a balanced diet, reasonable work hours and more sleep. The executives who worried about their company’s pricing performance all year long must also be ready for another chance to improve pricing operations- this time for good. Here are a few insights to help them move steadily from low hanging to high hanging and juicier fruit of improved pricing performance and profits:
* Baseline processes identifying who’s who in the distributed pricing function: Understand motivations and needs of stakeholders by engaging them in brainstorming sessions. Cause and effect matrix is a great tool to elicit information and prioritize issues.
* Map processes to understand system and process leaks: Prioritize implementation starting where most control resides for sure wins.
* Be relentless in communication: Simple, clear and consistent messages to internal as well as external customers through play books, standard operating procedure, etc.
* Organize the pricing function for maximum reach and speed: Reach out to other functions to support and get support.
* Broadcast successes for visibility to gain further traction: Establish pricing as a mainstream function and profit center.
Wishing personal and professional rewards to all in 2008!
Quality in Pricing
It is common among companies, especially in the B2B space, to drop prices in pursuit of increased sales and market share. There is little consideration given to pre-analysis or process. In times of economic slowdown, a top concern in the US currently, sales and marketing teams in companies are even quicker to reduce transactional prices. Companies who constantly manage the quality of their pricing operations should find themselves more profitable and better prepared than their competition to take on a recession, inflation or stagflation.
Obviously, when price actions do not follow the established guidelines or the guidelines are weak to start with the result is eroding sales and profit for the company. Opportunistic buyers spot pricing changes, even small ones, rather quickly and start demanding same or richer across-the-board discounts often pitting competing vendors against each other. This draws companies into the downward profit spiral – price reduction for “select” buyers without proper fences spurs awkward price negotiations with an increasing number of customers. Price variation arising from inconsistent processes such as lack of compliance to guidelines is analogous to a “defect” in the manufacturing process when widgets are produced out of spec. The solution, similar to manufacturing, is well-defined processes and quality control in pricing operations.
Message in Six Sigma Pricing
Pricing is the #1 worry for business leaders but companies can have far more control over pricing than they may realize. Many companies have developed solid sales strategies—but without equally good pricing operations, those strategies by themselves will not add anything to the bottom line. The goal of pricing operations is to consistently control price deviations in transactions and contracts over time and across customer segments. We discuss a breakthrough approach to the pricing discipline in our book, Six Sigma Pricing: Improve Pricing Operations to Increase Profits (FT Press), one that can systematically eliminate pricing-related leaks driving new profits straight to the bottom line without alienating customers. Six Sigma Pricing is not simply an application of Six Sigma to pricing operations but rather a way to overcome inter-function issues that make improving pricing processes so challenging.
The book follows the Six Sigma framework with examples of each DMAIC (define-measure-analyze-improve-control) step from a real company doing a major pricing project:
* How to identify pricing “defects”
* How to gather and analyze relevant pricing data and pricing-agreement processes
* How to identify and preempt failures of control; implement modifications that don’t create onerous approval processes
* How to sustain and extend pricing improvements into the future.
Six Sigma Pricing