Price level optimization is often viewed as the primary means for increasing realized prices and total revenues. Yet, this view is incomplete and often incorrect. The most important role of price is to improve the relationship—and ultimate profitability of a customer relationship.
Ethical conduct is the best way to foster a long-term profitable relationship. Ethics are the antecedent building block to trust and loyalty. Comparing the “World’s Most Ethical Companies” survey to the S&P 500 over time suggests that ethical behavior is rewarded: the most ethical companies outperform other (similar cap) companies by 7.1% over a 15-year period. There is considerable evidence that ethics is the constant and addressable means for improving customer relationships.
Ethical pricing is a very pragmatic way to build a customer relationship. It means pricing bounded by ethical rules. The rules (some reviewed here) are quite specific, concrete, and intuitive. Ethical pricing becomes even more powerful with an understanding of when and how some people will break the rules. Knowing when and how to guard against ethical breaches in pricing is “Strategic” Ethical Pricing.
Ethics is about doing good for all parties over the long term in a relationship. The idea that ethical guidelines are relevant to business is not new. However, ethical understanding has not been paired with the discipline of business strategy: understand your opposition and counter unethical behaviors with your strengths. This is how corporate top management and pricing can efficiently ensure compliance with ethics.
Not a lot has been published about the strategies employed by unethical and greedy people. However, a recent issue of the Journal of Professional Pricing outlined the twelve archetypes of strategy by greedy players. These twelve unethical strategies must be addressed by management. As discussed in the article, many greedy tactics are not readily apparent to customers or senior management. They include measures not captured by systems, e.g. changes in price level are captured, but changes in messaging or offer structure are not. Some price initiatives are also often not visible to line management (e.g. requests for changes in regulation, or pending sales of business lines).
Rarely does management have time for exhaustive review (to ‘boil the ocean’) looking for unethical behaviors (Fig. 1A), and so managers must know where to look. One approach to encourage ethical behavior is to build an ethical culture. With the right culture, chances are that some employees will report unethical actions. But for that to happen, most or all employees need to be part of the ethical culture, and that can take a long time—18 months or much longer.
The alternative to relying on culture is relying on rules. However, rules are frequently inadequate to the task, both because there are too many types of pricing, and because these rules work only under certain circumstances or contexts. If the task of screening actions against rules is left to top management and legal, the ratio of transactions to observers is large (Fig. 1B).
On the other hand, if management knows precisely what the ethical threats are, it can counter them effectively. This is why the outline of greedy tactics/strategies is helpful. This allows top management to ask the right questions, make sure the right screens are in place and have a strategy for stopping unethical actions before they start (Fig. 1C). This is the strategic ethical approach.
An example of management evolution of behaviors through instituting a review of transactions (1B in Figure 1) comes from a leading manufacturer of industrial equipment, including Aerial Work Platforms (“AWPs” or “cherry pickers”). The salesforce had become proficient in switching allowable discount amounts from one account to a different account. This way they could exceed the allowed account discount set by finance. The result was that some salesmen give away greater total discounts (since no discount allowance went unused). This was a violation of their condition of employment, and so unethical.
In addition to excess discounting, this practice also made it difficult to penetrate new market segments via discounting since intended discounts were transferred to accounts that the salesforce felt comfortable with. Other harm stemmed from the huge differential in discounts across accounts which, when made public, angered some accounts and led to defections.
Management was aware of this practice but had no idea of its extent. Given its infrequent awareness, it was reluctant to spend great effort to correct the behavior because it did not want to punish random salespeople. The abuse only ended when the AWP manufacturer installed a new accounting system that tracked cash discounting. It ended the shell game, somewhat abruptly.
The benefits of this action included a 5-7% increase in revenues. It also prevented accounts from being outraged by finding large (30%+) differentials in discounts compared to others and helped educate some salespeople on more scientific and ethical bases for discounting. This process took less than a year.
This raises the question “What is the right ethical standard?” As most readers will know, there are many articulations of ethical standards. The focus of ethics has varied over the years. However, some of the basic principles remain unchanged. One articulation that is particularly useful for pricers is a list published by Cambridge University professor Henry More. Prof. More was a leading figure in the group known as the ‘Cambridge Platonist’ group. He published a list of 23 principles (or “Noemi”) that suggest what guidelines management might use to show ethical integrity to their customers and partners.
