The Critical Questions to Ask about Pricing in 2022
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
As we enter 2022 there are some critical questions we should be asking about our pricing strategies. Some are driven by external changes in the environment, like the possibility of inflation and higher interest rates. Others reflect corporate priorities, like how to increase company value. At the same time, best practices in pricing are evolving, and we need to keep asking ourselves if we have the right value and pricing metrics, if we should expand usage based pricing, and how to evolve our pricing processes and the connections of pricing and value to customer value management.
What impact will inflation have on your pricing?
What impact will higher interest rates have on your pricing?
How can you use pricing to increase company value?
How are best practices in pricing changing?
Does your pricing track the value you deliver to your target segments?
Can your pricing process detect change early and adapt rapidly?
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What impact will inflation have on your pricing?
Will inflation settle in during 2022 or is this a temporary phenomena that will fade away as the economy settles into its post-pandemic configuration and supply chains sort themselves out? None of us really know, so the smart move is to be prepared.
The first question to ask is how inflation will impact your customer’s and their business models. Will the critical value drivers change and how will this impact the connection between your value metric (the unit of consumption by which a user gets value) and your pricing metric (the unit of consumption that the buyer pays for).
Inflation could change your customer segmentation, if different customer sets are impacted by inflation in different ways. Think this through and then go out and survey your customers. Ask if it is time to resegment and reprice.
Board and executive teams will be asking …
Is inflation an opportunity to raise our prices?
What will inflation do to our own costs? (And do we need to raise prices in response?)
Tread carefully here. These are reasonable questions and need to be investigated, but a knee jerk response to inflation could be counter productive. Before raising prices in response to inflation play this out a few moves and think through the inputs on your customers.
What impact will higher interest rates have on your pricing?
Central banks are likely to want to cool inflationary expectations and this means two things. They will ease up on quantitative easing (i.e. injecting lots of liquidity into the system) and raise interest rates.
Most central banks will be cautious about raising interest rates, but if they do you need to be prepared. The biggest impact of higher interest rates is a higher costs of capital. This may lead companies to want to avoid capital investments if they can. If this happens, it will be an opportunity for some companies.
If you have an offer than makes production more efficient, you may be able to position it as a way to defer or avoid capital investment. If the cost of capital goes up this can become a very powerful value driver.
How can you use pricing to increase company value?
Pricing is a powerful lever, but it cannot be used to do everything at once. So how do you decide what your pricing objectives should be? The best way to answer this question is to ask what will do the most to increase company value.
At some companies, revenue or ARR (annual recurring revenue) is used as a proxy for value. At others it is profits or profitability. In fact, all of these contribute to value and you need to treat company value as a system of interacting parts. Revenue and profit, together with risk, combine to determine value.
What is your 2022 pricing strategy meant to do? Grow revenue from new customers? Grow revenue from existing customers? Reduce churn? Reduce risk? Improve profit? Test your planned pricing actions, even the ones in response to inflation, against each of these factors and think through the interactions.
How are best practices in pricing changing?
Make sure your pricing process is up to best practices. Pricing is transforming as new technologies become available (especially AI), the connection between price and value is better understood, and the availability of information on the Internet leads to new norms.
The four key pricing best practices you should be aware of are …
Pricing needs to be fair (consistent, transparent, reflects the value you deliver; see Is your pricing fair? And why you should care.)
Pricing must be adaptable (even adaptive) - your pricing is responsive to changes in the external and competitive environment and can be changed when needed (pricing should not be a frozen accident)
Pricing should include a usage component (see How to introduce usage based pricing)
Pricing must track value (see What is the value of value based pricing)
Pricing must align with corporate goals - this sounds obvious, but in many cases pricing actions are short term and short sighted and will not support an organization’s long term goals
Does your pricing track the value you deliver to your target segments?
Value-based pricing is a powerful thing, but only if price and value are aligned to your target market segment.
A well defined segment is a group of customers and potential customers who get value in the same way and who buy in the same way. An industry vertical, a company size or a geography does not define a market segment.
When external market conditions change, as they are likely to change in 2022, segmentation can change. One of the first questions you should ask as we enter 2022 is …
Have there been changes to how our customers get value?
If the answer is ‘yes’ then askDo we need to re-segment our market in response to these changes?
andShould we change our target segments and how we price for those segments?
A grounded segmentation is the foundation for pricing (for all marketing actually) and when there are major changes to the environment segmentation can change as well. When segmentation changes, pricing needs to change.
Can your pricing process detect change early and adapt rapidly?
What signals do you track that suggest you may need to adjust your pricing? It is hard to have an adaptive pricing model without systems in place to track what is happening in the market and with customers. There are four major ways you can detect change.
Price signals - price scatterplots (how does price map to other metrics, how consistent is your pricing, what does analysis of usage of your pricing page tell you, what can you learn from sales, how is price impacting renewals)
Value signals - what value driver messages are registering with different segments, how much value is being delivered, is Value to Customer (V2C) larger than the Lifetime Value of a Customer (LTV), how is value delivered changing over time …
Customer signals - How are your customers businesses changing? Are they creating value in new ways? Do they face new competitive threats? What are their strategic goals and how does your solution support those goals?
External signals (market and competitor) - what major social, economic, regulatory or technology trends could impact your pricing (and how are you tracking these), what are your competitors doing, what alternatives are emerging
Part of your 2022 pricing plan should be to setup or update your data collection process and make it part of your regular pricing review. Depending on the cadence of your business and how fast trends appear, this cadence could be daily, weekly, monthly or quarterly.
