“Pricing and the CEO” – Hermann Simon, Chairman, Simon-Kucher & Partners
We are observing an increasing involvement of CEOs in pricing, which has a significant impact on profit performance. The CEO’s role is threefold: strategic, cultural, and custodial. If a company chooses a premium price positioning, all aspects of strategy, culture and implementation have to be different from those of a company that aims for a low price position. While the CEO should not get involved in the details of pricing or price negotiations, he or she must make sure that all efforts are aligned according to the necessities of the selected position.
In the global pricing studies which Simon-Kucher & Partners conducts every two years, we have observed an increasing involvement of CEOs in pricing. We found that companies whose top managers took a strong, personal interest in pricing stood out compared to companies whose senior executives did not take on such an active role, as the following results show.
For companies with strong CEO involvement:
- the pricing power was 35% higher.
- the success rate for implementing price increases was 18% higher.
- Twenty-six percent more achieved higher margins after the price increases, which means they were not just passing on higher costs to their customers.
- Thirty percent had a special pricing department, which in turn had an additional positive effect on profits.
CEOs often ask me point-blank for my silver bullet in pricing. Is there one thing in pricing they can do to make their companies better off?
Knowing that my background goes back decades in both academia and consulting, they probably expect the classic consultant’s evasive “It depends.-. or some scholarly rhetoric which is long on syllables and short on relevance. They get neither. Instead, the answer starts with one word: profit. “You need to cement the link between price and profit in the minds of your managers,” I tell them. “Price is a company’s most effective way to drive enterprise value, but it is an extremely sensitive lever’.
To cement that link between price and profit, a CEO must play three roles: a strategic one, a cultural one, and a custodial one. The CEO defines the primary strategic vector of a company: its direction and its goals. This includes the price position, which can range from ultra-low to luxury. Often viewed as malleable and somewhat arbitrary, the price position is in fact one of the most fundamental strategic decisions any CEO will make. It is also one of the hardest to change.
Flowing from that price position is a cultural tone, which underpins how the company creates, communicates, and captures value. The tone strongly influences how the company selects talent, locations, suppliers, and other partners. The CEO has the primary responsibility of maintaining this alignment between price position and culture. That is the custodial aspect. He or she accomplishes this by fostering price discipline and by avoiding any moves which will undermine or jeopardize the alignment.
Aiming High: Success factors of a premium price position
At this point, the CEO who asked me for my silver bullet usually wants an example. I offer one from the automotive industry and start at the high end. Few CEOs have played the strategic, cultural, and custodial roles with stronger commitment and higher profitability than Wendelin Wiedeking, who ran Porsche in Ger many from 1993 through 2009. He involved him- self in all major pricing decisions, but was neither a high-level arbiter nor the leader of price negotiations. Instead, he immersed himself in the details of value and pricing, and he challenged his teams to do deeper critical thinking and more rigorous analyses.
The manner in which Porsche continues to create value – by optimizing performance, providing only value for which customers will pay, and defending its price levels at the expense of volume – offers broad lessons applicable to many companies and markets. Upon hearing these details from me, the CEO interrupts with a legitimate objection: “Mr. Simon… we aren’t Porsche.”
It is a fair statement. Does my answer also apply to mid-range carmakers? Does it apply equally to the CEOs of software developers, technology manufacturers, bargain airlines, and deep-discount retailers? The answer is yes.
Porsche offers one example of a highly successful brand with a premium price position. Its pricing strategy reflects the seven recommendations (below).
The link between price and profit is always the central theme, and the CEO must play the strategic, cultural, and custodial roles.
Porsche clearly has a premium price position, if not a luxury one. An ethos of value creation and pricing emanated from the C-suite during Wiedeking’s tenure, as he ensured that the company fulfilled that price position by keeping product quality and costs in line.
What are the common factors behind successful premium pricing strategies? Here are some recommendations.
- Superior value is a must: Premium pricing will work over time only if a company offers superior value to customer.
- The price-value relationship is the decisive competitive advantage. Successful premium products derive their true competitive advantage from their high value (in objective, absolute terms), translated into an appropriate price-value relationship.
