Pricing power: using price strategy road maps and tools to maximize bottom-line results: CMAs are trained to achieve best-in-class practices that strive for continuous improvements in profitability, cost management, and efficiency. And yet, when it comes to pricing, many organizations fail to use the tools and processes that enable a best-in-class approach.
More often than not, anecdotes and "gut feel" remain the key drivers for pricing decisions. Consequently, organizations fall short of their potential for revenue and profit maximization In economics, profit maximization is the process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. (RPMs). In addition, lack of a pricing focus can translate into millions of dollars in hidden margin leakage LEAKAGE. The waste which has taken place in liquids, by their escaping out of the casks or vessels in which they were kept. By the act of March 2, 1799, s. 59, 1 Story's L. U. S, 625, it is provided that there be an allowance of two per cent for leakage, on the quantity which shall appear , as well as an inability to support an effective growth strategy. As described in a previous article, "Is the Price Right?" (CMA CMA - Concert Multithread Architecture from DEC. Management, May 2007), neglecting pricing practices can leave an organization's RPMs stuck in first gear. But all is not lost. Pricing, too, can become an effective process when it is based on developing a pricing road map using sound data and pricing tools to optimize RPMs. In Sodhi and Sodhf's Harvard Business Review Harvard Business Review is a general management magazine published since 1922 by Harvard Business School Publishing, owned by the Harvard Business School. A monthly research-based magazine written for business practitioners, it claims a high ranking business readership and article "Six Sigma Not to be confused with Sigma 6.
Six Sigma is a set of practices originally developed by Motorola to systematically improve processes by eliminating defects. A defect is defined as nonconformity of a product or service to its specifications. Pricing," they note: "Many organizations use disciplines to decrease the cost of manufacturing and service processes. They can use the same tools to increase revenues" (May 2005). CMAs, therefore, can lead the way as change agents, by leveraging the power of pricing and implementing best-in-class practices, an opportunity that translates into both short- and long-term financial gains.
Power of pricing
According to according to
1. As stated or indicated by; on the authority of: according to historians.
2. In keeping with: according to instructions.
3. an often-referenced study by Marn and Rosiello (1992), pricing is the most effective lever for increasing profitability--more so than managing cost and volume. In fact, for the average organization, a 1 percent increase in price can result in an 11 per cent increase in profitability. If pricing has such a major impact on net income, why do so many organizations fail to use an effective pricing strategy: "It's like throwing a dart at a dartboard," as one manager said. "How can anyone know what price will work? Just provide a target for the sales teams and leave it to them to hit that target. That's our pricing strategy." But as time passed and margins shrank shrank
A past tense of shrink.
a past tense of shrink
shrank shrink , organizations needed to dig deeper into their world of pricing. In this particular case, the management team chose to conduct a pricing diagnostic. This assessment revealed a strong need to gain control of the pricing process, to reevaluate the organization's value offering, and ultimately to strive towards optimizing profitability by focusing on pricing disciplines.
As an increasing number of boards of directors are realizing that a sound pricing process drives improved bottom-line results, there has been a corresponding increase in deployment of price audits to assess areas of improvement and opportunity. As outlined in "Is the Price Right?" an internal pricing process assessment helps determine which level within the five levels of world-class pricing (also called the world-class pricing framework) best describes an organization's current situation. This audit can help answer questions such as.: how effective are the current pricing processes? and what pricing areas need improvement? The framework (Figure 1) establishes a snapshot of where an organization is today, and helps chart a vision of where it needs to navigate.
[FIGURE 1 OMITTED]
Each level within the Framework provides an opportunity to add new tools and processes to the CMA toolbox See toolkit and toolbar. that sets the stage for improving an organization's bottom line. This article highlights many of these pricing tools (with a strong focus on the Level 2 toolbox) that have proven to be highly effective as organizations progress along the path to pricing improvement.
Improving pricing competency COMPETENCY, evidence. The legal fitness or ability of a witness to be heard on the trial of a cause. This term is also applied to written or other evidence which may be legally given on such trial, as, depositions, letters, account-books, and the like.
Level 1: Baseline process is ineffective
Management meetings at Level 1 companies are usually fraught fraught
1. Filled with a specified element or elements; charged: an incident fraught with danger; an evening fraught with high drama.
2. with stress and tension. One manager described this level as "table-banging arguments whenever the topic of pricing comes up." At this stage there is no defined pricing strategy; pricing processes and reports are non-existent; high margin leakage occurs at every turn; and there is a lack of understanding about the price-value relationship. Revenue changes are often explained using anecdotes rather than sound data and analytical details. As well, pricing managers find they spend a large portion of their time extinguishing internal political fires with little or no time spent investigating margin opportunities. If an organization resides within Level 1, it is important to perform a full pricing diagnostic across all departments to identify areas of pricing weaknesses that require process and tool enhancements. It is also important to meet with different levels of employees and map all potential areas for margin leakage. Once these weaknesses have been defined, it is necessary to audit and track improvements using various pricing management tools as described in Level 2.
