Indexing of Prices: Good Marketing or Bad Revenue Growth Management?

Price Indexing is when a brand owner sets one or more indexes between products for what the prices should be. The base product is set at index 100, and then other products in the range is set at e.g. index 90 or index 120. Competitive price indexing is when the brand owner wants to e.g. always be cheaper than the competition by setting a price index of 90 vs the competitor's index 100. Or index 110 to always be more expensive.

Indexing prices across a product range can be seen as both a good marketing strategy and a potential pitfall in revenue growth management, depending on how it is executed and the market context. Let's explore both perspectives.

When Price Indexing Helps Brand Building and Strategic Positioning

Brand Value Hierarchies

Price indexes can be used to build a hierarchy of pricing for own products and brands in a category:

One product, typically one with larger volume is set to index 100. Other products in the range, either for a same brand or a separate brand owned by the same company, then have target indexes set too. In the above example, the larger version of the main product is then aimed to be priced at 30% higher than the regular size of the main product.

Price Consistency

One of the advantages of managing a price indexing system is price consistency. Consumers appreciate transparent and consistent pricing, which can build trust and loyalty.

If communicated externally (not always the case), then a price index structure also provides simplicity: A clear pricing structure makes it easier for customers to understand the product range and make purchasing decisions.

Market Segmentation

By indexing prices, companies can effectively segment the market and target different customer segments with products at various price points.

Price indexing also helps in differentiating products within the range, allowing customers to see the value in premium products.

Psychological Pricing

 Within the space of psychological pricing, price indexing is very useful for "Anchoring": Setting a high-priced item as an anchor can make other products in the range appear more affordable, encouraging purchases. This plays into the perceived value, as proper indexing can enhance the perceived value of mid-range products by positioning them between economy and premium options.

Competitive Positioning

One of the most alluring aspects of price positioning is benchmarking against competitors. It is hoped that indexed pricing allows companies to position their products strategically against competitors, ensuring competitive pricing while maintaining margins. However, this is also one of potential pitfalls of price indexing, as we discuss below.

Why Price Indexing has many pitfalls in Revenue Growth Management

Competitors are not Always Right

Competitive price indexing is about setting an index for one's own brand versus one or more competitive brand. If you e.g. always want to be premium, then you set your own index at 120 against the competitor. If you want to be cheaper, you e.g. set an index of 95 against the main competitor.

As long as you only use the indexes to change own pricing and don't collude with the competition, this is legal practice, and it is tempting to apply to keep value-based price positioning against the competition. "Look, we are more expensive/cheap than the competition".

However, there are several problems with this approach, one being that the competition is not always right. So if you benchmark against a wrong competitor, almost by definition, your prices are wrong too versus what consumers are willing to pay.

Reduced Flexibility

Indexed pricing can make it difficult to adjust prices for individual products in response to market changes or cost variations.

Also, there are innovation constraints. New products might need to fit into the existing pricing structure, which could limit innovative pricing strategies.

Margin Compression

If the lower end of the product range is underpriced to attract customers, it can put pressure on margins across the range.

Also, increases in production or material costs might not be easily passed on to customers without disrupting the indexed structure.

Customer Perception

This is back to that the competitors might be getting it wrong too. Misjudging the price elasticity of different segments can lead to either lost sales (if prices are too high) or lost revenue (if prices are too low). On top, if the price indexing is perceived as artificial or not reflective of the actual product value, it can harm the brand's image.

Competitive Response

Competitors might respond aggressively to indexed pricing strategies, leading to price wars that can erode profitability, and price wars are rarely beneficial, neither to the instigator nor the recipient. In times of rapid changes in consumer preferences or competitive landscapes, such as Covid, high inflation, war or other factors, might require a more dynamic pricing approach than what indexing allows.

Willingness-to-Pay Gaps are Inconsistent

Say an index of 95 works in a single country, or for that matter in a specific channel in a country. Consumers indeed see the value of your brand as being a little bit lower than another brand. However, market research shows that such indexes are far from constant when it comes to consumer willingness-to-pay. The index between two products may be 95 in one channel, but 80 in another channel or even 110 in a third. And between countries market research finds willingness-to-pay differences to easily range from 50 to 200 for the same brands. It is therefore difficult to build price indexing systems against competition cross-channel or cross-countries.

Conclusion: Balancing the Approach

To leverage the benefits of price indexing while mitigating its risks, companies should:

• Regularly Review and Adjust: Continuously monitor the market and adjust the indexed pricing structure to reflect changes in costs, competition, and consumer behavior.
• Customer Insights: Gather and analyze customer data to ensure the pricing aligns with perceived value and purchasing behavior.
• Flexible Framework: Develop a flexible indexing framework that allows for adjustments without disrupting the overall pricing strategy.

Indexing prices across a product range can be an effective marketing strategy if executed with careful consideration of market dynamics and consumer behavior. However, it requires vigilant revenue growth management to ensure that it does not lead to reduced flexibility, margin compression, or negative customer perceptions. Balancing these aspects is key to maximizing the benefits of indexed pricing while minimizing its potential downsides.