Pricing Done Right

Tim Smith: I was born in Texas, sixth generation Texan. Went to high school in Germany, went to college and decided I wanna be a physicist. So I studied quantum mechanics and thermodynamics applied to nanotechnology to try to optimally control molecular dynamics. Sounds like a normal thing to do. I got my PhD from the University of Chicago, enjoyed it, finished up, and then I asked myself the question, how often do people need a quantum mechanic? And I hit another issue. I’ve always been a salesperson. Well, let’s consider selling. So now I am a mathematician who’s selling, and I get into coding, and I get into pricing pretty quickly, and then I find my love.

Rohit Agarwal: All right. Can we learn more about that journey that you had from Chicago all the way up to this point a little more and maybe understand the key milestones that have shaped your career so far?

Tim Smith: One of the first major jobs I had upon graduating with a PhD was with SPL WorldGroup. We made utility billing and customer care solutions. So for about half the planet, we’re in charge of that company made the software that drove your electric, gas bills, whatever it is, water bills. After having that job for a while, 2000 came around 2001 was a bad time to be in tech across the globe. So I moved out and started my own company in 2002 and I focused on quantitative marketing. That did not resonate well. It became clear when I started saying I focus on pricing. And then my company started to do much better. I found pricing to be interesting because it seems to be an unhoused business problem. The question is, is it a finance problem? Is it a sales mark problem? Is it a marketing? Is it a product management problem? Uh, it was a area where the, there was a significant amount of economic research into it, marketing research into it, some accounting research that goes into it and none of these fields talk to each other. So you had these disparate pieces of knowledge. You have these highly technical areas that are not actually shared by the general public, not used, not considered. And I saw a rich, rich problem space in which I could insert my capabilities and mathematics and selling to enjoy and try to make some progress.

Rohit Agarwal: So did you stumbled upon it? Did you, like, did you read a book and then said, okay, this is kind of my calling? How did it come together? How did you know pricing is something that I wanna go and tackle for the rest of my life?

Tim Smith: Well, in 2003, I gave a talk to the Professional Pricing Society about four different methods. I’ve seen a price discrimination here in the software world. My talk was well received, but I remember hitting some questions. People said, well, is price discrimination legal? And I’m just like, I’m not a lawyer. What do you mean? And then I realized there’s like huge bodies of knowledge that just, by the way, price discrimination is legal. But yeah, there’s huge bodies of knowledge that were just simply untaken. So I started to dive deeper into it. At one point I had a gig in Prague, working for an Irishman selling electric meters for automatic meter reading in Dubai, made in the Czech Republic with Chinese parts, normal global business, right? And while I was there, the Pricing Society asked me to give another talk at another conference. This time would be their first inaugural European conference. I think it was in Amsterdam, but it could have been in Brussels. I’ve been to so many at this point. And I thought to myself, well, if you need a speaker, I am a teacher, I’m a professor, I can do some research and put together a slightly better workshop. So I did. And I put together a workshop. One quarter of it was about bundling. And that was when the whole pricing society said, we’ve never had anybody do math and bundling and demonstrate how the mathematics works out and why you would do certain things in certain situations. I was like, this is, this is a piece of cake. I can do this all day long. And I just kept doing more and more of those mathematically driven, coupled with the softer marketing type questions to help provide some greater clarity of when you would do which kind of price structure, when you would do what kind of price analysis, how you would set the price based upon the kind of market or the challenges you’re solving. It was just a different way of going after these problems that had not been addressed before within the Pricing Society. By the time I finished my European tour, I was all in on pricing. Landed my first major project in pricing within software with Symantec. And I just said, this is my career now.

Rohit Agarwal: Very cool. You have been doing like this, practicing this art for how many years?

Tim Smith: Pricing alone since 2008.

Rohit Agarwal: Well, so at least 15, 16 years now.

Tim Smith: Yeah.

Why pricing needs its own books — and its own discipline#

Rohit Agarwal: What a pro. All right. You have written multiple books. Not the easiest way to get across your thoughts, right? Reading a book in itself is a big ordeal. What led you to write those?

