Meissner Research Group

There are three basic pricing strategies: skimming, neutral, and penetration. These pricing strategies represent the three ways in which a pricing manager or executive could look at pricing. Knowing these strategies and teaching them to your sales staff, and letting them know which one they should be using, allows for a unity within the company and a defined, company-wide pricing policy.

1. Skimming Strategy

   Skimming is the process of setting high prices based on value. Instead of basing your prices on your competition, a skimming price comes from within the company and the (financial) value your product represents to your customer. This strategy can be employed in emerging markets, where certain customers will always want the newest, most advanced product available. It also works well in a mature market, where customers have already realized the value of your product and are willing to pay for what they see as a worthwhile investment. Surprisingly, skimming also works in declining markets, as your diehard customers are willing to pay big bucks for what they see as an older but superior product with a dwindling supply.

2. Neutral Strategy

   In a neutral strategy, the prices are set by the general market, with your prices just at your competitors’ prices. The major benefit of a neutral pricing strategy is that it works in all four periods in the lifecycle. The major drawback is that your company is not maximizing its profits by basing price only on the market. Since the strategy is based on the market and not on your product, your company, or the value of either, you’re also not going to gain market share. Essentially, neutral pricing is the safe way to the play the pricing game.

3. Penetration Strategy

   A penetration strategy is the price war; this strategy goes for the deepest price cuts, driving at every moment to have your price be the lowest on the market. Penetration strategies only work in one of the four lifecycle periods: growth. During growth, your sales are continuing to expand, as your customers want the newest product but still a product that has already tested by others in the emerging period. This is when your average customer buys a product and when the sales numbers will be the biggest. A penetration strategy works here, and only here, because you’re attracting customers to a new but proven product with cheap productions. You’re developing relationships with new customers willing to try the new product but who will only come for a lower price.

   Penetration strategies fail in the other lifecycle periods by leaving possible profits in the hands of the customers. In an emerging market, your product is brand new and customers who want it first should (and will) pay for that right. In a mature market, a price war will simply start the process of endless and useless competition, destroying your profit margin. In a declining market, only those who still must have your product will purchase it, and just like in an emerging period, they should (and will) pay for that right.

Knowing which pricing strategy works best for your company is an essential tool for any pricing manager and can only be found by recognizing the lifecycle of your products. If your entire sales force is on the same page in recognizing product lifecycles and utilizing pricing strategies, your company will likely see greater returns.

In a price war, where competitors with similar products, designs, and incentives compete for customers by having the lowest price, the only person that wins is the customer. Always.

When allowing your sales staff to use price as their main tool to meet quotas for the month, week, or even year, you, as the executive, are actually making it harder for them to achieve the company’s goals. When competing on price alone, your customers will quickly realize that all they have to do is signify that some other company’s pricing is just a little bit better, and your prices will fall.

Don’t think this affects your bottom line? Not only will your profit shrink, there’s a good chance that if your sales team doesn’t have a bottom price range, the customers will manage to convince them that the only way to get the sale (which salesmen see as their one, main priority) is to dip below cost. Customer loyalty and all those other things the customer will promise your salespeople once that below cost sale happens will disappear the moment your competitor decides it is going to keep the war going.

So, playing the price war is a lose-lose situation for you, your brand, and your sales team, because your sales numbers may go up but your revenues will go down. You might even have happy customers – happy customers that will happily jump ship to your competitor with a lower price. Essentially, price wars are a no win situation, especially if you want to be at the top of your field.

Customers, especially in this recession era, have become very savvy at the pricing game. To them, only one thing matters in a market where everything else is equal: price. By choosing not to play their game, by pricing your products on value, your company can still win. While your competitors are eating away at their profits, focus your company on figuring out how to make your products different and worthwhile and showcase that value to the customers.

By pricing on your products’ value, your customers will realize the differences between you and your competitors. If you succeed in showing your customers a reason to pay just a little bit more, you can also create customer loyalty with a superior product. So instead of allowing your salespeople to empty warehouses below price, tell the rest of your company to create products and promotions that customers can actually see tangible value in. And avoid that price war altogether.

To understand how to best set prices, manager first must understand that all products go through four distinct periods in their life cycles: emerging, growth, mature, and decline.

Emerging products have just been released to the public; perhaps they’re even in trial form and only available to select customers. During the next period of growth, the products have entered in the market at full-force and with each passing period, sales continue to grow at a steady rate. This is different from emerging in that your product is now part of the everyday, standard business – not necessarily the newest product on the market anymore. Once your product enters the mature phase of its life cycle, the sales growth has evened out. A large portion of your customers already own your product and only come to you for problems or repairs. And finally, your product will enter into decline – it becomes obsolete (hopefully because your company has already put its replacement into the market) and its sales dwindle to a few stragglers who are behind the times or devoted fans of your product that simply don’t want an upgrade.

