November 23, 2020
This article originally appeared on Manufacturing.net.
Even in the most stable of economies, the modern enterprise operates in extremely complex environments. But when markets reflect today’s current turbulence, it seems impossible to think of what MIGHT happen. The trick is, if you don’t make time to understand the impact of your range of options before you’re in a moment of crisis, you’re left to respond to an actual crisis with little more than gut instinct.
This is where scenario planning comes in.
Scenario planning enables you to consider several alternative futures and plan for what could happen across each. You identify key variables that could impact your business performance and flex those variables to see the impact.
In addition to using scenario planning during the development of corporate strategy, it’s also proven to be a valuable tool for evaluating pricing strategy and tactics to grow your bottom line. Within pricing, scenario planning supports the timing and application of pricing models driven by the current economic landscape, product lifecycle stages, or even competitive intensity. By comparing the results of the various scenarios, you can frame the basis for decisions that preserve the value of your business mode over time.
Setting Pricing Objectives
To begin, scenario planning analyses should be specific to business unit or product category, particularly if objectives differ. Start by using a trusted pricing objective framework outlined in the book, The Strategy and Tactics of Pricing by Thomas Nagle and Georg Muller of Deloitte. They divide pricing objectives into 3 categories:
- Skim Pricing
- Penetration Pricing
- Neutral Pricing
When building scenarios to determine the right objective, consider:
- Customer price sensitivity
- Competitor reaction
To build a comprehensive picture of possible alternatives that can be achieved with pricing, create a scenario for each of the three pricing objectives. Even though the selection of the pricing objective may seem obvious from the perspective of corporate strategy, examining each alternative can reveal details that will ensure optimal strategy execution.
These scenarios are then weighed against each other and the best insights from each are used in decision making. And important to note here, scenario planning should be separated from forecasting exercises even though quantifying scenario impacts can be powerful and are therefore an important subset of the scenario planning process.
Take for example, a large industrial equipment manufacturer.
- The company manufactures industrial pumps for the process industry and they are at the beginning of a new product R&D cycle where the pricing objectives for the new product needs to be set. The R&D cycle is expected to take two years. The lifecycle of the product is expected to span at least 10 years.
- The basis for setting up a scenario team comes from the knowledge that introducing the new product will have a high impact and it’s a long-term play. The scenario team will be led by the Chief Revenue Officer who was also involved in the planning that identified the need to develop new products. Other members of the scenario team are selected from cross functional groups.
- To build alternative future scenarios, the first step is to understand the current state. A workshop methodology with the whole scenario team present is used to identify the key trends, which were then appended with web poll data gathered during work on the corporate strategy. Using these methods, a clear picture of the current situation and trends may be established.
Using these trends and the direction from the corporate strategy as a baseline, a common shared future is described in the ‘optimal scenario.’ This scenario follows the initial business plan laid out for the pump, set out in a narrative:
“As core-demand for pumps is driven by world GDP growth, a steady demand increase is expected on average for the pumps into the foreseeable future. New pumps are published annually from several companies. Our competitive advantage arises from a thorough understanding of customer needs and offering products that answer their needs with the highest quality. The new generation of pumps will have an emphasis on scalability and supporting the delivery chain. Upon launch, the new product will be widely adopted quickly in markets where we already have a strong position. Thereafter, the rest of the markets will adopt the new pumps and we will be able to reach a global leadership position. R&D costs will be offset rapidly as we realize healthy margins due to strong pricing power based on brand value and our expertise.”
With this as the optimal scenario, create the alternative future scenarios with the team analyzing the greatest uncertainties/risks in the current business plan. Risks could include:
- To what extent do we understand customer needs better than other companies?
- New competitors entering the market.
Using these two main risks, four scenarios may be built to identify the most suitable pricing objectives for each situation. For each of these four scenarios, a specific narrative is developed capturing the possible outcomes. For example, the “Slow decline” scenario might be summarized as:
“After introducing the new pump into the market, it becomes apparent that its benefits are not fully appreciated by customers; they are not salient enough. The new pump is not gaining traction in the market, sales and profitability goals are not met. We continue to launch new features using the new flexible software product platform, but they keep missing the mark from the customers perspective. From our original neutral price position, we need to move to penetration pricing to jump start sales and recapture the investment made into R&D. Each consecutive price repositioning downwards makes reaching the financial targets more difficult.”
With these different scenarios, create alternative visions and plans of action to maximize the likelihood that the optimal scenario is realized. If for example, the vision was to be able to use a combination of skimming and neutral price strategy by differentiating customer offering, you’ll know if you’re on track by asking yourself:
- Are the pricing objectives a means to an end and determined by our goals and how the business environment evolves?
- Have we selected internal and external metrics to determine trigger points for changing the pricing objective?
- How will we ensure robust pricing processes are in place to efficiently enact changes in pricing objectives?
- Has the customer’s perceived value combined with a comprehensive view of the market (key to managing risk) been adequately considered?
These four decisions are fundamental to guiding the pricing objectives throughout the pump’s life cycle and form the basis for possible future action, including:
- Preparation actions made to create organizational readiness to act on changes in the business environment, including pre-set action triggers.
- Immediate effect action, including the revamp of a customer segmentation model to ensure information is kept relevant and the selected initial pricing objective can be effectively used for each segment.
- There can also be mixed actions, such as a renewed price revision process going forward.
Scenario planning will require an investment in time and resources, but it will also provide significant returns for commercial excellence and profitability. The ongoing improvements in modelling and data processing capabilities through AI technologies will leverage new possibilities in scenario planning, especially in quantifying probabilities and consequences of scenarios that will provide more specific outcomes.
However, the creative process involved in scenario planning will remain relevant as the past will not always be a good representation of the future.
To learn more about the benefits of scenario planning in your pricing, download the whitepaper, Scenario Planning Pricing.