The history of pricing strategy as part of value creation
Go back 20 years and it is fair to say that any form of pricing capability and pricing strategy as part of value creation within a company was extremely rare. It was often only to be found as a strong function in a few select business sectors such as travel, telecommunications and retail.
Roll on a few years and dedicated pricing strategy functions began to appear in Silicon Valley tech sector companies. Software companies soon realised that the value their software delivered to their customers, such as customer insight, sales pipeline management, etc. was highly desirable and that the market's willingness to pay deserved dedicated pricing research and the creation of pricing strategy functions.
Pricing strategy as a tool in Value Creation
Private Equity portfolio companies and software companies can see material uplifts in their Enterprise Value through focussed Value Creation activities, one of which is Pricing Strategy.
In late 2019 a seminal article was published by McKinsey & Company titled "Pricing: The next frontier of value creation in private equity" which was authored by Walter Baker, Manish Chopra, Alexandra Nee and Shivanad Sinha. The original article can be accessed here.
There are three core findings from that McKinsey article that stand out in this context:
"For a typical midsize US company, a 1.0 percent improvement in pricing raises profits by 6.0 percent, on average"
“When PE firms tackle pricing in their portfolio companies, we typically see margin expansion of between 3 and 7 percent within one year.”
“Pricing has an outsize impact on valuations given the EBITDA multiple view that investors apply, and in many cases, it can also lead to increased multiples and therefore further competitive differentiation.”
Pricing research and pricing strategy as part of value creation can have a material impact on margins/EBITDA. Take for example a portfolio company in say a 15x multiplier scenario, a £1m improvement in EBITDA could result in a £15m Enterprise Value (EV) improvement.
Pricing Research
Pricing Research is often the launchpad to knowing where opportunities lie. Good Pricing Research not only tests the market willingness to pay, but also should include sections around getting insight into competitor products, competitor customer satisfaction and testing the product strategy and feature roadmap. Pricing research can often be used to understand the market's prioritisation and value of features. So even where the pricing research confirms current pricing, the insight into competitors and a clear feature product roadmap are highly valuable in themselves.
The bottom line
Pricing Research provides the insight into monetisation opportunities and product strategy; it is the north star that identifies and guides what can be done in these areas. With the potential for outsize impact, work across pricing research, pricing strategy and pricing execution should form part of any company striving to increase their Enterprise Value.