Pricing capability at Alfa

The part of the local corrugated packaging industry serviced by Alfa was characterized by low levels of product differentiation and price competition driven by large FMCG companies that required mainly standardized transport packaging. Alfa’s strategic position was described as lacking specific ties or close relationship to any specific niche in the market, which made differentiation more difficult. This resulted in a product portfolio characterized as comparable to competitor offers. The fact that Alfa’s products were viewed as comparable to competitor of-fers, in turn, led Alfa towards a focus on efficiency, capacity utilization, and volume. The overall strategic position, briefly recapitulated above, partly explains the type of pricing policy found at Alfa.

Alfa’s pricing policy can be labeled Capacity pricing. The objective and outcome of this policy was the tactical maximization of volume given capacity constraints on machines (i.e. maximization of contribu-tion/machine hour). This outcome was achieved through setting prices based on calculated full costs and available capacity on key machines at the time of the order. The cost-based price of the product was then ad-justed so that low value-added products (corrugated sheets, etc.) were priced with a relatively lower margin to generate a base-contribution on large and capital intensive machines, while more value-added and less comparable products were priced with a relatively higher margin to generate additional profits. Contrary to the classical notion of cost-plus profit pricing where price is set based on full costs and a fixed added margin that corresponds to the desired rate of return, the pricing policy at Alfa displayed a certain level of flexibility across products and time (as capacity utilization changed). This flexibility arose as a consequence of the use of different cost-bases and mark-up or mark-down for

differ-ent types of products, and responsiveness to customer demands put forward in negotiations.

Key characteristics of the pricing policy at Alfa are displayed in Table 6.5.

Table 6.5 Key characteristics of pricing policy at Alfa.

Characteristic Observation at Alfa

Label Capacity pricing

Key dimensions Price discrimina-tion

Product groups are priced at different cost levels to achieve capacity objec-tives

Price elasticity lev-erage

Market factors have a limited impact on the initial pricing decision but affects the final pricing decision through negotiations

Operating leverage Prices are based on the full cost calculation (full cost, cash-flow zero, and variable cost)

Reported benefits Maximization of volume/contribution given capacity restraints

The pricing process at Alfa was characterized by a strong focus on ac-tivities related to the costing of incoming orders and customer negotia-tions. Hence, in the first step, desired levels of overall volume and ca-pacity utilization were achieved by choosing a cost-base that matched the type of product being priced (i.e. full cost if it was a value-added product and cash-flow zero if it was a less value-added product). In the second step, an appropriate mark-up or mark-down on this amount was chosen. This internally oriented activity was focused on the information delivered by the costing system, and on the organizational process of defining an argument to bring into the customer negotiation. Due to the lack of “market input” prior in the process, the customer negotia-tion funcnegotia-tioned as an important instrument for assessing the commer-cial side of products, thus gaining information on the customer’s will-ingness-to-pay and the competitive pressure associated with particular orders.

Key pricing activities are outlined in Table 6.6.

Table 6.6 Pricing activities at Alfa.

Pricing activities Observation at Alfa

Evaluation and planning

(not a key activity) Customer

assess-ment

(not a key activity) Preliminary pricing

decision

Key activity

Price is set based on a choice of a specific cost-base and up or mark-down on the cost base decided by the external sales rep

Negotiation Key activity

Individual customer’s willingness-to-pay assessed through negotiations (high customer responsiveness)

The key pricing activities summarized above were enabled by a particu-lar set of capability elements that have been introduced throughout the case. These capability elements are listed in Table 6.7.

Table 6.7 Pricing capability elements observed at Alfa.

Capability elements Observation at Alfa

1. IT-based systems Plant pre-cost calculation system

2. Price parameters Variable cost, cash-flow zero, full cost, and index of coverage of overhead costs

3. Commercial organization Plant-level organization with internal/external sales reps 4. Pricing authority Pricing authority held by external sales reps

5 Incentive controlling ar-rangements

Secretly added margins in costing system and sales provision 6. Commercial experience Choosing cost base, mark-up and negotiation

The pricing capability at Alfa was, as indicated by the type of pricing activities performed, centered on product costing and the individual sales rep’s interaction with the customer in negotiations. The key ele-ments that enabled these activities are stated in Table 6.7. The most fundamental form of element identified in the case was the product costing system, which provided a fundamental point of reference and source of information for all pricing decisions made at the plant. The costing system should not solely be seen as source of cost information, even though this was an obvious function of the system, but it was also

a kind of an anchor, with particular routines tied to it, stabilizing the whole pricing processes. Even minor details in the design of the costing system played an important role for how pricing was conducted at the plant. An example of this are the different cost-bases (full cost, cash-flow zero, and variable costs) generated by the system prior to the pric-ing decision. The fact that the system was able to generate several dif-ferent cost-bases provided the decision-maker with an additional form of discretion that could be used to caliber the preliminary pricing deci-sion according to the decideci-sion-maker’s judgment of the specific situa-tion. Hence, it provided the decision maker with an additional means for meeting customer demands or adjusting the price to the volume and capacity situation in the plant at the time of the decision.

Other elements identified as important for enabling key activities were related to Alfa’s organization, authority levels and incentive controlling arrangements. Common to these elements was that they acted as a way of controlling the behavior of employees engaged in the preliminary pricing decision and customer negotiations. The secretly added margins in the cost calculation and the set-up of sales provisions provided man-agement with a tool to control the sales rep’s general tendency to re-duce initial prices in order to get the order, while the formal pricing authority provided accountability and ensured that pricing decisions were made by people who were perceived to have the necessary compe-tence and information.

As indicated throughout the case presentation, commercial experience played an important role in Alfa’s pricing capability. This was a key fac-tor in managing customer negotiations and choosing which cost-base, or which mark-up or mark-down, to use for a certain order. The prominence of individual and subjective pricing discretion at Alfa can be seen as result of the lack of other systems for assessing the commer-cial viability of a certain price independent of order costs. However, it also provided Alfa with a means of achieving flexibility and dealing with complexity in the pricing situation that was hard to achieve with a standardized technical system.

Several indications of the dynamic processes that shaped Alfa’s pricing capability were given in the case. First, pricing practices at Alfa were to a large extent developed in response to the competitive environment in which the plant was operating. Hence, coherence with the plant’s

over-all strategic position was an important factor for explaining the emer-gence of the type of pricing practices observed in the case. Moreover, the historical presence of particular assets, and the routines associated with them, shaped the direction in which practices developed. An ex-ample of this was given by the general manager who described how the plant early on invested in a product costing system, and over time ex-celled at this activity, which created a natural tendency to rely on prod-uct costs for the purpose of pricing. Furthermore, observations made at Alfa indicated a lack of explicit managerial intervention on any larger scale to reshape or redirect pricing practices. Rather, pricing had, for a long time, been following an established cost-based tradition and a logic best described as “business as usual”.