Tim Smith: So Pricing Strategy was the first major book that I, of merit, of merit. And in Pricing Strategy, the issue was I’ve been teaching pricing at DePaul University. And I’ve been teaching by having a collection of popular business books, and a bunch of Harvard Business Review articles, and then some Harvard Business cases. So by the time the gig was up, I had my students reading, let’s say, five to six Harvard papers a week, a couple of chapters in a popular book, and trying to do the case studies. It was a case study, always a case study oriented conversation when I’m teaching MBA level work. The case studies discussion was good. I thought this worked kind of okay, but the book I was using, it’s a very popular book but it’s not a good instruction book. It was missing all of the math. It was missing, it talked about hurdles, volume hurdles, et cetera, got it. But there’s a lot more to pricing than volume hurdles. There’s, you know, the question of what structure you’re having, when do I do promotion, when do I not do promotion, what are the cases of market structures and therefore related to pricing structures and business models. Totally missing from that article, from that book. And one of the things that I’m very clear about is that pricing is a quantitative field. If you can’t do the math, you kind of don’t belong here. We have a need when you’re going to set the price of a new product, you need to understand what the processes are, what their challenges are, meaning their biases and how they’re wrong. How do you address those biases? When do you use which method of research? I mean, I could always say, quant with analysis is the best and it is, but that does not mean that I should use it for every single product and offering I’m trying to price. It’s too expensive. It’s just not, and it would not work if I’m selling Boeing airplanes. Just it’s a stupid idea. So it’s like realizing what these questions are, the trade-offs that was missing in the literature. Plus having my students read five to six articles just to get an idea. I was asking too much of my students. And so I needed to have a more concise, quantitative, linear approach that would teach them the different methods of how to price, what price to benefits mapping does, perceptual mapping does, the different ways of discounting and rebate management in consumer markets and business markets. How do you analyze the price variance and determine if your price variance is bad or good, or how do you improve price variance, why would you want to do it? Moving on into the next section, which was price structures or business models, you might know it at that term. Am I doing a two-part tariff, a tying arrangement, a unit pricing, versioning, good, better, best versioning, price bundling, which is different from volume bundling, you need to know why, yield management, subscriptions, and I could write chapters now, pay what you want, index pricing. Lots of other things that can go out there. Dynamic pricing, like an Uber. I mean, there’s all these different methods of running your business model, which have had a huge impact on the performance of businesses. And then you go after that, okay, I’ve got a price model. The next thing was, how does the competition fit? How does the industry lifecycle fit? How does these other strategic issues impact the way I need to manage price for my company today? So you got a lot of stuff packed into this textbook, Pricing Strategy, and it has proven to be a good book. I know it’s used in India, I know it’s sold in China, I know it’s sold in the States. I mean, it’s a fine, solid textbook. I solved that problem. And the model I had when I was writing that textbook was the model from reading Hull’s book on option swaps, futures, and other financial derivatives. And I will mention that Hull was another physicist who then went off into finance and wrote the definitive textbook on how do you price an option? So I thought, hey, options, derivatives, you’re solved. Let’s go to the next subject, pricing of goods and services, actual goods and services. There’s this quantitative stuff, it’s not out there in the market. Can we put it in the market? Can we make it clearer? Can we help the business world move forward? In many ways, Pricing Strategy as a textbook has been a complete success. But I was also off by one basic core issue. You can’t expect existing profession executives to read a textbook. They just won’t. I’ve had some. I’ve had some. Don’t get me wrong. So I then said, let’s go to the next stage. And that’s where Pricing Done Right came out. Pricing Done Right squarely focuses on the CEO. And the CEO’s question of, well, I have this problem. Pricing causes arguments all the time in my company. We’re constantly discussing, and I feel like we’re never making progress. And I really don’t. I mean, I’m not going to go down into the depths of this. So what I need is a function to solve that problem for me. And what does that business organizational function look like, and what problems should that organizational function do? Give me the contours, the shape of it. So that’s where I wrote the Pricing Done Right. In page seven, notice I know the page number here, in page seven, I provide what a paradigm called the value-based pricing framework. And I break down the pricing challenges into five buckets. Price execution, the bucket of did I get the right price on the right invoice at the right time. Am I able to quote accurately? Am I able to if I’m doing rebates Am I able to tell my salesperson with a rebate what the net price will be for that customer? So that customer does not feel like they can argue for an even lower price Or am I just out there? Am I able to tell the salesperson that if you close this deal, this will be your commission, And if you close the deal a slightly higher price, that’ll be your commission, If you close it a lower price, you won’t get a commission Can I do it at the time of the sale? Because if I can’t do it at the time of the sale, that information is useless. It’s not informing the salesperson. Can I help that salesperson dynamically create other options, configure opportunities? How am I enabling my salesperson to handle customer engagement and negotiation at that point of sale? That’s one part. That’s kind of technology, but there’s a lot of thinking that has to go into it to make that technology even work, even AI. Okay, which is needs people. Next area up is the Price Variance management. What do I call it? I’ve had person recall it commercial policy. I’m fine with commercial policy. I’ve had lots of different things, but the point you’re asking here is, I had a price come up with somebody, you know, product group, and I have a customer. Do I vary that price based upon the fact that that’s a big customer versus a small customer? Do I vary the price based upon the time of day? Do I vary the price based upon the end of the month? How do I, what is the reasons as to what I’m going to systematically, right? Lower and raise the price. And outside of the systematically for that transactional pricing, how much space am I gonna give a salesperson to negotiate? And where can they negotiate the invoice price or can they negotiate the rebate or both? And how much can they negotiate? And when do I say to the salesperson, no. How do I escalate? So you get that. Whole nother box, price variance management slash commercial policy. Separate from the next question up about product strategy and pricing. Did I have the right price on this product? Is it a $10 price, $100 price, $1,000 price? You know, what is the price? And if it’s an Hermés bag, maybe it’s $100,000 bag. You know, I’m not sure if I’m saying this right, but the Birkin bag that made by… So how do I set the price of that product for its target market? And that’s a totally separate research problem than the price variance management problem. Moving up to the next level. And then it goes to business model or the Price Structure, which do I choose? Do I want to, and some authors just say, am I doing skim, neutral or penetration pricing? I’m like, yeah, that’s part of your pricing strategy, but it’s a lot more than that, okay? then Competitive Reaction matrix. I talk about it. If I’m selling a Kia, do I worry about the price of Volkswagen? Probably. Do I worry about the price of Audi? Probably not. You know, it’s not really, so who, which competitors do I need to pay attention to? Which competitors can I ignore? How do I want to respond to them? Do I want to be the first to go down or do I want to be the last to go down and constantly yelling at them, stopping? And that competitive reaction matrix played out strongly in the States with Beyond Beef versus Impossible Foods making plant-based protein burgers. That’s a fine name for it. Where Beyond Beef was publicly held and they needed to make profit. And Impossible Foods was backed by Google. They were okay losing money as long as they get any market share and nobody made any money in that market. So how do you manage that based upon the asymmetry? Important questions. Then the other part of your pricing strategy, somewhere this has to be a part of your strategy is Do you have a pricing team at all? You have to have, what kind of pricing capability am I going to invest in and where is it going to be? How am I going to structure pricing? How am I going to train people to do pricing? So that’s the pricing strategy part. Now all of this is working at the needs of the company. And the company is trying to win a customer in the face of competition and being led by some CEO. So how do I actually serve the CEO’s to help that vision become a reality, managing all the tools down to the end point of collecting money from that customer. That was the value-based pricing framework. The entire book talks about how CEOs are managing those questions. But when I laid out that, I’m now trying to tell the CEO, here’s the breadth of problems you need to address to help you move forward.

Rohit Agarwal: That’s a great explanation. Then let’s pick on a few of the points. You have mentioned a bunch of different frameworks that you have alluded to in your book. Let’s unravel maybe a few of those. I’m going to paraphrase you from some of the quotes that you have in the book. So one from Pricing Done Right. You said, a successful pricing strategy requires leadership. It’s not just a tactical activity, but a strategic imperative that needs to be championed at the highest levels of the organization. Can you contextualize why and how pricing is strategic to a company and the role leadership plays in this?

