The Value of Pricing Training: Avoid Costly Pricing Mistakes

nathanlphipps

Nathan L. Phipps
Consultant, Wiglaf Pricing

Published July 16, 2020

The business world is littered with examples of costly pricing mistakes that could have been prevented through the application of standard pricing knowledge.

These pricing mistakes take a few different forms. Some involve blind spots in pricing strategy. Others show failures in price management. And you can break price management failures down further into problems with determining market prices, discount management, or price execution.

I feel it must be said that it can be very easy to identify these errors in hindsight. My goal here is not to mock the very public pricing ignorance of others. (Spoiler alert: we’re all born ignorant about everything. At least, last I checked.)

Rather, my goal is to point out a few instances that may have turned out quite differently if these companies had a trained pricing professional present to influence and inform pricing decisions. After all, pricing ignorance may be the default setting, but that will not spare your company (nor your career) from the profit-destroying consequences of easily avoidable pricing mistakes.

Pricing training is critical to help you avoid costly pricing mistakes

Photo by Max van den Oetelaar on Unsplash

Pricing Case #1: Valeant Pharmaceuticals

For a time, Valeant Pharmaceuticals had a very profitable business model and pricing strategy. Developing new drugs is expensive, requiring an investment of around a billion dollars per drug, with no guarantee of success. Instead of developing drugs themselves, Valeant would buy existing drugs, mark up their prices significantly, and then reap the rewards. It was a genius move, until the unrelenting (and I would argue easily predictable) backlash.

In 2015, Valeant acquired the drugs Isuprel and Nitropress, which were both used for cardiac care. Their prices were promptly increased by 525% and 212% respectively. Even more dramatic price increases were recorded for Cuprimine and Syprine, which were both used to treat a rare copper-accumulation disorder called Wilson’s disease. Cuprimine’s price increased 5,787% to $26,189 from 2013 to 2016. Syprine’s price increased 2,934% to $19,783 during the same timeframe.

Pricing pro tip: if you need to use a comma in your price increase percentage, then you may want to double-check your math and/or get a second opinion, preferably from a professional.

Pricing training will tell you that price increases are risky business. Due to a cognitive bias known as anchoring, people are prone to setting their expectations quickly and changing them very slowly. This means that buyers in any market tend to mentally latch on to the first price they see, and this will subsequently affect all further decision-making. All future prices will be viewed through the lens of that first price.

Exposure to a very low price first will generally cause the buyer to view all future prices as far too steep, while exposure to a very high price first will generally cause the buyer to view all future prices as immensely affordable. Anchoring is one of the reasons that it is generally easier to enter a market with a slightly inflated price and discount as-needed than it is to enter a market with a discounted price and then try to increase prices at a later time. It can be very difficult to change these customer expectations once they are set.

If exposure to a single price “locks in” a customer’s price expectation to that level, what do you think the effect will be for a customer that actually purchases a given product for months or years before your company raises the price by a gajillion percent? Methinks the customer won’t take your price increase too kindly.

Also, did you know that the notion of fairness plays a substantial role in psychological perceptions of pricing? You would if you completed any pricing training worth its salt. Generally, customers view a price as fair if it matches their previous experience with similar purchases. Fairness is also generally considered more important for necessities, as opposed to discretionary goods. (Most people would agree that most pharmaceuticals would be considered necessities.)

As pricing professionals, we have quantitative tools to help inform and manage the inherent risk of price increases, like doing a simple volume hurdle calculation to find out how much volume you can lose without losing any profit dollars. Additionally, we also have practical knowledge of pricing behavior. Pricing is not all math. Sometimes it involves psychology.

Eventually, Valeant’s pricing practices came under intense scrutiny. CEO Michael Pearson was called before the Senate to testify in April 2016. If your pricing practices get you hauled in front of a Senate investigative panel, you can reasonably conclude that you may want to reevaluate your strategy and tactics.

During Senate questioning, Mr. Pearson was unable to name an acquired U.S. drug that did not have a price increase. Documents reviewed in the Senate revealed that in an early 2015 meeting some of Valeant’s executives advocated gradual price increases so that it would not cause problems for core hospital buyers. Mr. Pearson disagreed and championed a single, steep price increase. Mr. Pearson got his way, and now we can all learn from that pricing mistake.

Valeant’s methods allowed it to make large profits very quickly. However, it was an approach dominated by short-term thinking, so the profits were short-term as well. In the end, this impacted the company’s market capitalization: Valeant’s stock price fell more than 85% between August 2015 and April 2016.

In fact, fallout from their pricing practices was so strong that Valeant announced in May 2016 that it had formed a special internal committee that will be responsible for drug prices and “will consider the impact on patients, doctors and our healthcare-industry partners.” Sounds like the beginning of a Pricing Council to me, and I would consider that a pricing best practice.

Pricing Case #2: Whole Foods

My first example was quite sensational, and it provoked a fair amount of outrage nationally. Furthermore, the pricing mistake was right at the center of Valeant’s business and pricing strategy. My second example is much more mundane by comparison.

Pricing can be complicated: there are many topics to cover, and one thing frequently leads to another. Your business strategy flows into your pricing strategy, which flows into your market pricing, which flows into your price variance policy, etc. But it’s important to not forget about where the rubber meets the road: price execution.

