A study conducted a few years ago analyzed the impact of five operating levers—price; revenue; cost of goods sold (COGS); selling, general, and administrative expenses; and research and development—on the bottom line of any business.
Specifically, researchers were trying to understand how each of these independently impacts the overall profitability of an organization. The study concluded that a change in pricing makes the biggest impact on the bottom line.
Clearly then, the price of your product matters and has a more significant impact on the health and wellbeing of your company—for good or ill—than just about anything else. Setting or changing prices demands careful consideration and should not be done lightly.
In most organizations, pricing decisions are made by the chief financial officer (CFO). Very few companies have a dedicated pricing function or person managing pricing. However, this model isn’t optimal. In fact, organizations that are structured this way are missing out on the most significant lever in improving their profitability.
Who Should Set the Price?
So, who should set and manage prices? Well, as the saying goes, where you stand on an issue often depends on where you sit.
If the CEO designates the sales leader to be in charge of pricing, because they are “the closest to the customer,” a certain bias in pricing decisions will result. Sales is responsible for—and is often incentivized by—the basis of revenue generated (and not on profit).
This is despite the fact that profitability is (or should be) the lifeblood of any business. Thus, with sales in charge of pricing, there’s an inherent bias to lower prices so sales revenue (and commissions) can be increased.
If the CFO is responsible for setting and managing prices, you get a different set of biases. Typically, CFOs have a good handle on the cost structure of products and services. They also have a close understanding of the CEO’s expectations about profit. Thus, they feel empowered to take this understanding of unit costs, add expected profit on top of it, and set the price from there.
That said, CFOs also lack an understanding of how prices might impact sales volume and customers’ perception of value in products and services being provided. The math they use might work for a single unit (cost + desired profit markup = customer price), but there’s no analysis of what a specific price will do to market demand. Remember, the psychology of the target audience is also at play. Failing to take this into consideration can lead to some real market blunders, even if the unit math makes sense upfront.
The Psychology of Pricing
Netflix provided us with the perfect cautionary tale to illustrate this point, back in 2011, when they made a significant pricing decision without taking into consideration how it might impact customer behavior and response.
You might remember when the company announced that they were going to bifurcate their streaming and DVD rental services. Rather than receiving both services for a single price, customers would now be charged separately. The streaming service would continue to be called Netflix, while the now-separate DVD rental service would be called Qwikster, and each would have its own webpage.
Customers responded with almost universal derision, seeing this move as Netflix gouging them twice for the same utility of movie watching. They also hated the prospect of having to navigate two separate webpages. Over the course of four months, Netflix lost over 75 percent of its total value, along with hundreds of thousands of subscribers. The company ultimately scrapped the Qwikster concept.
Interestingly, and to their credit, Netflix went on to make significant pricing changes in subsequent years and handled each of them well. A single, disastrous decision was followed by a number of successful decisions. The key difference was the way Netflix incorporated a deep understanding of their customers and their psychology, which was reflected in how they communicated these changes in the marketplace.
Give Pricing Responsibility to Marketers
CEOs, of course, have the ultimate authority and responsibility for managing all of these elements. However, the best people within an organization to understand both sides—profit margins and market demand—are marketers. Thus, pricing should be their responsibility to manage.
My suggestion does not come out of left field. If you recall your business training, you no doubt remember the four Ps of marketing: product, price, place, and promotion. Since price is a key aspect of marketing, it makes sense to let marketing handle it, because they will also view pricing in the context of the other three Ps.
The benefits don’t stop there. Sometimes a problem that looks like a pricing issue is actually a problem with positioning and messaging. A sales leader might look at customer responses to prices and conclude that customers believe their product is too expensive, so prices should be slashed. A good marketer, on the other hand, might look at the same situation and realize that positioning and messaging need to be adjusted to communicate the value of the product more effectively.
You have to go beyond the math, beyond the profit margin, to look at the psychology of pricing. This is where your marketing team is best suited to make decisions. For that reason, I strongly encourage you to put pricing in the hands of your CMO.
For more advice on how to build a marketing strategy that maximizes profit, you can find Lies, Damned Lies, and Marketing: Separate Fact from Fiction and Drive Growth (Lioncrest Publishing; August 20, 2021) on Amazon. Written by Atul Minocha.