- Innovation is the foundation: in general, innovation provides the foundation for a successful, sustainable premium price position. This applies to groundbreaking innovations as well as continual improvements, such as Miele’s under the motto “For ever Better”.
- Consistent, high quality is a must. This prerequisite comes up time and again: successful premium suppliers maintain high and very consistent quality levels. Their service must also meet the same requirements.
- Premium pricers have strong brands: one function of these strong brands is to transform a technological advantage – which is often temporary – into a long-lasting image advantage.
- Premium pricers invest heavily in communication: They know that they have to make the value and advantages of their products perceptible and understand able to consumers. Remember: only perceived value counts.
- Premium pricers shy away from special offers: They are hesitant to offer promotions and special offers. If the promotions they offer are too frequent or too steep, these instruments can endanger the premium price position.
But what do the strategic, cultural, and custodial roles demand of a CEO who chooses a low-price or even an ultra-low-price position – positions which are both relevant for highly developed and for emerging countries? The key virtues in those companies are frugality, modesty, a thorough distaste for waste and anything non-essential, and perhaps even a certain amount of stinginess. The CEO needs to remain true to these virtues, even in years when the company earns stronger than expected profits. If the CEO yields to temptation and lets these virtues slide, he or she makes the company’s low-price position untenable. This helps explain why long-lived companies with low-price positions are both special and rare.
Aiming Low: Success factors behind a profitable low-price position
Winning with low prices is not merely a game of math, where you stay one notch below the competition. It is far more a game of culture and attitude. It takes a special kind of company – from the CEO on down – to make a low-price position sustainable and profitable. The skills and traits to pull that off – such as cost-consciousness, relentless efficiency, and customer-driven design – must be anchored in the company and its culture from the very beginning.
However, we should heed two caveats. First, we should not confuse a low-price position with the decision to wage a price war. The latter is akin to driving from Point A to Point B by causing hit and-run accidents and road rage. Such drivers may eventually reach their goal, but will struggle to go further and will leave a lot of damage in their wake.
The low-price position I refer to stands in stark contrast to that price-war mentality. It has a long-term orientation built on consistency and sustainability, not quick results. The early 1990s groundbreaking price war in the U.S. airline industry highlights this distinction. As American, Delta, and United changed their fare structures, then slashed prices month after month to undercut each other, Southwest Airlines took out advertisements which said, “We’d like to match their new fares… but we would have to raise ours”. Southwest was born with a sustainable low-price position the others could not reach, no matter how aggressive their price cuts.
The furniture company Ikea, airline company Southwest and discount retail chain Aldi are all examples of companies that have a profitable low-price position from Day 1.
The allure of discounting and the adrenaline rush of a price war seem irresistible. But they are delusions which have nothing to do with a low-price position. The best cure I have found for these delusions is a cultural one. Don’t start price wars. Don’t fight them. Don’t engage in over-the-top discounting which teaches customers – both in B2C and B2B markets – to buy cleverly on price and price alone.
The second caveat comes from my dear friend and mentor, the late Peter Drucker, who once told me that low prices and high profits rarely come together. That combination only occurs when a company has a clear, significant, and sustainable – often extreme – cost advantage over its competitors. The choice of the price position affects the overall business model, the product quality, branding, and how to innovate. It also determines which market segments the company will serve and what channels it will use to reach them.
When the combination of low prices and high profits does occur, it means companies have relied on seven decisive success factors:
- They have a low-price position from Day 1: all successful low-price companies have focused on low prices and high volumes from the very beginning. In many cases, they created radically new business models. Successful transformations from a premium position to a low-price one are extremely rare, though I will provide one example below.
- They have a high-growth, high-revenue focus. This creates economies of scale which they exploit to the greatest extent possible.
- They are extremely efficient: they operate with extreme cost and process efficiency, which enables them to enjoy good margins and profits even while charging low prices. They are procurement champions, tough but fair on supplier prices and terms. The German-based Aldi retail chain and the Swedish furniture company IKEA are masters at this.
