Digital Pricing

The potential for price optimization has increased exponentially in recent years due to digitization. Pricing processes must go beyond pure optimization to reflect higher-level decisions about the business model and the revenue model. These vertical processes and interactions are becoming increasingly important as business becomes more digitized. The multidimensional definition of price means that pricing must be part of a company’s strategy process. Strategies deal with the long-term focus on target customers with different products—in diverse regions and sales channels. Consequently, price is a central lever within the framework of corporate strategy. A planned price variation is always about both the right direction and the level of price change. The decisive factor is an accurate assessment of which demand reactions can be expected in the case of planned price changes.

Information goods (software, online content, digital services, etc.) are subject to different economic rules than products and personal services. The characteristics and framework conditions of digital offerings are of great importance for pricing. They must be taken into account when defining the pricing strategy and designing price structures. The strongest overall effect of digitization on pricing is a significant increase in price and value transparency.

Digitization enables new business models, additional revenue streams, greater integration of customers into business processes, innovative price models, etc. It affects all aspects of price management and enables innovation across the individual stages of the pricing process. Price optimization for business offerings (e.g., products like game consoles, services like air travel, and digital services like video streaming) is just one facet of digital price management! Important business decisions precede price setting: (1) The definition of revenue sources (the revenue model). (2) The definition of the customer benefit (value to customer) as a central pillar of the business model. Professional price management must go beyond the mere optimization of the pricing process to reflect the higher-level decisions on the business model and the revenue model! If the customer’s subjective value perception is the starting point for pricing, professional price management must necessarily begin with the higher-level business model (level 1). However, the linkage occurs in both directions. Creative pricing measures are one of the numerous examples of this principle. Innovative price models not only lead to better monetization of the benefits (“value capture”), but are also an independent value driver for the customer (“value generation”). Creative price models increase the value to customer (and thus enhance the business model)! So price management is by no means just monetization. Digital pricing can also contribute to value generation.

Digital business models are leading to a major change in the revenue models of companies. In most sectors, revenue shares are shifting from products (hardware) to services, software, and digital content. Online advertising and data have also gained importance as revenue sources. The choice of a company’s revenue model depends to a large extent on which stages of the value chain it takes on. The position of power of a company within the value chain is of outstanding importance. The position within the value chain is ultimately decisive for who captures revenue potentials and to what extent. In digitized industries, direct contact with the end customer is critical to success. The consequence of the significant expansion of revenue models is that there are many more challenges for pricing than 10 years ago. In more and more cases, the first question is which offerings should be priced at all. This challenge must be optimized before the details of the pricing process can be addressed.

The pricing process is one of the most important value creation activities of companies. The process begins with a comprehensive analysis of all pricing-relevant data. It translates the strategy—which follows the analysis—into concrete pricing decisions (price points, differentiation approaches, innovative price models, etc.). These form the starting point for shaping price negotiations and enforcing prices on the market. Pricing processes consist of numerous challenges that vary in importance depending on the sector (B2C, B2B, C2M, C2C), industry, and company. Monetization (“value extraction”) and value creation (“value generation”) can be achieved equally with this management process. Every pricing and product decision should be based on a measurement of customer value. However, costs and competitive conditions must also be included. At the core of the analysis phase are 11 essential pieces of information. These can be symbolized by the “11 C” of pricing.

At all strategy levels, the aim is to define the strategic thrust for various focus segments (products, regions, customer groups, or sales channels of the company). In essence, the strategy definition reflects the various dimensions of pricing. Price is thus by definition a component of a company’s strategy process. Pricing strategies have an outstanding leverage effect on the company’s target achievement. The selection of options in pricing must therefore be based on the company’s objectives or the strategies of individual business units. The challenge is anything but trivial: after all, companies pursue several objectives (such as profit, market share, and growth) that are very often in conflict with each other.

Price differentiation is one of the most important profit levers within the pricing process. This is particularly true for digital services. Customers are divided into subgroups that are as homogeneous as possible according to certain criteria. This allows the target groups to be addressed with differentiated prices. The overriding objective is to optimize profits by exploiting the differences in preferences and price elasticities of the segments. Data-driven business models enable multidimensional price differentiation. An example of this is simultaneous price differentiation according to region, user and their purchase quantities. Different prices per person and country are supplemented by a non-linear price model. The goal of multidimensional price differentiation is a finer segmentation based on the outlined price dimensions. This allows the existing willingness to pay to be captured even better. It should be noted, however, that the complexity of the price structure can still be grasped by the buyer. The more similar customers, products, timing and/or sales channels are and the more different the prices at the same time, the higher the risk potential for the companies.

One of the many motivations of this book is the presentation of the interplay between business model, revenue model, and pricing process. The starting point for price management is the business model (see Chap. 3). It is about a clear understanding of one’s own added values and the underlying value creation processes. This results in potential revenue sources and revenue partners (see Chap. 4). Suitable price models are derived on the basis of the revenue model. Price models (“how to charge?”) define the qualitative basis on which quantitative price levels (“how much to charge?”) area based. Price models are systems with multiple interacting parts. The object of price modeling is to answer the questions of what for, when, by whom, and on the basis of which parameters the price is defined. Digitization offers enormous opportunities for differentiation in pricing. Not via the price amount as such (“numerator” of the pricing formula). But via the price model (the “denominator” of the price). Numerous success stories prove that innovative price models have a very strong impact on perceived customer benefits. With value-based reference bases, the customer’s attention is shifted to the performance or the financial result. Innovative price models not only lead to a better monetization of benefits but are a value driver in their own right for the customer: They increase the value to customer (and thus enhance the business model)! The consequence of this is that price management is not just “value capturing” (monetization). Pricing can also contribute to value generation.