Tim Smith: One way I’ve heard strategy defined is a business strategy is a statement of where you will not go. It’s both a statement of where you want to go and a statement of where you will not play. Okay, and I can work with that, but saying no is part of the game. Now, if pricing is pushed down to the organization as an administrative role, and I do see this at many companies, even Fortune 500 or global 500 companies, when it’s a purely administrative role, you have no decision-making power. Your job is to enable the people above you to accomplish whatever they said they want to do. In which case, if a salesperson wants to drop the price, there’s nobody to stop them. That salesperson would just simply lower the price to close the deal. If revenue is the only metric that matters, the revenue will be the metric that gets, even if it’s profitless revenue or losing them. If product strategy says our job is to price here, well, okay, then that’s it. You’re just administrating. You’re not doing a decision and it’s just a number being given to you by somebody else. That number may not be well vetted, in other words. And so the company is likely leaving money on the table or pushing customers away that it would otherwise be able to serve profitably. So at some point, pricing needs to have a level of power to discuss as equals, or at least comrades, with their peers in product, marketing, finance, and sales. And they don’t get that unless the CEO promotes pricing to the level where they actually can hold that helpful, collegial conversation. Otherwise pricing is just a number that is printed around from side to side, like as a football or a cricket match, and just get batted around and nobody wins. It’s not a useful process. One of the things, articles I wrote is pricing is not a noun, it’s a verb. It’s a decision. And research has demonstrated that… Organizations that treat pricing decisions slowly and methodically, not quick, which is completely opposite to what a sales wants, but slowly and methodically outperform in the long term, have higher return on assets, are more profitable in the long term than those that just treat it as a political football. So there’s real academic research that demonstrates it requires leadership. There’s plenty of people in the field of pricing that have said, you know, without leadership, we just, well, we get kicked around. We’ll do it. It doesn’t mean that it’s a good answer.

Where pricing belongs in the org#

Rohit Agarwal: It certainly seems like it requires its own discipline, its own function, right? And the way you explained, it seems like it should be its own function, not necessarily maybe housed under a CFO or a CMO or a CSO, right? It should perhaps report directly into the CEO and work collaboratively with all the other functions. Is that kind of how you have seen an ideal pricing function to be laid out?

Tim Smith: In certain businesses, I would definitely say that is what they have done, and it is ideal. To say that every business at every stage needs to do this, well, that’s a bit more problematic for me. And the issue is you don’t want one issue. The number of pricing people per revenue is a factor of 10 to 100 fewer than the salespeople per revenue. Okay, so it’s just, it’s a elite function. It is not a normal, every small business needs to have a function, okay? I have seen pricing report to finance and that mostly works. The best part about reporting the finance is that finance understands mathematics and it’s important to driving decisions. It doesn’t completely work because pricing is completely dependent upon sales and marketing and product to get anything done right. Okay. I’ve seen pricing report to sales and that’s usually problematic because they push them down into just giving discounts whenever they want to. I’ve seen it report the product, which kind of works, but then you lost the connection with the sales and the actual point of sales. I’ve seen it report the strategy as well, like a strategy and pricing group. That kind of works. More commonly, I’ve seen directors of revenue management or where they started to change the name from marketing, chief marketing officer to chief marketing and pricing officer. So actually pointing out that is where it would work. I liked that approach, but I’m gonna have to state that at some companies, a large number of companies, marketing is really no more than the cups and pens company. Now they make cute looking cups and pens. And they do your marketing communications, but they’re completely incapable of strategic thinking. So there’s that issue of which department can handle strategic thinking and facilitate the cross-organizational capability that I find to be so critical in excellence of pricing.

Rohit Agarwal: Makes sense. When would you hire your first in-house pricing expert?

Tim Smith: I’ve seen it done at the level of $50 million company and they were happy with the results. Now that person focused on pricing, but their responsibility area often included business intelligence, often actually was pricing and marketing. That was their job, okay? I’ve seen that happen repeatedly, even down to a roughly $30 million company. And the results were… astoundingly strong.

Rohit Agarwal: I would imagine the right kind of hire would pay for herself in no time. You had mentioned earlier to me that pricing is very misunderstood across businesses. What do business leaders not get about pricing? And why is it so hard to get pricing right?

Tim Smith: One of the common refrains I hear from CEOs and CFOs is that price is just a result of market dynamics. We’ve got supply, you’ve got demand, they come to equilibrium, there’s nothing I can do about that. That’s just the result of market dynamics. To some degree, yeah, I mean, I teach economics, I understand what they’re saying. I don’t think they’re totally off base. Another degree, they’ve missed the entire point of making decisions. So there was an article in the Wall Street Journal the other day about Chipotle. Their target customer base is just barely richer than the target customer base of McDonald’s. So during this period of inflation, they were able to raise prices six times in the past couple of years without having any loss of actual customers. Now that’s a decision to raise prices, first of all. So I mean, somebody is making a decision. And it’s also reflects the idea that it’s not purely supply and demand. I have issues about what market segment I’m doing, how that market segment responds to different situations, and the ways that I can take advantage of that market segmentation variation.

Common pricing mistakes companies make#

Rohit Agarwal: Interesting. Can you highlight some of the common mistakes companies make around pricing?

Tim Smith: One common mistake, and there’s reasons why you would do this, but a lot of cases it’s done too far. They say there’s zero discounting by the sales team and the reason is they don’t want to have those prices go all over the place. I get it. But there’s ways in which you can allow for salespeople to negotiate within a range and align incentives to encourage them to negotiate at the top end of that range rather than anywhere in that range. So profit-based incentives done in a right way, okay? We call it a deal quality score. We took a customer company down, this was about a $30 million company, and they were doing zero discounting. Everything was all the decisions were being made by the central sales officer on the pricing. This was good, she was a very strong person, good thinker, nothing wrong with her thinking. The problem is, centralized forces can’t know 100 different customers, can’t understand 100 different situations, can’t understand what it takes for these things. You need that localized special. This is why we pay salespeople. We pay them to collect customer specific information. And theoretically, price discrimination improves profits. This is a simple mathematical truth. OK, so the question is, how do you do price discrimination right? Now there’s some ways you can try to systematically do it, but there is an area where I just don’t know the situation as well as this person on the field. So I’ll tell you what, I’ll let you play within a range, but if you get to the bottom of the range, you’ll get no money. If you hit the top of the range, you’ll get a lot of money. I’ll only make you make more money as long as you start to help push the, so they were able to lift the list prices, change the incentives at the same time, never lowering the bottom price and the salespeople suddenly started to capture slightly higher price. I mean that was a powerful, powerful little play right there. I forgot the question though.

Rohit Agarwal: No the question was basically the common mistakes that the companies make around pricing.

