How does a business know that it is a candidate for price optimization to improve business performance? Here are some guidelines to get you started
Unless a company already has very strong competency along the entire pricing continuum — from understanding true product and customer profitability, to setting optimal prices and then ensuring that these price guidelines and processes are consistently and efficiently executed — there are usually changes a company can make that will yield immediate improvements with minimal disruption. For this reason, pricing projects are often a top remedy for addressing company initiatives aimed at revenue and/or margin improvement.
However, to truly be ready to embark on a pricing initiative, companies need top-down initiatives and executive-level sponsorship, as well as the cross-functional team that could implement the recommendations. If this foundation is not first laid, the desire to improve pricing is likely to fall into a nice to have rather than a need to have category.
The impetus to focus on revenue and/or margin shaping projects is most often the result of cost-driven issues: Executives either know or suspect that their margins are too low and that there are identifiable things they could do to significantly enhance those margins. Less often, executives view the promise of revenue enhancement as being attractive enough to warrant embarking on a project.
In addition to having executive level support, supply chain executives need the following:
- Identifiable pain points that can be linked to pricing
- The willingness (over time) to change incentives and business processes to accommodate better pricing processes and adherence to them
- The belief that technology can turn what is largely an art into a science and identification of those processes where technology can make the biggest difference
- Pricing expertise and skills in-house to be able to provide necessary data and to work with the resulting output of the pricing initiative
How to Recognize Potential Pricing Problems
Some of the key indicators that lead organizations to believe they have a pricing problem that needs to be addressed include:
- They cannot understand the key causes of revenue or margin issues
- They lack visibility into the profitability of different customers based on existing sales history but suspect that some customers are getting unjustifiably good deals
- They see a lot of variability of quoted prices in seemingly comparable deals
- There are a number of products that do not have set prices
- The time required to re-set and institute new price guidelines is too long and/or the process is very cumbersome
- The time required to process quotes is so long that customers turn to other suppliers
- They lack the ability to measure true product profitability (beyond cost-of-goods-sold)
- Their first bid acceptance rate seems very low
- There is a large percentage of deals sold below target margin
- It seems like a lot of money is being given away during the negotiating process
- There is no concerted way to make sure that the field adheres to target prices
To institute effective pricing reform, there are a few prerequisite steps that should be taken before the start of a project, however there is no one right starting point across all companies and all projects. More often than not, companies gravitate to first seeing what their problem is using an analytics-focused solution, and then they use that information to determine what to address next.
Prerequisite steps include:
- Highlight the most dramatic impacts of pricing on the whole of the organization — create a sense of urgency around financial goals and operational goals across the organization so that momentum and consensus are maintained
- Dedicate a credible project manager who will oversee both technical and business aspects of the project
- Establish a standing team of committed business and technical managers who have sponsorship responsibilities for the project and are accountable for the ultimate results of the project
- Establish project goals and metrics. Prioritize project scope based on potential gains versus metrics-related goals. Be sure that the organization understands the size of potential returns
- Kickoff a data cleansing project in parallel that prioritizes efforts based on potential returns/improvements they can drive
Easing Pricing Reform Into the Company
In most cases, it is not recommended to take a big bang approach since the short-term risks are too high and the time to results is too long to encourage and embolden buyers to embark on such a project.
Gathered from years of pricing projects, one best practice is the importance of maintaining focus and progressing through well-staged and bounded steps (whether it be the most typical of starting with determining what is really the problem via a combination of analytics and diagnostics, or starting by attacking a specific issue such as price management or giving the deal desk all the information they need in one place and in an easily-accessible format). It is not necessary to boil the ocean and try to re-engineer every aspect of the pricing process at once. Greater success occurs by executing a focused and rapid assessment, identifying the low-hanging fruit and starting with that. This approach allows companies to quickly see results and build momentum for pricing initiatives across the organization.
The best starting point for each company will be determined by a unique combination of their most pressing requirements and current capabilities. The next step in succession will be determined again by these factors, in combination with leveraging the new data and capabilities acquired in the first step.
