Category Archives: Okategoriserade

Price models – how to capture value in a business ecology

A business model should give answers to how an organization intends to create and
capture value in the business ecology that it’s a part of. Value creation, as well as value
capturing, is heavily dependent on the pricing strategies that the organization applies.
Without well-grounded price models that identifies necessary value creation conditions
(price models addressed by partners and sub-contractors), and conditions for value
capturing (price models addressed towards customers), there is a great chance that the
business model won’t be realized.

As the digitalization of the society has increased, so has the possibility to develop
innovative price models. In the wake of it a myriad of price models that challenge
prevailing branch standards have occurred. But what are the actual ingredients of a
price model?

The five dimensions of a price model

The research performed by CASIP has enabled us to identify five dimensions that
altogether constitute the ingredients of price models. The Scope of an offering, the
temporal rights, actors influence on pricing decisions, the price base, and the price
formula. Below follows a description of all of these five dimensions.

Price model equalizer

Scope

In this dimension of the price model it is constituted what is the core of the
product and what is at the outer edge of it. The product can be a system, or package,
consisting of many different functions or attributes that are priced together as a whole
(e.g. an all-inclusive trip). Opposite to this the offering can be priced based on single
attribute level, where the customer can choose which attributes are of interest and pay
for them separately (e.g. a trip where you separately book flights, trains,
accommodations, etcetera).

Temporal rights

Dimension number two in the price model deals with five different
types of temporal rights that a customer can obtain when buying product. It can be pay-
per-use, which means that the customer must pay each time they use an offer (e.g. pay
for each visit at the theater). Then there are different variants of time-limited rights
from subscription (pay in advance for something that is not fully developed, e.g. a
streaming service), rent (access for a certain time, e.g. a car rental for a weekend), and
leasing (access for a certain period of time with the possibility of buying eternal rights,
e.g. private leasing of cars). The opposite of the pay-per-use is perpetual, which means
that a customer can theoretically utilize the offer forever and at the same time have the
sovereign and unlimited right to sell the price object if they want (e.g. traditional
purchase of a car).

Influence

The next dimension in the price model illustrates the power balance
between buyer and seller regarding the actual price decision. A price model holds six
different ways in which buyers or sellers may influence a price. If it is determined
exogenously, neither the seller nor the buyer has power over the price decision. Instead
it is entirely external factors that determine it (e.g. commodity prices on a world
market). The influence gradually increases for both parties depending on whether the
price is determined by auction, if the customer gets to pay-what-you-want (e.g. when
visiting cultural heritage institutions), if the price is result-based (e.g. brokerage fee) or
if it is negotiated (e.g. buying service from a craftsman). The other extreme in the
influence dimension is that the seller has complete power and the buyer is offered a
fixed price list (e.g. what we usually encounter as customers in a grocery store).

Price base

The fourth dimension of a price model contains three different stages that
affect the price level. Is it based on calculations of costs that have occurred during
development, production, distribution and sales? Or is it based on the price the
competitors are offering (taking into account if your offering is over or underperforming
in regard to competitors)? Or is the price set based on the value customer perceives in
the offering?

Price formula

The fifth and final dimension of the price model describes how the
price relates to quantity. Here we find five different types of formulas, one of which is
totally voluminous, i.e. price per unit (e.g. per liter of gasoline). Furthermore, there are
various combinations of volume-variable and fixed price formula, such as per unit up to
a certain ceiling (e.g. parking fee per hour up to 6 hours and then for free) or purchase
volume to use up and then you pay per unit (e.g. a certain volume of mobile phone
internet surf that you can use, then you pay for each additional megabyte of surf), or a
fixed price to access the product and then when you use it you pay per unit (e.g.
electricity subscriptions). The fifth price formula is fixed price, i.e. you only pay one
price regardless of how large or small the volume you use (e.g. subscription to a
streaming service).

Pricing impacts risk

Threat or opportunity?

In our daily life we often think of risk as a threat to guard against. In our private and professional lives we plan and prepare for what may happen, take out insurance etcetera. Risks of course can never by avoided entirely. Our future is uncertain. And on reflection, it would be both unpleasant and dull to have full knowledge of what will happen.

Risk

But risk also has an upside. The uncertain future may benefit us, and insurance firms earn money through selling insurance. “One man’s gain is another man’s loss”, it used to be said. Most deals, even in private life, can turn out to be successes or failures. The upside (a good investment) can not be distinguished in advance from the downside (markets go down).

This is where the link between price (and price model) and risk becomes important. The choice between owning and renting is an obvious example. For customers it may be about flexibility, for the supplier between selling the object now or expecting greater profits from continued ownership. In price models we also include the duration of a contract, service promises and how termination is regulated.

Price models allocate risks!

