“How am I Doing?” How to Measure the Success of Your Pricing Initiatives
Ed Koch, the mayor of New York from 1979 to 1989, was famous for his openness to feedback by walking the streets and asking everyone (from the homeless to Wall Street CEOs) one simple question, “How am I doing?” As you are working on your company’s next big strategy - pricing - it’s fair for your bosses to ask, “How are you doing?” This blog focuses on how to measure and demonstrate the benefits of your pricing initiatives.
Most companies measure pricing success with its operating margin (profits/revenues). Wall Street and the business community tend to subscribe to the “bigger is better” mentality. In other words, a higher operating margin equates to success. Guess what, Wall Street, the business community, and perhaps even your boss all aren’t thinking about better pricing correctly. Here’s my argument why:
First, a bigger operating margin can result from higher prices, efficiencies or better cost control. Thus a higher (or lower) operating margin may have nothing to do with how well your company is executing on its pricing strategy.
Next, as I’ve previously discussed, better pricing is more than charging higher prices. Consider my trusty gourmet chef pricing example. A gourmet chef that offers a variety of pricing strategies such as coupons and special bundles, as well as early bird, regular, and chef’s table offerings will make more money (profits) and serve more customers (growth) than a chef who is striving to achieve the highest prices for his/her delicacies. That said, there is a good chance that the “early bird et al.” chef will have a lower operating margin. Simply using operating margin as a metric of success does not acknowledge his pricing prowess.
And finally, consider the operating margins of Wal-Mart (#1 on the Fortune 500 list) and Microsoft (#44). Wal-Mart’s operating margin is 5.8% while Microsoft’s is 37%. Based on these operating margins, do you deem it reasonable to conclude that Microsoft is better at pricing than Wal-Mart?
If your company measures its pricing abilities based on operating margins, it is unequivocally leaving money on the table.
Measuring better pricing success is very straightforward and involves two key considerations: (A) Are we making more money than we were before the pricing changes (profits) and (B) Are we serving more customers than before (growth).
That’s it. So as you are focusing on improving your company’s pricing abilities, stick with the basic success metrics of better business: more profits and growth.
Readers' Comments on This Blog Entry
I feel a little uncomfortable because my first post to this fabulous blog sees me disagreeing with an expert. I do not agree that you can measure the success of a pricing strategy through an increase in the number of customers served. That is because some customers are simply not worth having. Every customer we serve requires an allocation of resources of some type, financial, physical, or human. As most businesses have limited resources, those resources should only be allocated to customers that are going to make an optimal contribution to profit. The pricing strategies we adopt must be focused on optimising profit through getting the best return on our limited resources and this does not, in my view, necessarily correlate with increased numbers of customers served. I support the proposition that we should give our customers a choice, but there are some customers that are just not worth having.
Measuring pricing contribution is about finding out what % of total dollar margin is coming from pricing Using a composite price index,it is possible to calculate the growth of sell prices from one period to another versus cost movement from same base period to current period This need sto be done at sku/customer level To obtain contribution to profit,multiply the sell price variance (base year to current year) x base year quantity and subtract from cost variance x base year quantity