Pricing 101: think like a retailer, not like a widget-maker

Tuesday's Wall Street Journal had an excellent feature on how Parker Hannifin Corporation's CEO Donald Washkewicz examined the company's pricing strategy when he took over and found it to be flawed in a much-too-common way:

For as long as anyone at the 89-year-old company could recall, Parker used the same simple formula to determine prices of its 800,000 parts -- from heat-resistant seals for jet engines to steel valves that hoist buckets on cherry pickers. Company managers would calculate how much it cost to make and deliver each product and add a flat percentage on top, usually aiming for about 35%. Many managers liked the method because it was straightforward and gave them broad authority to negotiate deals.

But Mr. Washkewicz thought that Parker, which had revenues of $9.4 billion last year, had stuck itself in a profit-margin rut. No matter how much a product improved, the company often ended up charging the same premium it would for a more standard item. And if the company found a way to make a product less expensively, it ultimately cut the product's price as well.

We here at Blackfriars always like to say that competing on price is the refuge of the incompentent marketer. Yet here was a $9 billion company that wasn't even competing on price -- it was competing on a percentage of its cost. No wonder it was stuck in a profit rut; I'm surprised one of their competitors wasn't taking them to the cleaners.

Fortunately, the company had an executive willing to question "how things always had been done."

While touring the company's 225 facilities in 2001, Mr. Washkewicz had an epiphany: Parker had to stop thinking like a widget maker and start thinking like a retailer, determining prices by what a customer is willing to pay rather than what a product costs to make. Such "strategic" pricing schemes are used by many different industries. Airlines know they can get away charging more for a seat to Florida in January than in August. Sports teams raise ticket prices if they're playing a well-known opponent. Why shouldn't Parker do the same, Mr. Washkewicz reasoned.

Today, the company says its new pricing approach boosted operating income by $200 million since 2002. That helped Parker's net income soar to $673 million last year from $130 million in 2002. Now, the company's return on invested capital has risen from 7% in 2002 to 21% in 2006, putting it on the verge of moving into the top 25% of Mr. Washkewicz's list comparing Parker with "peer" industrial companies.

The moral of this story is that companies should set prices according to the value of products in the eyes of the customer. Unique products like iPod music players, BMW cars, and FedEx overnight delivery change their customer's lives for the better and command prices that reflect that fact. Companies that don't market and price the unique value of their products shortchange themselves, their employees, and their shareholders. And executives that remind companies of that basic marketing lesson will boost their own value too.

Technorati Tags: Donald Washkewicz, Dynamic pricing, Management, Marketing, Pricing, Parker Hannifin