Tim Smith: So that was one where they didn’t let salespeople do any discounting. The more common mistake is they let the salespeople do anything they want to. And they tell the salespeople, the only thing that we’re after is market share. That’s a horrible, horrible business model. Profitless, absolutely profitless. Now, if you’re being funded by Google, okay, I get it. You’re using shareholders’ money to buy customers. As long as you can buy them cheap enough, they’ll share, I’ll just give you more money. But for an ongoing business, that doesn’t work at all. Business model changes, I think are far more complicated than people think. There’s out there. The other thing they do is they rely upon pricing to fix a marketing communications problem or a market targeting problem. It’s like, no, we will help you capture the right price in different situations. We will help you improve your predictability and price capture, but I can’t fix a bad product. You know, I just can’t. If you landed a customer that shouldn’t have been purchasing, don’t expect them to stick around. You will not retain them. These kinds of problems, yeah.

Rohit Agarwal: Makes sense. You’ve talked about pricing right. Can you share some frameworks that you have that can help companies to get their pricing right?

Tim Smith: So we already talked about the value-based pricing framework, and it’s five buckets. I’ve seen organizations literally align their companies so that we have a team working on nothing but price setting, another team focused on nothing but commercial policy and price getting, and that price getting to handle the execution and the commercial policy, the price setting team, the market setting, and maybe up to the business model decisions, price structure. So I’ve seen them actually use that directly to define their pricing team. I’ve seen people have economist on hand at certain large companies, which is critical when you’re dealing with global companies, economic uncertainty is a reality. And so how do you actually manage that economic uncertainty? So it’s not a business risk. It’s a, it’s a manageable business challenge to work with. When we had the great, when we had the COVID pandemic, we had a high rate of inflation of inputs, cost, cost inflation in the business markets. And I’ve talked to a large number of salespeople and executives that were afraid to raise prices during this. Well, they did not have a choice. Like glyphosate, which is used to kill weeds along with, you know, genetically modified corn that price went up from, I don’t remember, 0.5 to 3.5 per unit. What’s the currency? Again, I don’t remember. But it’s just a factor of seven increase in price. There’s nothing you can do. You’ve got to raise the price. This was a low margin item. We had people trying to absorb that, and that’s a good way to go bankrupt. I mean, it’s like I look at these things and people are saying, oh, well, we can’t raise prices. It’s like, then you’re going to have to fire people because those are your two options. If you can’t make more money, you’re going to have to fire people. And, uh, okay. Have fun. That lack of honesty that I see or that lack of directness. I think that’s part of the reason why pricing is not always ready to be a C level role because they can’t be that direct. Here’s your options. One of them is you fire 20% of your team. The other one is you raise your prices and you know, you might lose 10% of your customers. It’s okay.

The SpinoMeter — judging pricing capability#

Rohit Agarwal: Makes sense. You have a pretty unique, we call it framework, a meter, called SpinoMeter that you are using to evaluate public companies. Can you talk about that? What exactly is your SpinoMeter and how you’re analyzing these companies from a pricing standpoint?

Tim Smith: Well, one of my colleagues, man that I respect greatly, his name is Holden, wrote a book about negotiating with backbone. I thought that was great book. I thought it was just awesome. However, given the name of his book and my respect for him, I could not name it Pricing with Backbone because that would be improper, let’s just say. And I really respected the guy. But I like the analogy of talking about the spine. So therefore we had the pricing spinometer and you can call it Spino meter or spinometer. It’s up to you. I don’t care. Um, the issue was is that I’ve now written the two books I’ve talked about plus two other books. Um, one’s really quantitative. The other one’s more theoretical, but, and I was clear that my pricing done right, though well received, did not reach the CEO’s table. It reached below the CEO’s table. I was not reaching the audience I needed to address in pricing. And I also look back on my career. It’s been 20 years running my own business. And I can count on one hand, the number of times I’ve served a Fortune 500 company. So I realized that I don’t have their ear. I just don’t. Other, the illustrious big three consulting firms in strategy do, or the big five, four, accounting strategy consulting firms too, but I do not. And I’ve had directly said by my friends who work at those larger companies that, yeah, when they bring you up, we say, why would you hire him? He’s too small, he doesn’t have enough team. We have the best people on staff. So, you know, openly degrade me in front of those CEOs. No problem, it’s competition. I accept this, okay? So I wanted to write something that would get their attention. And I am a professor. I have graded people all my life. The idea was is I’m just going to grade you, CEO, based upon how well I see you managing your pricing capability. Five out of five, well, that means I’m sure that there’s things that you could do to improve, but I did not identify them from an external viewpoint. One out of five. I am so sorry you misunderstood how pricing works. Would you please learn something? And things get in between. Two out of five would imply two vertebrae out of five vertebrae. And the pricing spinometer would imply that the CEO understands the importance of pricing but lacks the capability organizationally to get it done. Three out of five vertebrae in the pricing spinometer says they’re beginning on that journey of building the capability. And that journey of Paul Hunt, we’ll talk about it, it’s a seven year journey. It’s not a short one. It’s an organizational capability that requires completely changing the way you’re thinking. That’s a, organizations don’t flip, right? Four out of five, almost everything’s there, but something’s not quite right. I’m just, I could see some enough holes that said, you know, there’s opportunity, take another look. And the goal in writing it, was originally about getting their attention and saying, hey, you should pay attention to pricing, but now the goal has transformed completely into, can I identify opportunities for improvement? Let’s document them. Can I explain to you about the things pricing should be doing at your company? Let’s document that. It has proven to be a wonderfully successful series. I have irritated a few. I accept this. Again, they never hired me, so what do I care? And they didn’t care about me before, why would I care now that they are upset? Anyway, moving on. Mostly though, even people with a two vertebrae out of five, right, that’s not good. Read it and says, thank you, we agree, we’re trying to create the momentum for the improvement, you helped us see the roadmap. It was like, that’s a win, that’s a win, okay? And the series has been wonderfully successful, my audience keeps going, people referring to it now. It works. Great people.

Rohit Agarwal: Can you help us understand it a little more in terms of what exactly are you analyzing and what are you trying to look for when you’re doing the analysis?

