Strategic and Innovative Pricing

Price Models for a Digital Economy

Mathias Cöster, Einar Iveroth, Nils-Göran Olve, Carl-Johan Petri, Alf Westelius

• Publisher: Routledge
• Year: 2020
• ISBN:
  9780429624292
• Edition: 1
• Topic: Business
• Subtopic: Business Strategy
• Index: Business

This book provides a concrete guide on how to execute strategic pricing to excel in an increasingly dynamic and digitised business environment, while developing and deepening relations with contract partners. The secret lies in crafting innovative price models that reward joint value creation in accordance with the business model, rather than engaging in confrontative zero-sum pricing reasoning.

Strategic and Innovative Pricing: Price Models for a Digital Economy provides hands-on tools that are applied on three interconnected levels of analysis. It illustrates how to explore the business ecology to understand its dynamics and how digitisation enables it to prosper and demonstrates how to construct a viable business model that enables an organisation to navigate in its vibrant ecology. Finally, and most importantly, it shows how to use innovative price models to realize and monetise the business model and its value offering, making the organisation and its partnerships sustainable.

Models pertaining to the three levels of analyses are applied in rich case studies and examples from different countries, and the book includes guidelines on how to use them. Special attention is paid to digitisation as an underlying theme, making this book of interest to researchers, academics, and students in the fields of strategic management and technology & innovation management.

1
A New Perspective on Pricing

Introduction

This is a book about strategic pricing in the digital economy, and it provides a guide on how to explore as well as execute strategic pricing to excel in an increasingly dynamic and digitised business environment, while at the same time developing and deepening relations with contract partners. The secret lies in crafting innovative price models¹ that reward joint value creation in accordance with the business model, rather than engaging in confrontative zero-sum pricing games. Special attention is paid to digitisation² as an underlying theme.

Several years of successful research and consultancy with private and public organisations were the testbed for our approach, which rests on three interconnected levels of analysis. First, the book shows how to explore the environment, using a business-ecology perspective (Chapter 2) to understand its dynamics and how digitisation enables it to prosper—and poses challenges. Second, the book demonstrates how to construct a viable business model (Chapter 3) that enables an organisation to navigate in its dynamic ecology. And finally, and most importantly, it shows how to use innovative price models (Chapter 4), an important but often neglected part of business models, to realise and monetise the business model and its value offering, making the organisation and its partnerships economically sustainable. Tools pertaining to the three levels of analyses are applied in rich case studies and examples from different countries, and the book includes guidelines on how to use them.

Business ecologies, business models and price models will be used together as a three-step sequence for analysing and articulating relations not only with customers, business partners and between different units within an organisation, but also with trends, ideas and models in the environment that influence the business models and price models one employs, and their viability.

In the first part of the book (Chapters 2 through 5) we arrive at a new perspective on pricing. We propose an analytical concept called the price model equaliser, to be used as a tool for imagining novel ways of pricing for the situations that contemporary organisations encounter. From our rich experience of working with consultancy clients and as researchers, we identify how relations nowadays often are long-term and characterised by joint value creation (and where digitisation often is a key enabler). The price model equaliser aids in identifying and discussing such aspects of a deal as the scope of offerings, duration of contracts and the attributes prices should be linked to. There is often unexplored potential for innovations in pricing, better adapted to the needs and preconditions of buyers, sellers and business partners. Pricing thus can serve to realise business models in ways many organisations do not now exploit. Due to differences between buyers and sellers, well-designed price models may be part of win-win contracts that both parties find preferable to traditional price models.

At the end of Part I, we discuss costs and other financial considerations, such as business risk, which obviously will always be important in contracts that regulate payments and how economic values are shared. The business models we find most interesting invariably involve joint value creation, where several firms, including buyers, impact value creation over time through their actions. Price models create incentives and influence risk sharing. We find them an under-researched field of study and regard our proposals as a first step towards rectifying that deficiency.

In the second part of this book, we turn to a rich selection of practical cases in order to discuss both the individual parts of our price model equaliser and the joint configuration of its attributes. Most of these come from our own practice, and we have been able to observe how practitioners have been able to absorb and apply the models we propose.

