Six Sigma operations: from manufacturing to pricing.(QED)(Column)

The other day someone said that operations refer essentially to manufacturing. In today's economy, it is worthwhile to discuss how operations underlie everything a company does--manufacturing, finance, human resources, IT, marketing and even pricing. Not only do all these functions have "operations," but also ideas from manufacturing operations apply to operations in other functions. Likewise, quality control from manufacturing applies to operations in other functions as well.

I will focus on pricing. People in operations research are generally familiar with yield management or revenue management (see the excellent book by Robert Phillips in this regard [1]) but less with the idea of pricing operations of which revenue management is a part. People are also not aware that ideas of quality control such as Six Sigma apply to pricing operations. This is what I discuss here. A recently released book by coauthor Navdeep Sodhi and me [2] discusses pricing operations and application of Six Sigma to pricing operations in detail.

Pricing Operations

Pricing operations entail two types of business processes to ensure operationalizing and adhering to pricing strategy. These are:

1. Modification processes involving list modifications in response to changes in the market environment (but not changes to strategy). For instance, increased petroleum prices in 2005 caused airlines to tag special fees as a way to increase list prices; such decisions are operational because they have a decision horizon of a few months at the most. Modifying price guidelines is also an operational process. Similarly, pricing of products in the same family at a company that produces more than a few of these every year is also operational. Communicating the list price changes as regards customers and internal operations (such as ensuring the update of ERP or other systems) is also part of such operations.

2. Control processes to ensure and track adherence to price guidelines. The purpose of these processes is to ensure high levels of realized prices relative to list prices, the latter being the embodiment of pricing strategy. (Realized prices are what a company actually gets after yielding various discounts.) Control processes also track whether a price promotion was effective in getting the hoped-for incremental sales and additional profits.

List-price changes are not as frequent as individual transactions. Still, tighter operational processes make this process of modifying list prices easier. Tighter processes also ensure that once list prices are changed, these changes can be implemented in the tens of thousands of transactions that follow.