Price execution ensures that you get the right price to the right customer at the right time. You can do everything else right in your pricing plan, but if you are not actually able to execute your pricing correctly, then you have a failure on your hands.

A pricing transaction that does not execute does not generate any revenue. It’s also possible that a transaction executes, but it does so at the wrong price. In June 2015, Whole Foods had an issue with the latter error.

New York’s Department of Consumer Affairs investigated eight stores in New York City, and it found 80 types of prepackaged items were regularly mispriced because they had mislabeled weights. Examples include overcharging $4.85 for eight chicken tenders and $14.84 for coconut shrimp.

Whole Foods swiftly admitted that there were issues with its food labels. Co-CEO Walter Robb owned the mistake and offered an apology to customers. The company committed to increase training at its stores. Mr. Robb also maintained that the mistakes were unintentional, and that this claim was supported by examples of labeling mistakes both in the customer’s favor and not in the customer’s favor.

Around six months after the investigation, Whole Foods and the Department of Consumer Affairs entered into an agreement. Whole Foods was fined $500K and agreed to audit the weights and labels of 50 products for quality control.

Luckily for Whole Foods, they were able to rectify this problem seemingly without lasting damage. You don’t have to be the CEO of a Fortune 500 company to know that incorrect pricing is an issue that you must fix immediately and permanently. The customer wants to get what they pay for, and customers were either overpaying or underpaying in this example. Adding further pressure, Whole Foods was already renowned for being expensive. A government investigation concluding that Whole Foods was in fact overcharging some customers did not help that perception.

This example demonstrates that pricing requires both an ability to see the system as a whole and an ability to dive into the nitty-gritty. The price labeling process broke down, and it led to failures of price execution: customers were no longer getting the correct price for their purchases. Sometimes errors in the most mundane pricing activities can lay waste to your entire pricing process.

Would pricing training have prevented the pricing mistake in this example? I will freely admit that I have never been required to calibrate a scale or verify product weights as a pricing professional. It’s a consideration that does not strike me as especially natural in the world of pricing. If a pricing professional never had to record scientific measurements or work in a metrology lab, then this pricing issue may not have been easily foreseen.

However, I wouldn’t bet against pricing professionals. In my experience, I find pricing professionals to be inherently curious individuals. Throw in a focus on process and accuracy, and it seems to me that there is a nonzero chance that a pricing professional would eventually ask, “How do we know these prices are correct? Do we do any auditing? How often and in how many locations?”

At the very least, a pricing professional would know that the investigation put the pricing integrity of Whole Foods on the line. Immediate action was necessary to both address the underlying pricing problem and to communicate the root cause of the error and the planned resolution with the public in as transparent a manner as possible. Whole Foods had to regain the trust of their customers, and a sincere apology followed by concrete action provided a path forward.

Conclusion: Get Trained

Pricing errors are common. (I’m sure it has something to do with being human.) Unfortunately, they are also frequently costly. And, to add insult to injury, many pricing errors are easily avoidable with competent pricing training. Part of pricing training is learning about the pricing mistakes of others and learning from them.

There are many sources of pricing errors. Sometimes it comes down to math. Sometimes it comes down to psychology. Sometimes it’s a combination of these, or it could be something else entirely. But pricing errors are almost always avoidable, if you do the proper research and you have pricing training to guide your decision-making.

References:

Associated Press. “Whole Foods Apologizes for Pricing Problems.” The Wall Street Journal. Dow Jones & Company, July 2, 2015. https://www.wsj.com/articles/AP0e96a0ce41f84a32b91a56f169a167da.

Becker, Nathan. “Valeant Forms Committee to Determine Drug Prices.” The Wall Street Journal. Dow Jones & Company, May 6, 2016. https://www.wsj.com/articles/valeant-forms-committee-to-determine-drug-prices-1462483657.

McNish, Jacquie, and Liz Hoffman. “Valeant’s CEO Was Key Force on Pricing.” The Wall Street Journal. Dow Jones & Company, May 2, 2016. https://www.wsj.com/articles/valeants-ceo-was-key-force-on-pricing-1462148551.

Ramey, Corinne. “Lawsuit Accusing Whole Foods of Overcharging Is Thrown Out.” The Wall Street Journal. Dow Jones & Company, July 17, 2019. https://www.wsj.com/articles/lawsuit-accusing-whole-foods-of-overcharging-is-thrown-out-11563403203.

About The Author

nathanlphipps
Nathan L. Phipps is a Consultant at Wiglaf Pricing. He is responsible for the training preparation and conjoint analysis that supports your company’s pricing project. Nathan will help craft recommendations to help your company manage pricing better. Before joining Wiglaf Pricing, Nathan worked as a pricing analyst at Intermatic Inc. (a manufacturer of energy control products) where he dealt with market pricing and the creation of price variance and minimum advertised price policies. His prior experience includes time in aerosol valve manufacturing and online education. Nathan holds an MBA with distinction in Marketing Strategy and Planning & Entrepreneurship from the Kellstadt Graduate School of Business at DePaul University and a BA in Biology & Philosophy from Greenville College. He is based in Chicago, Illinois.