As noted earlier, in many cases pricing analytics is the most logical starting point for companies seeking pricing reform. Many companies do not even have a clear picture of where their biggest pricing problems are, or a way to measure the ultimate financial impact on their business. In this case, analytics provides them greater understanding of their own pricing behavior in a well-bounded project, and then delivers insight that they can leverage going forward. In addition, customers should start with and begin to use the data they already have, as that information can rapidly gain value as more data is collected and good data is sorted from bad.
Some companies, however, choose to start with analytics. In some cases, significant pricing expertise already exists within the company, and the best starting point is in bringing their existing expertise into action with a project based on price setting or execution. In other cases, companies know that their existing pricing guidelines are not being followed, so they look to improve their execution infrastructure before moving on to using more sophisticated pricing methods.
The Pricing Optimization Process
To drive successful pricing initiatives, companies need to pick their best starting point (as noted above), and then build a sequential plan to address all of their pricing issues. An effective approach for companies today combines software, services, and technical and process expertise into cohesive steps designed to accelerate results and minimize risk. By leveraging complete, encapsulated solutions that include software, services and expertise to solve common pricing challenges, companies can swiftly break down price analysis, optimization or execution projects into discrete and quickly deployable steps — demystifying the entire pricing process and transforming pricing from an art into a science.
Companies should consider the following characteristics when evaluating pricing solutions that fit their pricing reform goals:
- The solution reflects the project structure that many companies have eventually arrived at after much discussion and analysis, basically designed so the company can learn from others' experiences so as not to repeat their mistakes
- The solution provides a common framework for determining a company's specific and most immediate needs
- The solution starts where existing data and systems investments can best be leveraged, and where the organization is most aligned to change
- The solution focuses change on one part of the organization at a time to minimize rollout complexity
Once started, pricing optimization is an ongoing process that can deliver continuous value to the organization. As previously mentioned, companies should embark on pricing optimization on a gradual basis rather than a disruptive approach to change the entire organization's pricing strategy all at once. Companies should sequentially address the pricing issues that have the greatest business impact. Keys to successful pricing optimization efforts over the long-haul culminate in that:
- They are designed to provide a logical path for additional steps to address the complete pricing continuum
- Returns from efficiency and new margin opportunities resulting from the initial steps can help fund and guide future initiatives
- Paths are laid out at the beginning to encourage proactive planning for additional progress of the pricing initiative
Pricing as a Lever in the Supply Chain
Price can act as a strategic lever in the supply chain and can be used to influence the demand curve to achieve business objectives while accounting for real-time variables. A company can increase the price of a product to a certain point, and that price change can then influence behavior on the demand side.
Using price as a lever can help organizations overcome situations they face everyday and help them reach business performance level goals for their overall product portfolio. For example, consider a company that has excess inventory of a given product. That company wants to move more of that product and does so by announcing a special discount or promotion for a number of weeks looking forward. Or, consider that same company that has low inventory of a product and needs to transfer demand to another product. Using price as a lever, they can increase the price of the low inventory product to shift buying behavior to another similar product.
Pricing wisdom can influence and impact the supply chain while not only moving the right amount of product, but do so at the price that is going to maximize the result on a company's bottom line.
To conclude, pricing reform can drive significant profitability and revenue improvement across the organization and should not be embarked upon reactively when there is a financial crunch threatening the company. Taking a proactive, continuous approach to pricing optimization will improve financial performance, put more thoughtful structure around pricing plans and drive greater customer and supplier loyalty by providing clearer understanding throughout the value chain.
About the Author: President and CEO Jim Clayton brings extensive experience in building new companies to the leadership team at the Metreo (www.metreo.com). As a principal with Symphony Technology Group, a venture fund affiliated with Bessemer Venture Partners and Accel Partners, he has lent his expertise to numerous portfolio companies, including Qiva, Trigo Technologies, and ePIT Systems. Clayton was an engagement manager with McKinsey & Company prior to his time at Symphony and he also served as a member of its Corporate Finance and Strategy Practice. At McKinsey, he worked with clients in a variety of industries, including transportation, energy, technology and finance. Clayton attended the University of Texas where he earned a BA degree in business administration and a law degree.