Each of these periods of the life cycle change how your product is viewed in the marketplace. Unfortunately, most sales teams are not equipped and don’t even realize when each of these periods happen and the effect they have on your product and pricing. As an executive, it is your duty to recognize the shift in life cycles and to guide your sales staff in pricing accordingly.

Most executives unfortunately don’t like to think of their products having any sort of cycle to them; they prefer to think of their products as entering the market and remaining in the same growth phase forever. This simply is not the case. While it is true that you continually want your profits to grow, a single product cannot manage growth indefinitely. It is up to the executives to watch for signs that a product is entering a maturity phase, or even its decline phase, and react. New products should enter the market, starting new emerging and growth phases for your company. Without adherence to this law of entropy in business, your company will suffer.

A good example of this is the yearly nature of car manufacturers, or the ever-changing nature of Apple’s iPods. The moment one version of the iPod becomes obsolete, or even before (allowing Apple to control when a product enters its own decline phase), a new version appears on the market. Use your knowledge of product life cycles to shepherd your business into continual growth phases.

[The following is an English version of the article ‘MBA in Europa: Die Mischung macht’s‘ that appeared as an op-ed in the MBA supplement of the Frankfurter Allgemeine Zeitung (FAZ) on October 29^th, 2009.]

Without a doubt, every MBA applicant needs an excellent GMAT score, a flawless academic record and a unique quality to stand out from the crowd, but social competence is what a potential applicant needs to have to be a winner to complete a MBA program, land a dream job and conquer the business world.

For the past several years, the secret has no longer lied in grades and academic awards but rather in a mix of different mental, personal and even physical strengths. From my teaching experience at the Lancaster University Management School (LUMS), I have learned that the GMAT is a strong indicator for the future academic success of a student, especially if the course in question is heavy on the quantitative side. This is, however, only half the battle.

Well-known MBA critic Henry Mintzberg strongly believes that no student can become a successful manager by just attending lectures. The difference between mere theory and actual practice of management implies that a student cannot learn what it takes to handle the challenges of a manager position without actually taking part in a production or service creation related job themselves. While case studies are in theory useful to get a feel for the daily life of a manager, they also undermine the importance of real-life work experience. The fact is that co-workers and subordinates aren’t just a set of data, but complex individuals who require more than analysis and strategies to be led effectively.

In a sense, this can already be seen during a MBA program where complex projects can only be completed successfully by a team, not just a strong individual. It is not about commenting on and controlling the work of others, but using them for guidance and stimulus. The students who are the most successful can identify the complementary skills of others and are able to motivate them to participate. A good MBA student can be paired up with the weakest team members and still deliver the best project, simply because he or she knows how to effectively lead a team. Authentic enthusiasm and positive attitudes help successful MBA students, and eventual managers, not only to utilize their laborers but to pass their ambitions on to others. By doing so, they create a healthier and more efficient working environment in which common goals and the well-being of the organization are highly valued.

Therefore, social competence is a must for top managers. Business schools are incorporating such components into their programs to enable students to gain this needed skill. At LUMS, we have added three consulting projects to our MBA program, and two of them must be completed in randomly assigned teams. After the projects, many students report that they have been a true highlight of the program, and one of the program’s aspects from which they have learned the most. The idea was developed after the success of International Master in Practicing Management (IMPM), a program for senior managers co-developed with Henry Mintzberg in response to his own criticism of existing programs and offered by LUMS in cooperation with McGill, INSEAD, and a few other partner institutions.

While there are MBA programs that attempt to integrate practical learning experience into the curriculum, the social management skills should already play a role in the admissions process. It is certainly not an easy task, since character can’t be easily evaluated in a short time period. Assessment centers simply cost too much. There have been rumors, however, that GMAC is working on a new version of the GMAT which will also test social components and time management skills, although nothing has been made official yet. It will still be the admissions office’s task to make sure that the right candidates are accepted.

However, one needs to be aware that this argument is often misused as well. A solid, quantitative understanding is still vital for every top managerial position and can not be replaced. But just alone, it is not enough. MBA programs that do not require applicants to take the GMAT, and instead claim it is sufficient to interview potential applicants, must be dealt with carefully. These programs are often more afraid about the external evaluation of its students, like the average GMAT score of their incoming class, than the social character skills of their candidates. These admission interviews often resemble sales pitches to the students. Because applicants also learn a great deal from fellow students, they should pay careful attention in such cases and research the student body of the institution they consider to join.

Altogether the MBA student needs excellent qualities in both academic and character-related areas for ultimate success during and after the MBA program. Just as in most other aspects of life, it’s in the mix.

Dr. Joern Meissner is a Lecturer in Management Science at the Lancaster University Management School in England and founder of the educational institutions Manhattan Review and Lancaster Executive.