Pricing and digitalization: Why digitalization is a boardroom topic

December 06, 2017

Pricing and digitalization: Why digitalization is a boardroom topic

Pricing is a boardroom topic – those who take it seriously earn more. Our experience and analyses of thousands of companies repeatedly show that companies whose top management have pricing on their agenda achieve an approximately 25 percent higher EBITDA margin. And in times of digital revolution, monetization has never been a more relevant topic.

The math is simple: Pricing is the biggest profit lever, quick to implement, and requires no major investment. If you sell a product for 110 instead of 100 euros, the ten euros extra revenue land straight in your pocket. That’s why the ability to charge higher prices, known as pricing power, is key to a company’s success. Or, in the words of investment legend Warren Buffett: “The single most important decision in evaluating a business is pricing power.”

But on the other hand, pricing can also be a dangerous instrument – use it incorrectly and it can quickly destroy profits in the long term. An example in Germany is a campaign ran by a renowned DIY store, Praktiker. In 2007 the company started their “20 percent off everything (except pet food)” promotion and followed this flat discount strategy relentlessly – until it went bankrupt in 2013.

This shows how good pricing is more than just an attractive campaign. That doesn’t mean top management should interfere with the price management department’s daily business, but rather apply foresight and entrepreneurial expertise and lead in four areas: 1) Setting clear strategic targets in terms of growth vs. profitability, positioning, and the business model. 2) Rolling out basic monetization strategies. 3) Establishing a pricing organization. 4) Creating a profit-oriented corporate culture.

Commerzbank is a prime example of how difficult this can be. Their strategic target “new customer growth in the private and corporate customer business” announced at the end of 2015 has already resulted in over 500,000 new customers and is celebrated as a major success. Although the private and corporate customer division’s EBITDA more than halved in the second quarter of 2017 compared to the previous year, and winning these new customers cost more than 150 million euros, this was described as an “investment in the future”. Yet how this investment is supposed to generate revenues remains unclear.

Price strategies: A mindset shift
A good example of a persistently and consistently executed price strategy is that followed for several years by former Porsche CEO, Wendelin Wiedeking. Under his leadership, sticking with high prices for new cars was a strict directive to strengthen the brand and stabilize used car prices. When demand dropped, production was cut back – dealer forecourts were therefore not filled with cars, and sales were not stimulated by the typical price measures used elsewhere.

Another example is Geberit, world market leader for sanitary installations. They recognized how important it is to anchor the price strategy in the company. Instead of delegating pricing to a lower hierarchical level or leaving it completely to the market, they introduced a central pricing organization with clear tasks, responsibilities, and processes. Their top management now not only sets margin targets, but also regularly monitors that they have been met, leading to significant margin improvements. Geberit’s 28 percent EBITDA margin sends a clear message: making pricing a C-level topic pays off.

However, this successful example cannot hide the fact that only a handful of companies really put profit before sales revenues. Salespeople are usually compensated according to generated sales, not profits. This kind of system rewards the “rainmakers” who generate large volumes (no matter the margin they create), rather than those who also keep an eye on the margin. We often observe that top management will shrug their shoulders at a few lost percentage points of margin, but heads roll over the slightest sales decline. They fail to realize that consistent profit orientation is more than a strategy document, it needs to be lived throughout the company – only the “boss” can initiate and implement this paradigm shift.

Digitalization: a double-edged sword
Treating digitalization as a leadership task is another paradigm shift that first needs to be anchored on a top management level. Particularly medium-sized companies often see digitalization as exclusively an IT topic or a buzzword that means everything and nothing at the same time. They often start a new digitalization project or hire a chief digital officer just to send an external message. The consequence: Three in four companies have so far seen no positive revenue effects despite their digitalization efforts. This message is reinforced by the results of Simon-Kucher’s recent Global Pricing & Sales Study 2017.

Like pricing, digitalization is a double-edged sword: It involves high potential and major risks. This reason alone makes it a complex topic that needs to be right at the top of every management board’s agenda. Being able to recognize the multilayer impacts of digital technologies, e.g. those that fall under the buzzword IoT (Internet of Things), requires a holistic perspective and in-depth understanding of the market. Sensors and connectivity suddenly generate unforeseen amounts of data, which can shake up existing business models. For example, smart machines and predictive maintenance not only increase production efficiency for customers, they put pressure on manufacturers, since their high-margin aftersales business (selling regular maintenance and expensive spare parts) suffers as a result.

For example, with General Electric it was expected that aftersales revenues for oil drilling equipment would drop by more than 25 percent due to the IoT. The company reacted and turned its entire revenue model upside down. Instead of selling gigantic machines plus the additional costs for maintenance and expensive spare parts, GE now offers a “drill by the day” service: Customers pay per day for the full material and maintenance package – and less in total than they did previously. Thanks to the IoT, GE knows the exact moment when a component needs to be maintained and onsite service technicians are supported remotely by specialists in the headquarters. This way, the manufacturer still profits and is able to enter the majority of the “digitalization returns” on their own books. A win-win situation for everyone involved.

But these types of future-oriented changes are still few and far between. Time and time again we see how established companies enrich their “hardware” products with new, digital services, without giving any thought to monetization. Be it route optimization software for forklift trucks in a depot or automatic notifications when a garbage container needs to be emptied – these additional services are no gimmicks, they create value. Simply adding them on top of the product without thinking about customer value or willingness to pay is a fallacy. Once you have started giving away things for free, it’s hard to switch to a payment model and you might end up having to forgo considerable revenues.

That’s why the same applies for digitalization as for pricing: Both are boardroom topics that go hand in hand.

“Five top management tasks for successful monetization and digitalization”

  1. Concentrate digital transformation on revenue growth and not just on cutting costs. You need a clear digitalization strategy. 
  2. Invest in data-based price optimization and monetization of digital offers to generate the highest revenue effect.
  3. Invest in professional price management, and set prices using big data. Your price strategy should increase value, not trigger price wars.
  4. Use digitalization to improve customer segmentation and sales processes. Steer well clear of automating ineffective processes.
  5. Make digitalization a top management topic, not just another IT project. Involve all departments – from marketing and sales to pricing and operations.

    These recommendations are based on the results of the Global Pricing & Sales Study 2017, conducted by Simon-Kucher & Partners with approximately 2,000 participants worldwide.