Risk and uncertainty is split between the parties to a deal, depending on the contract. A wise price model may reflect that their views differ. The supplier may have past statistics showing that repair needs are infrequent or that most customers overestimate their use of a service, like the case is with gym cards. A customer may worry about high monthly fees and therefore prefer to buy full service at a fixed, high price on joining.

Especially for objects whose price on the market is highly cyclical, like housing, this may seem rather self-evident. We probably think less about it for price contracts for audit books or an e-book library, or suppliers delivery capacity. But in those cases also, there are price models that mix a fixed (monthly) component with variable charges based on usage. And usage can be measured differently, in the audit book example for instance based on how many books you started reading, how many you actually read through, how long you used them, and if you are allowed to download and keep them.

Mixing different price models for different deals can have a high impact on profitability. A gym that charges per visit, but has high fixed costs for staff and premises, takes a greater risk than another gym which sells annual membership long in advance and can adapt staff and localities after customers usage pattern.

To identify risk and how they can be handled through price models is a field where we at CASIP want to learn more through continued research. In our books and article we have not yet written that much about it, but that will come soon!

Revenue model, remuneration model or price model?

Words like revenue model and compensation model sometimes signify a reluctance to talk of price models, maybe because the word price seems too commercial. To be compensated for something implies a fair payment for the cost and trouble a supplier has, maybe on a no-profit basis.

If we look more closely the distinction is not so clear. Suppliers need to get paid. Not only for direct costs when they do something for a customer or a user, but also for things which are not always easy to link to a particular delivery: equipment, premises, competence and solutions developed earlier. Even without a profit motive cost calculations can be rather tricky. (For reports in Swedish by some of us at CASIP go to www.konkurrensverket.se)

Fair remuneration and unfair prices?

In order to develop improved compensation or remuneration models, emerging knowhow on price models is therefore highly relevant. A price model concerns a particular business deal and describes what is included and what determines payments. Examples we all are used to include mobile phone contracts: fixed and variable fees, pots and duration differ between suppliers. Which contract suits whom best, and how supplier and customers reason when they design and choose between different options, are some of CASIP’s key research areas. Price as a strategic selling point!

Using the word price rather than remuneration or compensation puts the emphasis on how customers react. A fixed fee for you mobile phone may lead to higher usage than if consumption affects your monthly bill. In this example this fee may actually match operators’ costs, as each call or message hardly makes a difference. But if fixed fees lead to demand which has to be met through additional capacity this will no longer be true. A price model with different prices over the day, or for different days of the week, would then reflect long-term cost more fairly.

In a market economy one basic idea is that prices adapt over time, making it possible for suppliers to produce what customers value, and for customers to pay the costs they cause. If it is no longer individual goods or services that cost, but for instance access to a network, or a hospital nearby (even when we don’t visit it), then we need price and remuneration models which allows us to pay for these.

Compensation models are price models!

Both companies and public activities need price models that provide fair compensation for costs, and as users we need to show our preferences for different “bundles” of goods and services through price models which allow a rational choice. When a firm or a public utility buys goods and services the same is true. Within a state, a region and inside corporations similar models are needed in order to agree on how supplied goods and services should be accounted for. Like mobile phone contracts such agreements are usually long-term, and both buyer and seller should be happy about the deals. They should also have incentives for joint improvements: increased quality through new methods, and joint initiatives for the future.

Compensation models should then mirror the experiences being won through innovative price models. What should be included in an agreement? What is the basis for prices? How are they linked to different aspects of the deal?

At CASIP we find innovation in price models and revenue models particularly intriguing and challenging. By linking prices to different factors and mixing fixed and variable compensation prices impact behaviour. What is right for your industry and your organisation?

Course in pricing

Are you interested in a course in pricing? If so, we suggest one of ourcourses based on our book “Pricing – Business ecologies, business models, price models”. The book will be released in 2019. In these courses we teach about howto align the business model and the price models. As well as how these should bedesigned to fit with the greater business ecology that the company is part of.

People around a table in a classroom

If you are a business professional, we suggest any of the following two courses; ”Strategisk prissättning och innovativa prismodeller” at Företagsekonomiska Institutet in Stockhom. Or ”Strategisk prissättning, innovativa prismodeller och digitalisering” på Chalmers Professional Education i Göteborg

Pricing, and the selection of appropriate and innovative price models, is an important and strategic issue. Their design will directly affect the business’ revenues. In our book and in the courses, we present a framework that can assist companies in developing innovative price models and strategies to improve the business model. In addition to the theoretical framework, we also present a number of practical examples of companies that have designed and implemented innovative price models. Both Swedish and international cases are described.

If you are a phd student who is looking for a course on business ecologies, business models and price models, we suggest you apply to our phd course at Linköping University.

Finally, if you are interested in a tailored program about strategicpricing and innovative price models for your organization, please send a mail toany of the researchers in CASIP. Our contact information can be found under About CASIP