Price Structure Improvements Drive UPS Earnings Up

United Parcel Service Inc. (UPS) reported U.S. ground revenue up by 5.3% and domestic-packing operating profits 10.5% by in the first quarter 2015 partly due to improvements in their price structure.  The stock market reacted with a 3% valuation increase in one day [1].  Can you achieve similar results?

What Is A Price Structure?

Price structures are the means by which the prices are calculated.  Standard price structures include unit, add-on, tiered, bundled, two-part tariffs, tying arrangements, subscriptions, and revenue management.  The strategic impact of price structures and the nuances in selecting between them is so important that an entire section of the book Pricing Strategy: Setting Price levels, Managing Price Discounts, and Establishing Price Structures is dedicated to the issue of clarifying differences in price structures alone.

From these standard price structures, firms make numerous variations and evolutions in price structures.  For instance, enterprise software solution was once largely priced by the number of users.  Now, many enterprise software solutions are priced with multiple factors such as the firm’s employee count, customer count, site count, modules in use, revenue, budget, etc.  And as observed, the evolution continued in moving from software licensing to SaaS subscription price structures.

As a pricing issue, price structures are as strategic as the choice to use neutral, skim, or penetration pricing.  They fall right after the overall business strategy challenge (customer, competitor, and corporate strategy) in the Wiglaf Pricing Framework.  As a pricing issue, they deserve CEO attention informed by solid pricing analysis that derives from information sources spanning the organization.

Changes in price structures can create market disruptions.  They should be seen as a part of Schumpeterian creative destruction process itself.  The revolutions in freeware, SaaS offerings, and the “sharing economy” all involved engaging new price structures.

How Do You Improve Price Structures?

Improvements in price structures come through improving the alignment of the price segmentation drivers to the market segmentation strategy while addressing cost to serve challenges.

In terms of market segmentation alignment, different customers receive different benefits (perceived or real) from the same or similar product. This drives variation in willingness to pay.  One goal in improving a price structure is to improve the match between the willingness to pay and the price extracted.  It is a form of price segmentation.

In terms of costs to serve, variations in an offering or in how customers utilize an offering will drive different cost factors.  The other goal in improving a price structure is to improve the match between cost to serve and the price extracted.

Both cost drivers and customer demands are mutually important in price structure design issues.

Why Is This A C-level Issue?

If the financial results UPS achieved alone don’t convince you that this is a CEO level issue, consider the organizational engagement and buy-in required to drive a change in price structures.

To get at the information required to make an informed price structure decision, research must be done that engages much of the organization.  Sales and marketing will be engaged to understand customer behavior and potentially conduct market research.  Operations will be engaged to capture information on cost drivers.  Financial data will be required to capture transactional revenue and costing information. And other organizational parties may also be needed to provide information.

Outside of information gathering, extensive statistical effort may be required to identify the best price structure which addresses both the ability to execute and the drivers to profitability.  Once the range of potential new price structures is narrowed down, financial modeling is required to estimate the expected impact on the bottom line and the customer base.

But the largest challenge, and the key reasons CEO’s must be behind this decision, is that a change in a price structure is likely to impact some customers positively and others negatively.  That is, changes in price structures may discourage certain customers from continuing their relationship with the company while encourage other to purchase.

This isn’t bad as long as those customer that are negatively impacted were relatively unprofitable and those that are positively impacted are more profitable.  Nor is it bad as long as the business strategy chooses to target certain customer segments over others.  But losing some customers may come at the cost of market share and will impact sales and market efforts.

Only the CEO can set the agenda of “go for market share” or “go for profitability”.  If managers understand the goal to be “market share” and the price structure could have a negative impact on certain customer relationships, then it is likely to result in a “don’t change the price structure” decision with a “save every customer relationship” mentality.  But, if the CEO sets the agenda of “go for profitability” or “go for this market segment”, then a change in price structure is possible.

I have personally had the honor and privilege of defining or redefining price structures for larger corporations several times in my life as a consultant.  Each time, managers raised important, pointed questions:  Which customers will this harm and which will it attract?  How large will the impact be?  Can the new pricing metrics be operationalized? Underlying these questions was a more personal one:  How will this impact my job and income?  While the first set can be addressed through pricing analytics, the second one requires the bosses’ attention. That is, the CEO has to engage.

What Did UPS Actually Change?

UPS shifted the pricing metrics from weight only to a combination of weight and size.

The shift was touted as a potential win-win for customers, wherein customers can reduce their overall shipping costs if they used smaller boxes which, in turn, reduced UPS’s operational costs.  But clearly some customers, those with light-weight but bulky items, were going to see a higher shipping costs and others, those of higher weight density, lower.

Toys “R” Us Inc. is one of the customers that decided to part ways with UPS.  This potential outcome could have been anticipated considering the weight density of most toys.  (I am confident that at least one sales manager is less than happy with this result.)

Yet even without this very important customer, UPS grew its revenue and profits.

This is what strategic price segmentation looks like:  a price segmentation strategy which enabled UPS to attract the more profitable customer segment while leaving the less profitable segments to their competitors.  And this is what a good change in price segmentation strategy looks like, one which increases both revenue and profits, simultaneously.  But getting there is hard work and requires CEO level attention.  Well done David P. Abney, CEO of UPS, and team.