Book Review: Pricing With Confidence

The American writer Alfred Kazin remarked that “One writes to make a home for oneself, on paper, in time and in other’s minds.”

Well, Reed Holden certainly has had a place in my mind since I first read him back in October 1998. His book, co-authored with Thomas T. Nagle, The Strategy and Tactics of Pricing (STP) is a seminal work, adorning the bookshelves of anyone who takes pricing seriously. With this influential book, Holden and Nagle are probably more responsible than any other individuals for putting pricing on the organizational charts of companies around the world.

In addition to seeing both authors present for the Professional Pricing Society, I had the great good fortune of attending their University of Chicago Graduate School of Business course: Pricing: Strategy and Tactics, in April 2001. It’s one thing to read an author, it is something quite different to spend three classroom days absorbing the vast amount of tacit knowledge that resides in their cumulative experience, wisdom, judgment, and intellectual capital.

Since that program, I’ve also had the pleasure of corresponding with Reed innumerable times, exchanging ideas, discussing various business topics, books, authors, and yes, even disagreeing with him, but never being disagreeable. He has become my distant mentor, adding immeasurably to my intellectual capital, for which I will never be able to repay him—except with endearing gratitude.

I’m happy to report that Reed has a new—and for me, long anticipated—book coming out in late February, co-authored with his Holden Advisors colleague Mark Burton: Pricing With Confidence: 10 Ways to Stop Leaving Money on the Table.

I was fortunate enough to receive an advance copy of the book, spending a couple of days after the New Year absorbing its many lessons. Of course, there is no possible way to do justice to this work in such a short space, so instead I will simply share with you some of the more brilliant insights that struck me like a thunderbolt.

In addition to a brief synopsis of the Ten Rules of Engagement, the Introduction starts out with a discussion of the pricing death spiral, a never-ending process whereby the buyer continuously gets the seller to offer more and deeper discounts. A process, the authors teach, with no winners, only survivors. The Ten Rules offered in the book are effective strategies to counter this trap—along with capturing more of the value a company creates.

The Introduction also contains a discussion on “What Is Your Pricing Purpose?” offering this advice: “In Reality, pricing is far from simple. Setting the optimum price is one of the most difficult decisions managers ever make.”

Amen. This statement recognizes that pricing is not a science, it is an art; but it’s also a skill, meaning the more we do it, the better we get. The authors also suggest that the highest purpose of pricing is to increase profits.

One of their mottos is breathtakingly simple, yet incredibly insightful: “Innovate for growth and price for profits.”

I have long believed that much of pricing is based on self-respect—especially in a professional knowledge firm (PKF)—so I cheered loudly when I read the chapter title for Rule One: “Replace the Discounting Habit with a Little Arrogance.”

The summary of Rule Two proffers this sage advice: “You can’t have confidence in your pricing until you have confidence in the financial value that your offerings create for customers. Even though many managers are convinced they can’t get this information, the reality is that most of your customers are eager to tell you. All it takes is asking the right questions and being willing to listen.”

If all you talk about with customers is price, no price is ever going to be low enough.

Yet how many firms truly understand this? It’s much easier to sit around and lament the fact that what they sell is increasingly a “commodity,” complaining about the procurement process, and whining that customers simply don’t understand the value they create. But that’s the cowardly way out, shifting blame and responsibility onto others.

If companies themselves don’t take responsibility for comprehending, communicating, creating, convincing and capturing value, who will? How can you change something if you don’t accept responsibility for the underlying causes?

Price competition is a fact of business life that’s not going to go away. But as the authors point out, it’s also a fool’s game “because any fool can play it. In fact, weak competitors have an advantage in price competition because they’ve got little to lose and nothing else to leverage.”

The discount habit—what they label discount creep—is usually the result of either selling to customers who don’t value what is offered, or a wrong customer to begin with—as they write, “the price isn’t wrong; the customer is.”

The example of how Oracle and Peoplesoft—before the former acquired the latter—were both offering discounts as high as 80% to close deals in order to make their numbers is startling proof of the end-of-period desperation. Thankfully, the authors offer strategies to counteract this lunacy.

Rule Four identifies four types of customers: price buyers, value buyers, relationship buyers, and a group they call poker-playing buyers. The chapter goes on to discuss strategies—honed by real-world experience—on how to deal with each type that are worth the price of admission.

I also enjoyed their comments on price elasticity research and how it is often the wrong approach in business-to-business markets. Instead, they posit the concepts of derived demand, customer behavior, and the cross-elasticity of demand.

The book contains excellent discussions surrounding the three pricing strategies: skim, neutral, and penetration, while tying each one to a product’s life cycle. One thing I did notice is that Reed has evolved his thinking from his earlier book, since he now believes the prices these strategies dictate are relative to that of competitors, not the value of the offering, as he and Nagle posited in STP.

You will also learn effective strategies for bundling, dealing with Requests For Proposals—and the dreaded winner’s curse—establishing walk-away prices, and why professional pricers should have to visit at least ten customers each month. The book also gives kudos to Accenture and its CEO, William Green, for structuring approximately 30% of their contracts under Value Pricing principles, which is encouraging for all of us who work in the PKF sector.