Tim Smith: So I already talked about the value-based pricing framework. So first question I have is, do you have the capability to address all those buckets? And frankly, India, Europe, China, Australia, the United States, Mexico, completely different economic environments. So if I’m dealing with a commercial sale of say agro-chemicals or…I don’t know, backup power. I need to have a different commercial policy in all of these areas. So do I have the pure sheer number of people to help guide the pricing decision in Colombia differently than the pricing decision in Indonesia as a global company? Now, some prices or products are global with one price. I see that with Autodesk and I think that’s true with Adobe. But… Those are not expensive products and that’s software. When I’m moving into something else, we have a completely different problem, okay? So I’m looking for the people. I’m looking for the global footprint. I’m looking for the economic impact of different things. For instance, there was a pasta maker in Italy that makes pastas globally famous. They were shipping pasta to Dubai, which is perfectly normal, right? until suddenly we had some bombing taking place in the Red Sea off the coast of Yemen. And now you can’t get pasta there. Are you capable of reacting to the needed price increase in Dubai? Do you have that skill set? Do you have that? Do you have the vertebrae that says, okay, we’re going to take up our price? Not because we’re trying to price gouge you, but because we, it’s kind of cost more to get you your pasta. And it’s just, I’m sorry. I kind of raised my price on Pasta, it sounds so menial, but somebody has to make that decision and someone has to make it in a timely manner, not after everybody goes gray, but to enable that salesperson to tell that customer in advance of closing the deal, we got to raise the price of your pasta. There’s just no other way. Yeah, that was a weird little story. So I first read over the financial reports and I’ll try to get an idea of what a 1% improvement in price will do for the net profitability. Will it increase my operating profits by 3% or 13% or 45%? And I have seen 45%. All right, so how does the, yeah, yeah. How does the 1% rule impact the profitability of this company? 1% windfall of raising prices by 1%, bottom line, what’s that impact operating? Is it a big or small impact? I also want to clarify that part of my audience are investors, so therefore I want to report what happened in their P&L of this quarter or this year compared to the same last year. How did the stock market response and what’s the price to earnings ratio? Simple little facts that you just look up, but they provide context for reading about the business. So now we have context, we understand the financial performance and we understand the industry it works in. Recently I did auto, advanced auto and they sell car parts, all right, got it. Next, I want to see what the CEO says is their problem. The CEO, he or she will have prepared remarks to their investors earnings call. We can read these things as publicly available. So I will read them and I will hear what the CEO and CFO or whoever else is on that earnings call says, here’s the problems because they’re laying out their vision to shareholders about why they should give their money. Here’s the problem we’re seeing in our market. Here’s the approach we’re going to take to solve them. They will not always but often will talk about pricing and whether or not prices went up or down. Okay. Good enough. Now I understand from the CEO, from the leadership’s perspective their problems, how they perceive it, and their needed route to move forward. I’ve been working in pricing and marketing and buying and money for over 20 years. Not a fool, okay? I put together what they’re saying with my own experience, the pricing frameworks, and all the questions to see pricing solved, and says, what is the gap analysis between what the CEO says they need to do and what they have a capability of doing? So now I state, this is what you said you do, this is the capability it would take to do it. Then I go online to my favorite tool called LinkedIn, and I look to say, do you have people doing this? Just do you have them? And I can’t just simply count people who say pricing’s the skill. I mean, pricing’s the skill of every administrative assistant there is on the planet. No, I need to actually read what their core responsibilities are, and they list that on LinkedIn. So I now understand what kind of team they have to execute against the goals that the CEO themselves stated and the shareholders care about. What’s the connection?

Value-based pricing in practice#

Rohit Agarwal: Makes sense. You are a proponent of value-based pricing. To quote you, the key to successful pricing is understanding how customers perceive value. It’s not just about the cost of production or the margin, it’s about how much customers believe your product is worth to them. So value-based pricing leads to higher margins, right, based on that corollary because you are arguably going to price or based on your cost or not based on a certain margin, arguably you are going to get higher margin, right? Is it a fair statement or no?

Tim Smith: Not exactly. So yes, I firmly believe there are three questions every pricing person needs to ask in every question. For the customer, what’s my alternative? The competitive price, et cetera, because that sets the field, all right? What’s the customer’s alternative in this situation? Am I better or worse? And does the customer care about that difference? If I’m better, I can charge a higher price. If I’m worse, I need to charge a lower price. But if I’m worse and the customer didn’t care about the difference, I get to charge the same price. If I’m better and the customer did care, I get to charge a higher price. If they didn’t care, there’s nothing, I mean, that extra, they didn’t care. That’s not a problem they’re solving. So the reason why I was hesitating and agreeing that drives higher margin. One of the famous case studies of value-based pricing is Southwest Airlines here in the States. Southwest Airlines, and I think what’s in the book too, Southwest Airlines is an airline company, and it competes head to head with Delta, United, and America. I think in the United States, they have within the domestic market, I think they may be number one for flights, but they’re definitely in the top four, okay? They’re… We can always worry about what month it is. Exactly. So let’s not do that. So they came in when they started in the 1970s with a triangle flying from Dallas to San Antonio to Houston and back to Dallas. It’s just this little triangle. All in one state so they didn’t have to pay attention to national laws. Texas is its own place. So they didn’t have to worry about the federal laws. They worked with the state laws. which allowed them to get away with a few things. And their idea was I want to keep it simple. So their price was roughly $20 to go anywhere you wanted to. And all you had to do is show up with the $20 bill and get on the plane. And this is before we had security and all these wonderful aspects of modern travel. Anyway, you just go to the gate and give them 20 bucks and get on the bus with wings. Now, once you own the bus with wings Southwest Airlines, there was no, um, there was no first class or second class. There was no assigned seating. There was no fancy meal. It was nothing really. Basically there, they were famous for peanuts and Dr. Pepper, Dr. Pepper’s the beverage known in Texas. And if you’re from there, you kind of have it. Yeah, that was it. Now this for an American Airlines or Delta or brand. Brandiff existed at the time. This was ridiculous. There’s no service. This is really inferior product. There’s no sign seedings. You didn’t even have me register before I got on the plane. I just gave you 10 bucks and got on, 20 bucks and got on the plane, whatever the number was. How does this work? But for the Texan flying a 45 minute flight, they don’t need that stuff. They just have to wait. They want to wake up in Dallas, get to work in Houston, have their days worth of meetings, get back home at night. And their alternative was driving. It wasn’t flying. So a different target metrics, different idea about how the pricing. So they did wonderfully. Southwest did with this business model. And people say, well, there’s no frills. It’s sort of like Oh man, I forgot Ryanair. And it’s not like Ryanair. Ryanair really takes everything out of flying and charges you for your luggage. Southwest ever did that difference of do I, you know, do I take out the food? Do I take out the seats? All of those things, the customer didn’t care about. So they were able to charge a decent price. They weren’t able, it didn’t have to be lower. They could, it was lower initially, but then it went up to basically the market price, just a different service. In other cases though, to your point, the value-based pricing can raise the price up, and I see that too. Another example, I looked at AutoCAD. I forgot the name of the actual company, but the AutoCAD pricing, and I strongly believe it’s underpriced in many situations, but I was hearing that certain people were upset because the price is too high, and I’m like, Right. I kind of understand the issue if you’re not using AutoCAD often. It’s a pretty high license price They could value-based pricing could say well, let’s go to a consumption model rather than a seat model, so that if you’re doing one AutoCAD project you pay this low price If you’re doing a hundred of them you pay a much higher price That’s what value-based pricing would lead you to do is a consumption model based pricing now. That is not what AutoCAD has done whether they should do it or not depends on what their strategy is and doesn’t appear aligned to their strategy to maximize profits instead it’s to maximize usage and dominate the world. That’s fine but you know these are different things that value-based pricing will lead to. As far as the margins concerned remember that’s just a made-up number anyway. I mean, who’s to tell me what the right margin is? It’s whatever you can get.

