Business Europe

The value of pricing

Twice-monthly report to managers of European operations

June 1st-15th 2004

Vol XXXXIV, No. 11

As markets become increasingly global, pricing strategy is moving up the corporate agenda Newspaper headlines in the last few weeks have proclaimed that Microsoft cuts Xbox price in fight with rival, .ord to give incentives on new Mustang, and Nokia cuts prices to grab back lost market. Each report suggests that pricing strategy has been radically changed at the top level to try to win a global marketing battle. Together, they are strong evidence that price is moving up the corporate agenda. It has always been an important issue, of coursemore in some businesses than in othersand local price wars and exchange rate fluctuations are recurring headaches. But markets are globalising, and grey markets are becoming more prominent. Legal regulation in the EU and US is getting stricter, the penalties more painful, and the social profile of some industries and their pricing is rising, especially in pharmaceuticals. So boards can no longer afford to delegate supervision of pricing policies or treat them, as many still do, as essentially local concerns. There is a further reason why pricing is moving up the agenda. Consultants frequently find that client companies are receiving half, or less, of the list or recommended price for their products. The other half goes in promotional discounts, quantity discounts, special discounts, freight costs, technical support, rectification, and so on. Companies frequently dont know how and why the residual pocket price is so low, or even which are their profitable (and unprofitable) customers. More astute pricing policies and better internal management controls, the consultants claim, can yield big increases on the bottom line without materially affecting volumes or customer goodwill. Their rule of thumb is that thanks to the gearing effect, a 1% increase in the average price will yield a 10% increase in operating profitand a 1% decrease will cut profits by a similar margin. Simon-Kucher consultancy, all the international companies we work with, in consumer electronics, tyres, pharmaceuticals etc, have introduced central pricing departments. Markets, however, are essentially local. Even though a product may have a near-global reach and application its price in each country has to be considered and negotiated separately. Country and business unit managers therefore need to retain some authority over prices in individual markets. That, at least, is the conviction of .rederik Rystedt, chief financial officer of Electrolux. We follow price movements at the centre, he explains, but profit-and-loss responsibility remains in each sector, so pricing should not be centrally managed. Electrolux is now divided into seven sectors, defined either geographically (such as the US sector) covering the whole product range, or by product group (like floorcare worldwide), or by both (like white goods in Europe). Setting prices in the single US market is relatively straightforward, but in the other sectors each country needs separate consideration, even in the euro area.

Corporate strategy Winning the price war Pages 1-2 Biotechnology Consolidation may be the best bet for Europe Page 3 Europe Voting for a new Parliament Page 5 Industry forecast: .inancial services UK: lending is set to slow sharply as households retrench Page 6 Slovakia Investor optimism

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Greater Europe Russia: Western insurers start to move in Page 8 .eatures Industry forecast .............6 Greater Europe ................8 Regulatory watch.......10-11 Regional and country data..................12 Business outlooks Greece ...........................4 Hungary.........................9

A corporate view

Global versus local

Improving the management information system may well clarify the issues but only at the cost of laborious comparisons across borders and against the competition. Analysing the huge volumes of data produced requires special skills. That is why, explains Stephan Butscher, UK managing director of the international
The Economist Intelligence Unit Limited 2004

Retailing is a highly competitive landscape, so its a very sensitive issue, says Mr Rystedt. The big buyers are in no way stupid: they know what theyre paying, and we define the margins with them. As retail chains cross more national borders, a corporate view of pricing becomes critical. The problem is, how can it be done? SimonKucher, significantly, has come to specialise in pricing strategy, and as a warning, cites the case of a large international software company. The special discounts on all its bids had to be cleared with head office, but the investigating consultants found that the executive giving approval was a mid-level employee sitting in a corner with no back-up. The company hadnt realised that a large share of its profitability depended on this one person. In many industries, the pricing process can be divided into three levels. At the tactical level, nearest the customer, is pure transactional pricing, encompassing