Professional pricing offers great potential for optimizing companies’ profits. To optimize profits, data on customer behavior is required: historical information, current statistics, or forecasts. In more than 400 pricing projects conducted by the author since 1996, survey-based methods have proven their worth. Among them especially: conjoint measurement as well as the direct price query via adapted price-sensitivity meter. I recommend price elasticity estimates based on an internal workshop as a supplement to customer surveys. For the company’s most important focus products, a combination of the adapted price-sensitivity meter with conjoint measurement and expert estimation is recommended. The exact determination of the new product price is of high importance. Even minor misjudgments of customer and competitor reaction can result in major financial disadvantages. A systematic process is required to determine the optimal price for innovations. The starting point is the comprehensive analysis of external and internal information. All steps—from analysis and target definition to implementation in the market—can be supported by modern data analysis and market simulation methods. Decision support methods bundle these sub-processes into a comprehensive model.

Given the range of their assortment and the diversity of input data, many companies rely on simplified rules for making pricing decisions. Optimizations of the price architecture are made for the most important customer segments, product variants, regions, and channels. All remaining price points are derived via a standardized process. From an efficiency point of view, pricing must concentrate on the segments and product groups that are significant both strategically and from a profit point of view. These success-critical price points define the brand images of companies and determine their long-term survival. In many other cases—in the case of slight product modifications, less relevant product elements, etc.—it is not possible to invest a great deal of time in each individual pricing decision. In all these constellations, companies need precisely defined processes that lead to a successful “value extraction.” These processes are more or less standardized depending on the industry. Dynamic pricing is a special field of portfolio pricing. Dynamic pricing adjusts the prices of products, services, and information goods to the current market situation according to defined time cycles. The concept of constantly changing prices is becoming increasingly professionalized and more closely timed as technological change progresses. Due to the rapid development of information technology, dynamic pricing has become one of the most important levers within the price management process.

The optimization steps within the framework of the price structure are followed by the implementation of prices in the market. List prices are the starting point for price negotiations. The actual price parameter in the discussion with customers is the discount—or more comprehensively formulated—the condition system. Target segments and negotiating partners differ in many ways. The condition system must reflect these customer differences. Therefore, a list price is defined with a view to the target positioning (value to customer). This gross price is the starting point for a discount differentiation, in which attractive customers receive targeted incentives. The value of customer—i.e., the importance of the customer for the company—is rewarded with corresponding price reductions. In addition to the structural approaches to sales management, there are also numerous levers for increasing earnings in the area of tactical measures. In the case of price increases, it is in the interest of the company that these are not recognized as such as far as possible. This is highly relevant in the current situation of cost inflation. Numerous tactics can be used to enforce higher prices.

The main challenge of price monitoring is to measure the overall success of price management in the company. The measurement of success is differentiated in detail for the following two dimensions: hierarchical levels (company, business unit, product line, product) and price dimensions (product, customer, region, sales channel, etc.). In the sense of a pricing audit, the aim is to achieve the greatest possible transparency with regard to performance in price management. The measurement of the pricing index closes the circle to the target definition. Integrated performance measurement on the basis of an overall indicator comprises three levels: financial targets, market targets, and professionalism of the pricing process. While the items of pricing excellence can be adapted to specific sectors and companies, the evaluation process should be standardized. Simple maturity models are not sufficient for corporate practice. Many maturity models have limitations (e.g., inaccurate measurement via an ordinal scale, insufficient delimitation of the maturity level, lack of operationalization of the maturity level via practical criteria, and non-existent implementability for pricing). Among the KPIs which relevant for price management pricing power has an outstanding role. Pricing power includes the ability to pass on costs (e.g., due to inflation) to customers without affecting sales volumes. Quantifying the pricing power of a company, a business unit or a product is of crucial importance. An assessment tool is a basic requirement for measurement. A pricing power score is based on the following criteria, among others: competitive strength index, brand image, market share, capacity utilization (supply-demand ratio), number of competitors and market share distribution of competitors, and relative importance of price compared to benefit criteria.

The starting point of the three-dimensional optimization approach “digital pricing” is the customer benefit (“value to customer”) defined within the framework of the business model. The immediate consequence of this is that professional pricing must incorporate the latest findings in behavioral psychology. Since customer behavior is the most important factor influencing profits the perception of benefits and prices is of paramount importance. Controlling perception is critical to success. To put it another way: A provider’s perceived benefits and price image are more significant than its actual positioning. I present the latest findings from brain research as the final chapter of the book. Against the background of the challenges of the pricing process, it is shown how the perception of customers can be controlled with the help of price-psychological levers. Eleven principles of pricing psychology are assigned to the point in the pricing process where they can be applied in terms of process sequence and content. The focus is on the key decision fields in price management that relate to interactions with customers—the process challenges “structure” and “implementation” and their detailed steps.