Ignorance is Not Bliss
Most organizations have traditionally used changes in average pricing as a blunt instrument to incrementally drive revenue and profit as well as compensate for
input cost inflation. Decisions that are made more often resemble art than science.
Due to a lack of data, analytics and centralized control, most managers have
no clear idea of the impact of small changes in price on volume, revenue and profit. As a result, many P&Ls come to be afflicted with profit seepage, tracing to
regular, often hidden and uncontrolled on- and off-invoice discounting.
Moreover, these discounts have often become decoupled from customer size and performance as
well as total system cost to serve. Not only is this "giving away the store" on a per transaction basis, but the foregone profit loss over an extended period turns out
to be considerable.
But the times are a changin'.
The New Normal
Today's globally competitive, low inflation environment is no longer amenable to such an ad hoc approach. Conventional wisdom usually rules out price increases due to
volume risk, especially if competition does not follow with a similar increase.
Even maintaining current price levels is challenging enough in a world with Wal Mart,
web-based pricing and a growing number of offshore competitors.
Since delivering profits by growing volume and shaving costs is often no longer the quick and easy fix,
can pricing return as a profit lever?
Thanks to Strategic Price Management (SPM), many firms can now leverage price as the major profit driver, without unduly risking volume. For example, a
study of US retail banks showed that a 1% increase in price, keeping volume and costs constant, increased Return on Equity (ROE) by 6.8%.
The corresponding ROE results
for a 1% increase in volume and 1% decrease in cost was 1.8% and 2.3% respectively. Similar results were found in the Insurance and Fund Management industries. A Boston
Consulting Group study of 1400 US firms with various margins and cost structures found that a 1-2% increase in average price levels increased profits by 25-50%.
Do these dynamics occur in your business?
Enter Strategic Price Management
The objective of SPM is to simultaneously maximize profit, volume and customer value based on the optimum pricing and customer value levels.
SPM leverages the following to deliver ROI-based strategies:
As was illustrated earlier, there is considerable potential to increase and maximize
profits with minimal volume risk. But there are other direct and indirect benefits as well.
- Internal data
- Innovative analytics
- Improved pricing management
SPM can also enable fact-based decision making, improved financial discipline
through centralized control of pricing and discounts, lower sales operations costs, and enhanced customer understanding.
Although SPM will benefit all firms, some sectors and firms are more likely to benefit than others. Industries like packaged goods and wholesalers that market hundreds if not thousands of
products will inevitably have pricing issues.
In some Companies, there can easily be upwards of 10 separate discount programs, administered by
different functional groups, with discounts totaling almost 50% off the list price!
Other firms that do not feature centralized and policy-driven control over pricing,
will also likely face pricing problems as a result of rogue discounting, minimal program transparency & ROI and a price strategy decoupled from the brand positioning.
In most environments, there is wide scope to raise prices a modest 1-2%.
So where do you begin?
Boiling the pond
Answering the following two questions will go a long way to understanding your pricing power (or elasticity) and ability to drive profits:
Although quite straightforward, BCG research indicates that less than 10% of today's managers can answer these questions, and therefore, manage pricing strategically.
- What is the volume, profit and margin impact of a 1% price increase? Conversely;
- What is the volume, profit and margin impact of a 1% price decrease?
This is usually no fault of the manager or his/her team. The science or math of pricing management can be daunting. Often, pricing policy and responsibility is
not 'owned' by one person or group combined with a myriad of standard and performance-based discount and rebate programs.
How do you begin the process of discovery and renewal?
A gradualist approach, focused by product or category, can yield rich (pardon the pun) insights and recommendations.
Elements of this approach would include:
Internally, the effort would require an analysis of historical prices (yours and the competition's) linked to volumes as well as a complete list of all on-
and off-invoice discount programs.
- Specialized analytical tools and resources to quantify the problem and opportunity;
- The role of product substitutes
- An understanding of how customers value your product.
Careful consideration should be taken of how this effort is empowered and executed. Since many of the discounts cut across multiple groups and the data is rarely in
one business unit or level, a multi-functional team including sales, marketing, IT and finance should be commissioned. As the potential returns (and embarrassments)
are large, ultimate responsibility should reside with senior managers with profit & loss responsibility as well as the authority to overcome institutional barriers.
Copyright 2007 Quanta Consulting Inc.
For additional strategic planning insights and a discussion of our relevant client experience, please contact us-
Quanta Consulting Inc.
99 Bideford Ave