Lest anyone accuse me of writing a hagiographic review, I don’t agree with everything in this book, a source of endless exchanges of emails between Reed and myself. One minor disagreement is the authors’ characterization of sales being just a poker game. The problem with this analogy is that poker is zero-sum, whereas exchanges in free markets are positive-sum—that is, both sides to a transaction have to gain or it simply won’t take place. Although I know Reed and Mark know this, and I understand the context in which they use the poker analogy, I still wish a better metaphor would have been used.

They also reject the notion that value must be determined by each customer, uniquely, claiming firms that follow this strategy see margins decline and incur unnecessary selling expenses. But value is subjective, so the fact is, it is going to be different for each customer—like it is, I’m sure, for Accenture’s 30% VP customers. Perhaps this is just a bias since I work within the PKF sector, where the marginal cost to an accounting, law, or advertising firm of subjectively valuing one customer at a time is small, and leads to better value for each customer, as they receive a customized offering. Since the book is mostly written for product sellers in B2B markets, I can understand their point, but still posit that one-customer-at-a-time pricing is the ideal world, made more accessible with cheaper information—EDS, BI, and CRM systems, RFID tags, etc.

I also find unconvincing the authors lament of the airlines so-called dumbbell pricing—the extreme difference in airfares between a leisure and first-class, loyal, frequent-flyer fares. They claim the airlines would be more profitable if not for this, but I’m skeptical. They point to Southwest and Jet Blue as airlines that are profitable with much simpler yield management systems. However, how does one explain the exemplary profit record of Singapore Airlines—which almost matches Southwest’s—especially since it engages in dumbbell pricing? Other factors must be at work.

General Electric and Cisco are held out as two examples of companies that teach its salespeople to sell on value. But as I pointed out in an earlier post, Jeff Imelt, the CEO of GE, admits that the company is leaving $50 Billion on the table because of “discretionary”—read: poor—pricing.

My biggest disagreement, though, is with Rule Nine: “Take Simple Steps to Move From Cost-Plus to Value-Based Pricing.” It’s not that I disagree with the necessity of an incremental approach—since the cultural change required for any company to move to real Value Pricing is massive—it by necessity must be incremental.

My issue is with this statement: “There is nothing wrong with cost-plus pricing as long as it does a good job of leveraging the financial value you create for customers.” Yet, it’s highly unlikely that cost-plus pricing does this, except by coincidence.

My worry with this statement is that some leaders will use it as an excuse to delay, or put off entirely, making the transition to VP. Replacing cost-plus theory with value-based theory is hard enough without some people clinging to any last vestige of the proprietary of the old model, especially from someone as prominent as Reed Holden.

What I do agree with in this Rule is their advocacy of incremental costing versus average costing. It’s well established that marginal costs, not average costs, should be considered, especially in a PKF environment where most costs are fixed. Activity-Based Costing is a superior alternative to standard cost accounting, since it can attempt to answer “what-if” questions, and challenge the processes that drive costs, rather than merely allocating existing costs.

As Henry Ford pointed out, we can account very accurately for costs, but no one knows what a cost should be.

Also, the authors point out that “Successful initiatives to improve pricing are rarely pricing-driven.” This is true. Concepts such as intellectual capital, project management, KPIs, utilizing Change Orders, and a strategic value proposition are all necessary prerequisites for creating the value that better pricing attempts to capture. We often say that Purpose drives Strategy, which drives Value Marketing, which drives Value Selling, and only then can we Value Price. Pricing, indeed, is the last part of the chain. This is why most companies can’t do it—they are unwilling to make the changes in all of the other areas.

But when they write: “An important point about cost-plus pricing is that most organizations are comfortable with it,” all I can say is a lot of people are comfortable being fat, but that doesn’t make it optimal. I also reject their notion that “If an organization sharpens the quality of its costing data, it is always in a superior position.” And “Applying incremental costing produces what we call value-enhanced cost-plus pricing.” Huh? That’s an enhanced contradiction in terms—like jumbo shrimp.

But becoming more accurate cost accountants isn’t going to make a company become better pricers. Toyota doesn’t even use a standard cost accounting system, but rather a process they call target costing. We at VeraSage see a correlation—and I might argue it’s a causal relationship—between firms that have trashed timesheets and have become superior pricers. We have examples of firms from every PKF sector, which I find compelling.

These technical disagreements aside, they take nothing away from this work—a fantastic book that should be read by anyone who considers themselves serious about creating and capturing value through better pricing.

As Rule Ten states: “Customers buy results, not rhetoric. Moving beyond the rhetoric of value will enable you to prove those results to customers.”

Every day your company delays implementing value pricing is the equivalent of ripping up dollar bills (one of the authors favorite motivational visuals).

Reed and Mark have created another permanent home in my mind with this work.

Stop leaving money on the table. Read the book—it is priceless.