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Business strategies
volume discounts, promotional offers, delivery charges, etc. These have to be matters for the local management, even individual salesmen, but as we have seen, that is where margins are frequently eroded without management realising it. The second level is life-cycle or market strategy pricinghow much consumers are willing to pay and what they perceive as value for money. Much will depend on where the company decides to position itself vis--vis competitors and the strength of its brands. A critical point is the launch of a new product or range: if its overpriced, as Microsoft found with its Xbox, sales are blighted from the start. If its underpriced, the company loses valuable revenue for ever. The third level is what McKinseys pricing specialist Michael Marn defines as the industry strategy, based on trends in the industry and economy as a whole, and how the company can take advantage (or minimise the damage) of long-term trends. The price of oil, the value of the dollar against the euro dictate profitability, and will have an unbalancing effect on multinational operations. The three levels fit naturally into different parts of the organisation, but at the moment, pricing tends to be scattered (and divided) among finance, marketing, line management, production and elsewhere, and if its everyones shop, its no ones shop says Mr Marn. He and two colleagues at McKinsey have recently published a guide to pricing techniquesThe Price Advantageaimed at the general management reader, because theres a crucial educational role needed, to inject basic pricing ideas into the corporate bloodstream. If the company can only get its hands round the complexity, it can manage pricing to its advantage. AT Kearney is another big US consultancy that evidently sees a bright consulting future for pricing. It too has just produced a textbookWinning the Profit Game: Smarter Pricing, Smarter Branding. Rather more loosely written than McKinseys offering, it covers roughly the same ground but with greater emphasis on the value of brands in maintaining price premiums. (Its also well under half the price of McKinseys offering, suggesting that in the value-for-money algorithm, someone has put in a very high figure for the McKinsey brand). Neither book deals adequately with the organisational issues, and they ignore the international dimension completely. Perhaps that is because the authors themselves have difficulty getting their hands round the whole subject, but theres no doubt that their focus is justified, since interest in the subject is increasing much more quickly in the US than elsewhere. General Electric have already done. But the precise role and responsibilities of such an executive in the organisation are left vague. Liaison across internal boundaries, collecting and interpreting information from the market, checking net margins, and sounding the alarm if the marketing team is out of line are all included. So is a voice at the table when new projects are being considered to ensure that the projected price is realistic. Appointing a central pricing czar with a small research team does not, by itself, solve the organisational problems, however. Both McKinsey and Kearney see him or her operating in an advisory capacity alongside the marketing or product managers who decide on the price structure. But there are so many different functions in the company with an interest in the pricing process, that a good networking culture as well as good information is vital. Purchasing, estimating, manufacturing, R&D, customer service, distribution, remuneration, training, major accounts, may all be concerned with prices, and therefore need to be brought into the picture, and to be consistent with the strategy behind it. The complexity leads Mr Rystedt to conclude: You cant have one person deciding on price. .oreign operations add a further layer of complexity. Most country subsidiaries need the freedom to set their prices to suit the local market conditions. These often vary from country to country for historical as well as economic reasonseven the advent of the euro has not evened out these differences in the 12 counties that have adopted the single currency. But total freedom, limited only by the required profitability, is not an attractive option as markets become more international.

A good networking culture, as well as good information, is vital

Setting the limits

Most country subsidiaries need the freedom to set their prices to suit the local market conditions

Enter the CPO?

Both books suggest that a chief pricing officer (CPO) or pricing manager, reporting to the CEO or profitresponsible unit head, should be appointed to oversee the pricing processmuch as both .ord and
2 Business Europe June 1st-15th 2004

One way of avoiding problems is to adopt what Simon-Kuchers Stephan Butscher calls a price corridor, where the parent company merely lays down upper and lower limits to guide its subsidiaries. There is a hard lower limit below which the local prices, net of discounts etc, are not allowed to fall, but a soft upper limit so that the local management can keep their prices higher if circumstances permit. In 99 out of 100 cases, says Mr Butscher, the corridor is the best way. Countries are jealous of their freedom, but they understand the need for restraint, because they are hurt by the parallel trade. One company which has long adopted this system is Lego, the Danish firm that sells its famous plastic bricks in 130 countries. A central pricing department works out what it terms price frames, within which the local companies work. If they need to go outside the frame, a spokesman explains, the matter is discussed with the pricing department and if necessary the top management has the final say, but its not difficult to get co-operation.

The Economist Intelligence Unit Limited 2004