- They guarantee adequate and consistent quality: low prices can never offset po or and inconsistent quality, at least not over a long period. Sustainable success requires only adequate quality, but you must deliver it consistently.
- They focus on core products: they do nothing that isn’t absolutely required by the customer. That saves costs, without jeopardizing value creation.
- Their communication focuses on price: To the extent they even advertise at all, they focus almost exclusively on price. Please see Aldi, its German competitor Lidl, the low-cost airline Ryanair, and the “Transfarency” campaign from Southwest in the US, which goes: “Low fares. Nothing to hide. Were all about being open and honest with Customers and making sure pesky fees stay away from our low fares”
- They never mix their messages: almost all of the successful “low price – high profit” companies stick to an “everyday low price” or EDLP strategy rather than a “hi-lo” which relies on frequent temporary promotions.
Marketing is a formidable challenge for companies with a low-price position. Their hard work differs from the classic marketing efforts of premium and luxury goods companies, who combine attractive design, high performance, and high quality with elaborate packaging and aspirational advertisements. The art of marketing for low-price companies lies in understanding precisely what a customer needs and wants, at what level of quality, and perhaps more importantly, what the customer can do without.
The same seven success factors apply, but to an even greater degree, when a company or one of its business units wants to go one step further and pursue an ultra-low price position. In his book The Fortune at the Bottom of the Pyramid, the late C.K. Prahalad said that the ongoing growth in China, India, and other emerging economies means that every year, millions of consumers acquire enough purchasing power to afford mass-produced products for the first time, albeit at “ultra-low” prices.
The Wave, a motorbike manufactured by Honda for the Vietnamese market, is clear proof that a huge, global manufacturing company can win in the ultralow price segment against local competitors.
Honda once dominated the motorbike market in Vietnam, with a share of 90 percent. Its best-selling model, the Honda Dream, sold for the equivalent of around $2,100. Chinese competitors then entered the market with bikes selling for between $550 and $700 each. The Chinese manufacturers soon sold over 1 million bikes per year in Vietnam, while Honda’s volume dwindled from about 1 million to just 170,000.
Honda cut the price of the Dream from $2,100 to $1,300, a price it knew it could not sustain profit ably. But this action did not signal a price war; it was the first step in a change in Honda’s price position. At the same time, Honda was developing a much simpler and extremely inexpensive model called the Wave. The new bike combined acceptable quality with the lowest possible manufacturing costs.
The Dream may have been over for Honda, but the dream wasn’t. Honda launched the Wave at an ultra-low price of $732, which was 65% less than the former price of the Honda Dream. Honda re-conquered the Vietnamese motorcycle market so thoroughly that most of the Chinese manufacturers eventually withdrew.
Large manufacturers such as Honda can indeed compete against ultra-low price suppliers in emerging markets, but not by cutting prices on their existing products. Success requires a radical reorientation and redesign, massive simplification, local production, and extreme cost consciousness.
Ultra-low-price products from emerging markets have already started to penetrate high-income countries. Renault’s Dacia Logan, originally meant for Eastern European markets, sells well in Western Europe. Siemens, Philips, and General Electric have developed radically simplified medical devices in Asia, conceived for those markets. Yet they are now selling those same ultra-low price products in the United States and Europe. These devices do not necessarily cannibalize the much more expensive equipment used in hospitals or specialty practices. In some cases, the ultra-low price products have opened up entirely new segments, such as general practitioners, who can now afford the cheaper equipment and can make some basic, preliminary diagnoses themselves.
The price positions available to companies cover a vast spectrum, from extreme luxury down to ultralow. No matter what strategic price position a CEO chooses, he or she must still fulfill two additional and essential roles: aligning each function of the company with that price position, and then defending it against threats from inside and outside the company. Only then can the company capitalize on the powerful link between price and profit and create long-term value for shareholders.
Hermann Simon is the author of Confessions of the Pricing Man: How Price Affects Everything. He is the Founder and Chairman of the consulting firm Simon-Kucher & Partners, a global management consulting firm headquartered in Bonn, Germany, Cambridge, MA, USA, and Singapore.