Note that moving towards Level 2 will require a change agent, as there are internal cultural implications with pricing policy changes, as well as a need to constantly sell the advantages of using world-class pricing management practices--a perfect leadership opportunity for a CMA.
Level 2: Internal processes in place
This level is primarily defined as the "gaining control" stage for pricing. It involves tracking key pricing pitfalls, areas of margin leakage, and poor pricing practices that the company has identified as weaknesses in Level 1. It is important throughout this stage to employ pricing tools that continuously audit pricing activities, track progress, and ultimately strive for improvements. It is also necessary to train and gain buy-ins from important stakeholders Stakeholders
All parties that have an interest, financial or otherwise, in a firm-stockholders, creditors, bondholders, employees, customers, management, the community, and the government. to ensure they use the pricing tools. A prime reason why many organizations remain locked within Level 2 is the lack of engagement and communication with such stakeholders. A majority of the price audit tools are focused within Level 2, since their key objectives are to take a snapshot of the current state and provide a target that overcomes a pricing weakness and gains control. Gaining control of pricing practices is a critical stage within any organization, and requires the support and engagement of stakeholders in order to progress towards a higher level within the five-level framework.
Case Study: Using a competitive pricing report (Level 2) to grow margin
A large technology value-added reseller A value-added reseller (VAR) is a company that adds some feature(s) to an existing product(s), then resells it (usually to end-users) as an integrated product or complete "turn-key" solution. wanted to increase margins within its hardware category (e.g., printers, cables, notebooks, etc.). However, it was having trouble convincing its sales force. Negotiations were excessive, and pricing, to say the least, was out of control (Level 1). A newly formed pricing committee created a competitive price audit report (Level 2 price tool) that was routinely reviewed to assess competitors' online and print catalog catalog, descriptive list, on cards or in a book, of the contents of a library. Assurbanipal's library at Nineveh was cataloged on shelves of slate. The first known subject catalog was compiled by Callimachus at the Alexandrian Library in the 3d cent. B.C. pricing against the company's own. To its amazement, the company discovered it had been "giving away" seemingly irrelevant addon accessories, items that ultimately translated into a bottom-line gain of over $1.5 million after the organization had trained sales reps to take advantage of this margin opportunity. The report ultimately helped the company gain control of pricing, and set the stage for moving to the Level 2 roadmap.
Two of the most commonly used Level 2 tools include the price waterfall waterfall, a sudden unsupported drop in a stream. It is formed when the stream course is interrupted as when a stream passes over a layer of harder rock—often igneous—to an area of softer and therefore more easily eroded rock; the edge of a cliff or and price dispersion In economics, price dispersion is the distribution of prices across sellers of the same item, standardized for the item's characteristics. Price dispersion can be viewed as a measure of trading frictions (or, tautologically, as a violation of the law of one price). charts. A successful Price Waterfall chart A waterfall chart is a special type of floating-column chart. A typical waterfall chart shows how an initial value is increased and decreased by a series of intermediate values, leading to a final value. (Figure 2a) must integrate the CMA's talent for costing analysis, as well as the ability to work closely with all departments to identify areas contributing to margin leakage. Not all revenue is good revenue, and the Price Waterfall helps companies truly understand the net realized price being charged to customers after factoring in these hidden costs. A price dispersion chart is another useful pricing management tool that focuses on gaining control of pricing practices. It provides a snapshot of customer discounts based on their account size (often measured as revenue per year). One CEO (1) (Chief Executive Officer) The highest individual in command of an organization. Typically the president of the company, the CEO reports to the Chairman of the Board. experienced a highly uncomfortable situation when the company's largest multi-million-dollar account discovered that a smaller account was receiving better pricing (buyers often move around companies that are within the same industry). This created a crisis internally, but it also caused the company to try to understand the current state of discounts and use the Price Dispersion tool (Figure 2b) to establish future discount boundaries. The choice of which pricing tools to use will depend on an organization's pricing-strategy road maps, defined within its original pricing diagnostic. Some tools will be more relevant than others, depending on your pricing needs, and it is important to use those that drive the greatest improvements in RPMs. Other Level 2 tools include: competitive analysis reports, outlier outlier /out·li·er/ (out´li-er) an observation so distant from the central mass of the data that it noticeably influences results.
an extremely high or low value lying beyond the range of the bulk of the data. analysis/reports, deal/bid sheets, pricing process documentation--accountability & guidelines, customer profitability Customer profitability (CP) is the difference between the revenues earned from and the costs associated with the customer relationship in a specified period.
According to Philip Kotler,"a profitable customer is a person,household or a company that overtime,yields a revenue reports, and cost-to-serve analysis.
Figure 2a (Price Waterfall) % of List Price List price 100.0 Price concession -18.0 Net freight charged +6.0 Invoice price 88.0 Sales commission -8.5 DSO carrying costs -3.0 Quartery rebate -4.0 Annual rebate -3.0 Mechant fees -1.3 Financing -1.0 Early pay discount -2.0 Free value-adds -14.0 Credit rebills -2.0 Net (realized) price 48.3 COGS -40.0 Contribution margin 8.3 Note: Table made from bar graph.