Rohit Agarwal: Where I was going with that question was, if value-based pricing gets you any kind of alpha margin, then in a free market, competition will flock to those areas with higher margin and try to normalize it, whatever is that normal, which is basically all participants in a market are agreeing to get to a certain margin. Maybe it’s 20%, maybe it’s 30%, maybe it’s 50%, maybe it’s 8%, who knows? But that is kind of everyone, through their business practices, are agreeing to do business at, right? And so that was kind of the thought process that, hey, isn’t value-based pricing going to really drive that kind of competitive behavior, which ultimately is gonna bring down the prices? So then why might not go with a cost plus margin structure to start?

Tim Smith: I like your question, I do. But I don’t agree with the assumptions that go into it a lot. And that’s my problem. Take a look at laundry detergent. Both Unilever and Procter & Gamble produce a perfectly fine laundry detergent. Right? I forgot the names of these products. But the Unilever brand is more valued in Europe than the Procter & Gamble brand is and vice versa. And both of these brands, are extremely expensive compared to cheaper laundry detergent you can use to clean your clothes. There’s plenty of cheaper clothes. So what we have here is two global competitors with a totally different price point for the Premier Brand than they do for their cheaper brand and then even people below there competing at a different price. You might say well that’s consumer markets, yes it’s emotion. Okay let’s switch it into business… Across the globe, there’s only one dominant provider of sputter machines for making silicon and doping silicon. That would be analog devices. Other people could compete, but the amount of intellectual property that went into that thing prevents other people to compete. Now, if you’re analog devices, how much do you raise your price? Well, you can raise your price up to the value of putting through more wafers, big wafers, better line width. Similar for AMSL based in Netherlands, they’re one of the best at making a low line with lithography, like two and three nanometers. Incredible, incredible thin lines. They become unique. And even like Drive Chains, Eaton Corporation, it has a sort of monopoly over the drive trains in the States and they compete with ZF in Germany, but you know, so you have these different areas where you are actually different and you’re not in direct competition with anybody. And that changes what you can do in terms of pricing. You have other areas where you are not alone and other people can compete and you’re saying, well, why would these places exist? Come on, competition would take away all these things. That’s the point of innovation is that you’re constantly trying to innovate moving that barrier forward creates an insurmountable hurdle to enter into certain industries. Other places like fried chicken, yeah come on anybody can make fried chicken and so you’ll have plenty of people starting up making fried chicken and there’s not a lot of profits in that. There’s not a lot of profits in dry cleaning but it’s a useful job I mean you can raise your family on it there’s nothing wrong with that but there’s no money in it that’s a commodity and the world of pricing focuses on the area between the commodity and the one-off, and that enables a lot of opportunity spaces. A finance background people do generally think in terms of commodities and auctions. And I’d say about 80% of commerce happens in monopolistic competition. That’s the cool economics word, where you got enough differentiation and you can keep working on that differentiation that enables you to actually price differential between you and the next person.

Rohit Agarwal: So that was going to be my next question. Can price be a differentiator in itself? Can I say, hey same product, I’m going to charge $10 versus this $6 product.

Tim Smith: Yes, yes it can. Generally, you think about this in terms of price competition. So I went back to glyphosate. That is a complete commodity. I can get that from anybody. So whoever has it cheapest would be the right company to buy it from. Got it. I can go up the scale in agro-chemical. There’s plenty of things. Vitamin B12. India has a large market of making vitamin B12, which is useful, I think, for raising chickens or pigs. Anyway, some… farm animal and you make a lot of it. Yeah, yeah, there’s that on the low end where you can use it just to undercut your competitors. That story is why the US forestry is usually considered not as competitive as the Canadian forestry because Canada has more subsidizes their lumber mills is the claim. And so that’s why Beloit, Wisconsin’s lumber mill had to close down. is the claim. I don’t know. I wasn’t that close to it. But it gives you that idea. But you have the opposite thing happening too. There was this bottle of water called 90H2O, Beverly Hills 90H2O. And they called it the champagne of water. That caused them problems. But they were selling a liter of water for $20. I mean, that’s just ridiculous. So you actually use the price there to say we’re elite. And then you just jacked it up. It would be hard to describe the price paid for a Louis Vuitton without talking about using pricing as a point of differentiation and exclusivity in and of itself. That does occur, especially in consumer markets. It occurs much less often in business markets. In business markets, it’s more the price structure that’s going to change things than the actual price point. For instance, can I turn my product sale into a subscription sale? And we cannot do that profitably. Not all subscription models are profitable, and a lot of them go under. We had in the States this revolution of meal box kits. Everyone wanted to sell meal box kits. How many of them survived? You know, it didn’t work. Just because you put it in a box doesn’t mean that that’s a great deal for me.

Pricing structures, discounts, and complexity#

Rohit Agarwal: So on the pricing structures, so I would think by disclosing your prices openly and fairly, customers tend to feel trusted, right? But then we see a lot of custom pricing, especially in software, there’s a lot of custom pricing, which naturally to me, flags that I might be paying much more than someone else for the same product, same capabilities, right? I mean, do you think about pricing structures and especially kind of custom pricing, how to really conceptualize that in that on one hand, openly putting it out on your website and kind of really building that trust versus having this purely custom pricing on the other hand?