By strategic, we mean that pricing will have effects beyond a particular business transaction. Through linking prices to different aspects of the offering, a price model defines it and influences how it is conceived by both seller and buyer, and in this way shapes the identity of both and the preconditions for a continued business relation between them. It also provides incentives for exploring joint value creation, for instance in the areas of service and accessory sales. While not new, such insights have proved particularly interesting to practitioners we have met for reasons related to other current debates, such as value capture, risk management, transparency and open-book accounting.

By the digital economy, we mean a society based on digital computing technologies, not just shaped by the widespread use of the Internet but increasingly involving embedded computers and sensors that communicate via digital channels to control and monitor physical resources, processes, activities and behaviour, and where people take it for granted that data is recorded and analysed regardless of time and place. This can both pose threats and challenges, enable new business practices and restrict existing ones. For relations between organisations and units within them, digitisation presents previously unimagined opportunities to monitor and price specific aspects of a business transaction, making it apparent how prices provide incentives for buyers and sellers. Such exploration of digitisation and pricing can uncover aspects that, in turn, can trigger changes to not only an organisation’s offering as such, but also necessary changes to relations to actors and ideas in the ecology, changes to the business model as well as the overall strategy. In this way, and as we will communicate and explain in more detail throughout the book, digitisation and pricing can be a key-enabler for innovation and a long-term sustainable and financially viable organisation.

Although this is not a book about organisational control through (internal) transfer pricing or purchasing practices, our three-step perspective of business ecology, business model and price model highlights how prices may determine division of labour and thus co-creation of value among business partners. In this way, pricing can be seen as a skill impacting the sustainability of an organisation and even an economy. Is market efficiency through price level competition, with a “survival of the fittest” attitude, always the best path to a sustainable society? Will we see more of multi-year, “obligational” contracts where firms and government organ-isations use price models to define joint value creation?

Following this brief overview, this initial chapter will now discuss some of the observations and contacts which led us to start on our journey into innovative pricing ten years ago. We highlight what many of us observed in markets and explain briefly how we came to work in this field.

Pricing That Attracts Customers

Probably, mobile-phone contracts introduced many of us to the idea that price models could differ between suppliers and that they were becoming competitive tools. A monthly fee plus variable cost for calls, messages etc.—or a fixed package? Unlimited surfing? A new phone included? How many months before you can exit the contract? Compared to the fee structures for the old fixed-line phone, often provided by a government-run monopoly, many were bewildered. Bewilderment was reinforced as the technology spread quickly—in Western countries there are often more mobile phone contracts than inhabitants—and price-model variations multiplied.

There have been reasons for this new price competition. Versatile new generations of phones meant that some were attracted by the phone itself, some saw it as a symbol of modernity and a way to signal success and being an active part of modern trends, while others saw it just as a necessary prerequisite for the services they craved. The range of included functions and services that people are willing to pay for varies widely. Some want streamed video several hours a day, while more traditional customers just want phone calls and messages. Few in a digital-economy environment can get through the day without actively seeking, or being forced to use, apps to perform tasks. Yet most of the services build on a shared network, which is available for anyone with the right type of mobile phone and operator contract. Capacity and service qualities depend on complex decisions and industry agreements that have little to do with providing individual customers with services—except in extreme cases, like regions with very few inhabitants.

Similar trends exist in other industries, and theoretically they are of course not new. Economists have grappled with issues of road fees for close to two hundred years: should they be charged to finance retroactively the building of a road? The debate has been particularly fierce regarding bridges where no alternative connections exist, and it is socially harmful to discourage the use of an existing facility. In the late 20th century, terms like “up-front costs” became common. Almost-zero variable and marginal costs made it difficult for new entrants to challenge and compete with firms that had been the first ones to invest in a new field. Costs increasingly pertained to the customer relation as such, not to specific offerings, as electronics were making goods and services more interconnected. In countries like the US, government had long been fighting firms that used their monopoly to require camera buyers to buy a particular brand of films, or razor buyers to buy their blades. Mobiles created a situation where many of us may have been unsure:

• whether we bought a phone and had to promise to buy a particular operator’s services, or bought a phone connection and received a free mobile,
• whether we understood correctly the cost of the two- or three-year contract we were entering, or would find out later about its limitations and extra fees for features we would find it hard to resist, and
• whether service quality—coverage, service disruptions etc.—would prove adequate.

