July 18, 2012
In a recent IHS Chemical Week article, Vincent Valk wrote about resisting commoditization in specialty chemicals. I was happy to see that he chose to address pricing strategy (albeit briefly), saying “Pricing strategy, in general, is another key component of maintaining high-margin specialties.” What is commoditization, if not downward pricing pressure and the resultant price erosion? Commoditization means interchangeability, no barriers to customer switching behavior, and more downward pricing pressure.
Valk also notes that “In many industries, it is the application that matters, not the product.” And Ray Will of IHS Chemical is quoted as saying, “the chemicals become insignificant, the outcome is the focus.”
Indeed. In our work in specialty chemicals, we see 2 key trends in achieving optimal price realization:
1) Value-in-use-pricing (often called value based Pricing)
To do this, you must be able to understand (or at least estimate) where the different end-uses or applications drive differentiation in customer-perceived value. You may have ideas or hypotheses about this already, but how do you quantify these? And where are there other segments of value in the end-use or application of which you are not aware?
The challenge has been that calculating value-in-use has historically been either too complicated or too time consuming to be practical for most companies. With hundreds of products, hundreds of applications, and dozens of product attributes that influence value in use, you can end up with a lot of calculations.
But the wonderful thing about the state of modern technology is that software and computing power have made what used to be a time consuming, academic exercise, a practical reality for product and marketing managers. Just ask some of our specialty chemicals customers.
By using statistical techniques like clustering and regression with your own data you probably have today, it is possible to develop these “pricing segments.” Once you have these segments identified, you can then use them to actually implement what Valk and Will mention above, moving this from pricing theory to pricing practice.
2) Outcome based pricing
In some cases, the next step in value-in-use pricing is to price based on the value of the output of your products and services (rather than the inputs you provide your customers). If you can quantify the value that your product and service offerings deliver, at an application or industry/segment level, then you, the seller, can switch your revenue base to the outcome of the process, rather than the input. This focuses your customer on the value you actually deliver them, instead of the “cost” of the units of products or services you provide.
Where to go from here
To read more on this approach – including a specialty chemicals example – see my colleague Colin Carroll’s article on Outcome Pricing in the Journal of Professional Pricing.
Remember: a 1% increase in realized price yields about a 10% increase in profits. Most pricing projects yield between a 10% and 30% increase in profits. And with your product innovation and R&D most likely being funded from your profits, you can’t afford to let your competitors outperform you in terms of profit growth. So, an effective pricing strategy – that can actually be implemented – is critical for your company’s continued success.
So how long will it be before you start operationalizing a pricing strategy like this?
– Alex Hoff