Tim Smith: So when I’m working with software, B2B software pricing, you’d need to put a public number out there and it’s a list price. And I suppose if you bought one item in your small business, you might actually pay that list price, okay? It’s reasonable. But as you start to move up and you’re buying 30 or 100, that price per unit drops dramatically and that’s normal. I, as a business, still need to put out a public price. My competitors will watch my public price. My competitors don’t need to know my private price. Now why would I want to have all these private prices? Because wouldn’t that cause distrust? So much okay. This is where price structures and that commercial policy comes in. Perhaps, I have a Automatic volume based discount and this is very common and that volume based discount is based upon a logarithmic size area and it breaks down now what I want to do is tell my salespeople this up front I want that price that they’re being told up front to be useful when they’re given a quote, a budgetary quote and I might give them also some reasons to, you know, areas to negotiate down from that budgetary number. Okay? That would be common to do. What’s happening there is price discrimination improves profitability. Plain and simple. With price discrimination, I can serve more customers with the same offer than I could if I have no price discrimination. So I want price discrimination in the market because that makes me more profitable, it allows me to serve more customers, it gets that software out to more uses, which is great, but I need to make money. So that’s where the price discrimination comes in. That creates a lot of complexity, which leads to the need for the pricing person to provide paths of managing that complexity, and hopefully all the way down to execution. So we’re back into the salesperson giving a quote, saying, aha, it’s this customer in that situation on this Friday here’s the quote, budgetary price, and that’s my range to play at. So it has all the specificity. Make it easy for the salesperson to communicate and understand, that doesn’t mean that they have to know all of the mathematics behind it.

Rohit Agarwal: On that point, how do you think about discounts? I’ve always thought of it as a tool to close deals, not necessarily sell. Do you have a particular framework around discounts, when to best utilize it?

Tim Smith: Well, recall there’s many kinds of discounts. We have the systematic discounts like seasonal discounts. You may have an early buying season. You may have the end of season discount. Discounts also exist to get rid of inventory. So if your inventory is wasting away, I’d rather give it away at a lower price than just have to throw it away. So there’s that. Those are systematic reasons why I would do a discount or a rebate, either way. Okay, I’m flexible culturally as to which one we do. There’s that part. And then there’s the part of, I’ve gotten it in the right ballpark, I need to close, they’re asking for 2% off. What is the risk that I have of losing the sale if I don’t give them another 2%? And if that risk-adjusted value says close the deal take the 2% hit, close it. And if it says don’t, well, that means somebody tells me what the risk-adjusted value is. And I’m able to make a decision. There’s… It plays many roles, discounts and rebates. Fundamentally though, they play the role of price discrimination between the list price of the offering and customer specific buying behaviors.

Rohit Agarwal: Got it. Back on the pricing structure side, my second question. When I look at payment companies, it’s beyond crazy how complex those pricing structures are. It’s almost as if they’re profiting from the complexity in the pricing. I’m sure a customer would love the simplicity of pricing there. Why are these companies so resistant to changing these?

Tim Smith: So academic researchers looked at this particularly. And they have found that for incumbent companies like telecoms and payment companies, the complexity actually improves their retention. The issue there is the customer, you and I, are afraid of what we’re giving up when somebody comes and says, I’ll give you all of that for just one set fee. No, it’s all in there, but it’s just one set fee. People like us are like, well, what did I give up? Am I still getting my free international calling because I got to call my friends in Italy? You know, am I giving up my ability to roam because I got to go down to Bogota next week? You know, what am I giving up? And that fear prevents people from switching from an upstart who says, I have a simple payment plan. Here it is. Because they say, well, I might be losing something. So they’re willing to stick with that. There’s been research and documented. If you’re an incumbent, you want a complex bill. If you’re the invader, you want a simple bill. And repeatedly, this invader doesn’t succeed very well.

Rohit Agarwal: Interesting. Seems like there are just so many different ways to price today. Can you discuss the most pertinent type of pricing traveling in the market? And perhaps ones that are emerging fast.

Tim Smith: In my viewpoint, all pricing methods come down to roughly eight. Okay. And there’s just variations on those eight. Now, if you know what the eight fundamentals are, then when you see the variation, it doesn’t catch you off guard. Most people don’t study the first fundamental eight. This is where pricing as a discipline really does make a difference when you do treat it as its own discipline. They’re being played with. The SaaS model is asking a question. Do I keep it simple? But then I push certain customers out of the way and I leave money on the table for others. Do I use credit systems? Do I use pay for use? Well, pay for use makes it too expensive for certain customers. I can’t really actually get all that price. There’s a lot of things that people are debating in the area on the price structures. But to repeat, the basic structures are two-part tariff and tying arrangements, unit pricing, which can go into add-on pricing, think about the grocery store, two-part tariff, think about your electric bill, tying arrangement, think about a, well, neither one of a shave, but you get the idea, razor and blade, ink and paper. Versioning, good, better, best versioning, that’s pretty self-explanatory, but now I’ve just reduced my dimensions from anything you want, like a grocery store, to a single dimension, market segmentation. Price segmentation. Price segmentation as defined by economist is I’m taking two desperate market segments and putting them into a new segment. In order as I’m taking segments, I’m not taking products. You see the products, but really I’m taking two segments and putting them together. Revenue management, better known as yield management because revenue management can mean anything. In the yield management, that’s a specific term and that’s used by your airlines, your shipping companies, your hotels to vary the price from one day to the other and it’s made progress into the bus, human bus industry as well, revenue management, trains, use it. We got the subscription based pricing which we’ve mentioned. Then we have the fully dynamic pricing where we’re trying to match market demand and market supply like an Uber or a Lyft or something like that which has had some serious challenges with it. Ask yourself how profitable is Uber and Lyft. Ask yourself questions like, if I raise the price, can I actually increase supply in a timely manner needed for the market to get it? How does that manage my long-term relationship and brand? But it’s a method. Another method that’s been studied is Pay What You Want, which sounds crazy, but in certain… industries letting customers pay whatever they want actually made more money. Another method is indexing. Index pricing I think it’s you know it didn’t make it in my textbook I wish it had. Example you and I are contracting for a 10-year contract where I’m going to provide services to your entire city for 10 years. Now you don’t want to replace me every year because that means I’ve got to fire everybody and you somebody else has to hire them and it’s just expensive. It’s cheaper to go with one guy for 10 years. Now, how do I price my services for a 10-year contract? Price of gas can change, price of labor can change, price of tools can change. Now, I need indexing. You’re seeing indexing used a lot in chemicals industry or anything related to chemicals like batteries, carpets. That’s what a carpet is, it’s just a chemistry. You’re seeing it in service industries as well. So those are your basic tools. And then it’s a question of mix and match. And how do I make that mix and match align with the value I’m delivering in a palatable way that the customer’s willing to accept and will pay.