The failure of practices to accord with Noemi link closely to some ethical failures and business reverses suffered by modern corporations. Some examples of principles and corporate results, from several perspectives:
||Principle: Lack of clarity in principles results in confusion, and customer greed reduces revenues.
Example: Leading legal service provider which worked on retainer for being listed on company’s state incorporation documents. The company knew that some smaller companies were listing the legal service provider as their representative, but in fact, they were not subscribers and paid no fees for the representation.
Rationale for behavior: Managers were thoroughly trained to strictly observe procedures for signing new clients, and so felt they could not bill the self-listing clients for the service.
Ideal Management Strategy: If the provider had been clear on a fair exchange of benefits and payments, there might have been a procedure so customers would have been billed immediately upon signing up.
Benefit: The service provider billed approximately 20,000 self-service clients and added over $3.1 million to revenues.
Risks: The risks to encouraging workers to go beyond normal routines is real, but it can be countered though effective communication up and down the chain of command.
||Principle: Treat customers candidly. Be sincere and share issues with them.
Example: Leading tax service provider found that a competitor was materially undercutting published prices and standard industry rates. The provider experienced a slow erosion of its most profitable clients who defected based on lower prices. But the provider did not act.
Rationale for behavior: Tax provider did not want to alert customers that there were price variations for fear of provoking questions of its own pricing.
Ideal Management Strategy: Management contacted the competitor’s older ‘best’ customers, letting them know that other, new customers, were obtaining a much lower price than them. This incensed the older customers, who complained to the other provider.
Benefit: The undercutting of prices by the competitor ceased immediately. While none of the angry customers defected, several exacted deep rebates. No further defections occurred.
Risks: There was some risk of a broader price war, but this did not happen as it was to no provider’s benefit.
|Quality of Service
||Principle: Live by promises.
Example: Leading systems developer rolled out a new billing system for telcos in the US and Canada. However, the $65M billing systems did not function properly, or according to specifications. In Canada, the first system was sold to Bell Canada Mobility. After ongoing attempts to make the system work, the developer abandoned the project. Bell Canada canceled the contract and communicated the failure to all telcos and other leading businesses in Canada. In the next year, the systems developer was forced to close all but one of its Canadian offices as its customer base collapsed based on the Bell Canada story. In the US sales continued for over two years.
Management actions: In the US, the developer had gotten away with the failures, as customers did not communicate with one another. Management failed to address the problem. As a result, there was a material revenue contraction in Canada.
Ideal Management Strategy: Work to stand behind promises and products, e.g. LEGO’s customer satisfaction policies contribute to its position as the world’s most valuable toy brand.
Benefit: Many markets reward high quality of service or products. If the developer had secured Bell Canada Mobility as a satisfied client, it would have locked in that client for another five years and gained at least three more Canadian telcos as clients.
Risks: Risks of standing behind the product would include costs of further development, and complaints of delay — perhaps not rewarded in the market.
||Principle: Treat customers well despite short-term goals.
Example: Leading internet service provider of the 2000s was rapidly losing customers because its dial-up technology was being replaced by broadband and other less expensive offers.
Management actions: The provider had structured its pricing to retain customers. There were penalties for cancellation outside a narrow time frame, and alternating periods of limited and unlimited usage, which led users to incur excess usage charges.
Rationale for behavior: This pioneering internet service provider was facing rapid share loss as dial-up was replaced by broadband and lower-priced providers entered the market. Management compensation depended on retaining customers. Many subscribers were not adept at avoiding traps and exiting.
Management failed to address the problem, despite overwhelming hostility from subscribers. It also failed to rapidly update its technology and offer because it saw the older subscribers as a “cash cow” and hoped they would remain loyal (as many did).
Ideal Management Strategy: Company should have pursued a more benign ‘harvest’ strategy. Such a strategy can produce superior profits for a company with a declining technology position (e.g., mainframe computing, print photography, etc.)
Benefit: This would have positioned the company to develop alternatives under consideration, e.g., nationwide wireless service (“WiMAX”). If it had not alienated customers, it might have achieved renewed leadership and revenue gains.
Risk: Unless management renegotiated incentives, the transition would have been painful.
||Principle: Integrity brings benefit.
Example: In 2007, The Coca-Cola Company received an envelope from an employee at a competitor containing information regarding the competitor’s product development programs and their market focus. Coca-Cola immediately sealed the envelope and sent it back to the competitor’s management, including the name of the employee who had sent it.