But we also began to realise that some service providers might provide offerings that matched our requirements better than others, for instance, a guaranteed fixed monthly fee for a well-specified package of services. A problem might be that most of us learnt only through experience how far a specified number of gigabits would take us. But after some time, we found it natural to choose a service provider for the next few years, rather than buy a phone or a television set.

Firms (and even government organisations) increasingly set up “package deals” of goods and services which can be priced in many conceivable ways. In this book we call the financial terms in offerings such as the different phone contracts price models. For a seller, a wise choice of price model is an important part of realising a business model. Let us limit ourselves for now to the case of one seller and one buyer. In the mobile phone case, this would normally be an operator and a user (a person or an organisation), although the buyer might think of the transaction as “buying a new iPhone” (which is not manufactured by the operator), and the seller may buy network services from some other firm.

In this situation, the buyer’s choice no longer is just who offers the cheapest identical phone. Offerings may differ in many more dimensions, and especially when phones’ functionality increased rapidly, competitors’ offerings and pricing differed. How to innovate pricing in such situations is what this book is about—and perhaps particularly, how to innovate in situations where a change similar to that in phone services has not yet happened. A price model is about a particular business deal: what is included, and what will determine how much customers pay? But we also use the term somewhat more broadly. What generic types of price models does a firm offer its customers? Often, firms offer different constellations of goods and services that are priced according to fundamentally different models. Each firm has a repertoire of price models. Sometimes, a fundamentally new price model is launched, like when one Swedish mobile phone operator abolished the time factor and gave customers the right to cancel without waiting (like before) for a 24-month period to expire. Price models have become part of competition, and firms have to consider questions like:

• Is there a significant group of customers who want a monthly cost they can predict and would be attracted by a fixed fee? Can we handle the increased traffic that is likely to follow?
• How will it affect our customer-service function if unlimited support is included at no extra cost to customers, who are then likely to use it more?
• Will our competitors follow us if we change our pricing to attract specific groups, or will they use dissimilar price models to find niche markets of their own?
• A unitary fee for a bundle of goods and services, including support, will need to be split between the units of our organisation if they shall remain profit centres. Their products and functions will be used to different extents by different customers. How can we organise this inside our firm to provide incentives and enable management evaluation?

Questions like the final one also exist for subcontractors and outsourcing partners: how much of our revenues should be passed on to each? Price models for a firm’s relation with those (inbound pricing) may require as much attention as the price models for final sales (outbound pricing).

Conclusions Before We Started

Casual observation of our own behaviour as consumers, and that of firms we have been observing, yielded several conclusions which motivated our interest in the field of pricing. They were reinforced by debates in media and politics over public-sector procurement, where contracts for health-care and large infrastructure projects were accused of providing wrong incentives, leading to low quality and encouraging cost overruns. Yet we found little research on pricing beyond the established issues of price-level competition between firms offering rather standardised products. So, we drew a number of conclusions early in our own exploration of the field:

Prices are becoming multidimensional. The object that is being priced can no longer be taken for granted. Beyond “bundling” and “versioning”,³ which have been discussed in price literature, offerings are being differentiated through selling something “as a service”, or through limited-time free access which can be updated, or using a guaranteed “price ceiling” (like public transport in London, which is free once you have reached each day’s maximum fee). Contract duration and payment terms may also be varied.

Prices matter. A price agreement will impact the behaviour of both buyer and seller, and it should be seen as an active choice concerning incentives for joint problem solving. Traditional literature regarded cost or customer value as the prime determinants of price. The pricing we could observe often was part of an ongoing relation which aimed to explore co-creation of value. Price models will differ in their impact on the incentives they provide for this and how a shared success is rewarded.

Price models influence costs. What you include, and how prices are linked to various aspects of a deal, has an impact on costs. Especially when agreements are long-term and involve promises of service levels, updates, or data links to improve logistics, both supplier and customer w...

Table of contents

• Cover
• Half Title
• Series Page
• Title Page
• Copyright Page
• Contents
• List of Figures
• List of Tables
• 1 A New Perspective on Pricing
• PART I Theory and Conceptual Models
• PART II Cases and Examples
• Author Biographies
• Index