Rohit Agarwal: Interesting. How do pricing strategies vary across global markets? Is it something that, hey, these kind of things work well in the US versus some things work well in Europe versus Asia? Have you seen kind of certain different ways of pricing across different markets?

Tim Smith: Well, that’s the beauty of treating pricing as a discipline. You realize the laws of physics don’t change just because I’m on the moon, right? Still have laws of physics. Entropy always increases, plain and simple. The laws of economics don’t change just because I walked across the border. If I do rent control, I’m pretty much guaranteed to reduce the quantity and quality of rental housing in that area. It’s been proven regardless of I’m talking Germany or… China or New York City. It’s just, this is the facts, okay? So by treating it as a discipline, you’re able to come up with repeatable scientific tools that allows you to actually manage prices wherever you are and say this is the predictable areas. Companies like Medtronic, Parker, Parker makes hydraulics, Medtronic makes machines for human healthcare, health tech, medtech you’d call it. Their markets are global. I’m not sure about medtronic zone go there but I’m selling things to China to the states to Mexico to Germany to India if I’m medtronic they all need my products because I’m saving lives I’ll even I’m not sure about my tronic. Here’s the part. I’m hedging on. I may even do business with my rival in a war during time of war because my job is to save a life. I’m not selling Coca-Cola, I’m selling life-stating stuff. So there’s that, and I gotta manage my prices in Germany, just as I do in India, on this big expensive capital equipment, knowing the cost of the surgeon’s time in India is different from the cost of the surgeon’s time in Germany or the states. So now I have a reason to actually change the price, depending upon the region. But that’s the deal with the value being delivered in India is lower because I’m not saving, the value of the ton I’m saving is lower than it is in the States where our doctors get paid a million dollars a year, kind of a thing, or sometimes 10. But you get the idea. So we have a variation that would actually drive the way the price is being managed with this big piece of capital equipment. You get it? Other things, the variation doesn’t exist. If I’m doing oil well drilling, I didn’t matter if I’m… deep sea oil, well, it doesn’t matter if I’m doing it in Australia, Indonesia, Malaysia, or Mexico, my price is going to be the same. It’s a fungible product that can go across areas and this is the global price. So I have these basic principles that, yeah, they are applied differently in India than in Kenya. They will be applied differently, but the principles are still the principles. They’re fundamental truths.

AI and the future of pricing#

Rohit Agarwal: Very cool. Let’s talk about the future of pricing. What are the biggest challenges facing pricing today and how can organizations prepare to tackle them?

Tim Smith: Pricing is emerging from being considered just an administrative function into being considered a strategic function. I’m seeing it. I’m seeing people being raised to VP of pricing roles instead of just simply manager or analyst. I am seeing individuals who have left pricing and became CEOs of Fortune 500 companies. Right, you’re starting to realize that this field is being taken seriously. And that’s one beautiful thing, but it’s a long transition. You still have a lot of need for training, which is why I work with the PPS, Professional Pricing Society, in the design of the Certified Pricing Professional designation, a set of courses, to try to teach people how to do this job. I’ve seen companies send entire, their entire company to take these courses, because they needed to learn how to do that job. There’s that, just the pure professionalization of the field and the recognition that it’s not an administrative role, it’s a role with an actual impact. Iron Mountain, if you had invested in Iron Mountain when they started the journey, you would have done extremely well with that investment. It was just money to be taken.

Rohit Agarwal: No worries, let’s move on. Why don’t we talk about the impact of technology on pricing? AI seems to be everywhere. One could argue that pricing can use a lot of data analysis, right? And especially you are a math person, so you would hopefully appreciate that a lot. How do you think technology is gonna impact pricing?

Tim Smith: First of all, pricing has been and is using artificial intelligence to drive better pricing decisions. So whenever I do a transactional pricing analysis, I’m basically using machine learning and AI to tease out the drivers to price variance between different customers and customer situations. And I want to think about the market segment, the buying situation, the size of the customer, what the product is. All these things, that is the application of what you now call machine learning and artificial intelligence to a set of data. You may call it a multivariate regression analysis. You may call it cluster analysis. But these are techniques that go directly. We’ve been doing this for over 20 years. There are a few large software firms that have really taken on the aspect of doing this. I won’t mention their names right now but they have done okay. The investment cost is high and they usually do not actually lead to a reduction in head count. And still what they lead to is enabling the head count to do a better job. So more accurate pricing, pick up a few percentage points in revenue here and there. It’s pretty well proven path. One of the challenges with these software vendors is that if you’re less than 500 million in revenue, it’s going to be hard to cost justify any other software. That’s in the B2B side. On the consumer side, there’s a group of vendors that are trying to create software to scrape screens and tell you the price of your competitors. That’s fine. That’s input. That tells me the cost of the alternative. It doesn’t tell me if I’m better or worse. Maybe I just copy them, or maybe I’ll copy them plus 10% plus 2%. All of these rules I can make up. I’ve seen them. And there’s tools for automating that screen scraping. Tools for automating the input of that into your stuff, into your pricing. In India, there’s a large number of people who spend all of their time teasing out prices between different competitors and trying to estimate cross-product elasticity. What if I’m 299 and they’re 298? How much volume do I lose? Kind of a question. It’s good work. It’s analytical work. It’s wouldn’t be what I call strategic work, it’s just necessary work for price optimization.

Rohit Agarwal: Makes sense. Where do you think the future of pricing is heading?

Tim Smith: I do see pricing increasingly becoming a VP level role, definitely that. I hope my contribution will lead to pricing being treated as a discipline rather than simply an input factor or some number that somebody woke up one day and said that’s the number we’re going to charge and I do see that happen a lot. I’m hoping that will occur. I don’t know if it will happen in my lifetime.