Rationale for behavior: Coca-Cola did this as a reflection of its ethical culture and confidence it could win in the market without borrowing others’ secrets.
Ideal Management Strategy: Coca-Cola did exactly the right thing.
Benefit: This action reinforced its world-topping reputation and set the desired example for its employees.
Risks: While ethically impeccable, refusing illicit intelligence can be a disadvantage. Sometimes victory depends on learning the other side’s secrets, e.g. military examples like the Battle of Agincourt where the English intercepted France’s battle plan.
|Discrimination not reflecting costs
||Principle: Show fairness and social equity to all.
Example: Repeatedly market trials have found that women are charged more for the same car repairs than are men. Also, often there are unnecessary repairs. Indeed, many services and products bear a “pink tax” and are priced higher for women than for men.
Sometimes this is because of costs. Average prices of haircuts, laundry services, and clothing, are often higher. In some cases, this reflects higher costs.
Rationale for behavior: Not clear, but possibly they expect to “be able to get away with it” on added charges. Alternatively, some may have found that unexpected charges above the initial quote are harder to explain.
Ideal Management Strategy: Offer different means of charging, and improved levels of documentation. Women may (e.g.) prefer different warranty periods.
Benefit: Examining segment preferences closely can be rewarded. For instance, Colonial Penn found that while elderly drivers were thought to be accident-prone, they in fact were lower-cost insureds because they drove fewer miles. So Colonial Penn was able to use price to become the leader in the senior automobile owner market.
Risks: Some administrative burden in tailoring price structures by segment. But often those burdens are slight, and sometimes management may underestimate longer-lasting harm from naked price level discrimination.
The last principle suggests a basic management point. There is often no reason to base differential pricing on race or gender—they are crude screens. Generally, there are more sophisticated behavioral criteria that better serve revenue purposes. For instance, rather than differentiate car repair prices based on gender, it is much more effective to base them on the history of car ownership and prior repairs. This will distinguish the price-insensitive from those who carefully evaluate costs. Doing this by gender may generate anger and repercussions.
Only if one identifiable group has been subject to a unique set of factors, can it be easy for pricing and marketing managers to derive confident conclusions regarding potential actions. But this is almost never the case. For instance, confronted with a low customer Net Promoter Score, many line managers simply undertake the program they wanted to execute anyhow and say—usually incorrectly– it will cure the low score in the market.
How do you implement an ethical pricing program? The key question is: Who will be the champion of such a program? It may take some effort to convince some categories of managers that ethics increases profitability. For instance, some market-facing managers have obtained short-term revenue hikes from unethical actions. They may be uninterested in the longer-term consequences and may not link those to their actions. In other cases, there may be unethical actions that may be highly annoying to customers but important to a small budget. For instance, the shift from billing via USPS to online-only has a 5-15%+ impact on billing operations but may alienate some classes of less computer-savvy buyers (e.g. some demographics).
Ethics initiatives may differ from general marketing initiatives in that there should be no trials regarding the ethical standard. Trials of standards suggest doubt that the company is firm regarding ethical practices. Calling it a trial may create the perception that the company could later say “Oops! I guess we won’t be ethical in that way!” That would be bad. Trials are okay as long as they are clearly operational trials, e.g., testing out a new supervisory approach.
An ethical pricing trial also cannot be a consensus-based process. Confidence in ethics must be absolute, and the vast majority of employees look for strong leadership from top management in dealing with ethical issues. This is particularly true where the changes have a short-term cost and will generate anger among the salesforce or other workers.
Institutionally, it is worth distinguishing management roles. As the CFO of one bank observed, some “C” titles are inclined to defend the institution (e.g.: CFO, chief counsel, head of operations, etc.) while others are more focused on short-term revenue (head of sales, product management, etc.) In general, more institutionally oriented management will be more willing to make a short versus long term trade-off in migrating to more ethical practices, and so maybe the better initial senior champions. Later, after proof of concept, the leadership might flow to revenue-oriented titles.
For many companies, the notion that ethics may be a powerful driver of annual revenues is a novel concept. However, for some, this is foundational for their longer-term growth. All may benefit from applying explicit ethical rules. As business and even personal transactions are increasingly more subject to public scrutiny, ethical discipline belongs on all company pricing agendas.