[FIGURE 2a OMITTED]
[FIGURE 2b OMITTED]
Level 3: Value Processes in Place
Value is a frequently used term within the B2B (Business to Business) Refers to one business communicating with or selling to another. See B2B e-commerce, B2C and B2G.
B2B - business to business and B2C (Business to Consumer) Refers to a business communicating with or selling to an individual rather than a company. See B2B. environments, but it's also one that is least understood. What does value have to do with price, one might ask? Everything. In fact, pricing and value go hand in hand, and drive the top-of-mind mentality at the higher levels of the world-class pricing framework. Level 3 is often considered a paradigm shift A dramatic change in methodology or practice. It often refers to a major change in thinking and planning, which ultimately changes the way projects are implemented. For example, accessing applications and data from the Web instead of from local servers is a paradigm shift. See paradigm. for many CMAs, especially for those who rely heavily on cost-plus pricing Cost-plus pricing is a pricing method commonly used by firms. It is used primarily because it is easy to calculate and requires little information. There are several varieties, but the common thread in all of them is that you first calculate the cost of the product, then include an practices. Cost, of course, is always an important consideration for ensuring a price point drives profit. But a cost-plus pricing approach is far from an optimization practice. Value-based pricing Value-Based Pricing
A pricing strategy in which a product's price is actively dependant upon its demand.
This method of pricing allows companies to take advantage of highly demanded products by charging more. , on the other hand, seeks to truly optimize revenue and profitability by understanding what customers are willing to pay based on the value of your offering. Historically, value has been more subjective than quantitative. But there are ways to measure how customers perceive value, their willingness to pay Willingness to pay (WTP) generally refers to the value of a good to a person as what they are willing to pay, sacrifice or exchange for it. See also
Value also plays a critical role in market segmentation Market Segmentation
A marketing term referring to the aggregating of prospective buyers into groups (segments) that have common needs and will respond similarly to a marketing action. and growth strategies. Many growth strategies fail, unfortunately, because they focus too much on acquiring market share with price, a tactic that often leads to lower profitability and back-and-forth market-share gains and losses. A best-practice growth strategy, by contrast, takes a more hands-on approach to help companies understand the value perceptions of different market segments. An understanding of how these market segments perceive product attributes, and their willingness to pay, is critical for value-engineering effective products and offerings. The price-value map (PVM (Parallel Virtual Machine) Software that enables multiple Unix and Windows NT/2000 computers to function as one large, parallel machine. It is used to solve scientific, industrial and medical problems around the world. For information, visit www.epm.ornl.gov/pvm. ) is an excellent Level 3 pricing tool that can help assess how customer segments perceive a company's offering and prices relative to the competition. Other Level 3 tools include: In-market research tests, pricing tests (conjoint analysis See also: Conjoint analysis (in marketing), Conjoint analysis (in healthcare), IDDEA, Rule Developing Experimentation
Conjoint analysis, also called multi-attribute compositional models or stated preference analysis, is a statistical technique that originated in ), transactional analysis, cost by SKU (StockKeeping Unit) The number of one specific product available for sale. If a hardware device or software package comes in different versions, there is an SKU for each one.
SKU - stock-keeping unit , cost by customer segment, and price-volume-profit modeling.
Level 4: Optimization processes in place
Level 4 is the stage in which an organization fully integrates what it has learned in Level 3 about its customer segments, as well as the purchasing behaviour driven by these segments, based on pricing and the value of an organization's offering. Level 4 pricing experts will integrate all of this knowledge within an optimization model to drive a product offering that results in the optimal RPM. Such models estimate the impact of short-term promotional prices as well as longer-term price scenarios.
Historical transactional analysis can also play a critical role in optimization, by helping companies understand the past purchasing behaviours of their account base. This stage will require CMAs to wear their statistical and analytical hats, since they will need to build optimization and forecast models. The key to building such models is to understand the price actions and reactions as determined from both Level 3 research as well as historical transactional datasets. For a bank, this might include a model that determines which combinations of account savings rate Savings rate
Personal savings as a percentage of disposable personal income. offerings produce the most profitable outcome. Models would need to address key questions, such as how savings rates affect new-customer acquisition, as well as their impact on the current customer base. For a newspaper firm, a model could address how historical classified-advertisement purchasing data can be used to determine optimal bundles that encourage these customers to upgrade to larger and more profitable classified ads.
Another key consideration for optimization modeling is the long-term optimization benefits (i.e., customer lifetime value, or CLV (Constant Linear Velocity) Rotating a disk at varying speeds. By changing speed depending on which track is being accessed, the density of bits in each track can be made uniform. ). In the case of a bank-optimization model, a low savings rate might show a dramatic short-term increase in profitability (e.g. paying out less interest to customers). But as time passes, the bank could lose current customers and find it difficult to acquire new ones, thus lowering optimization profitability in the long run. An optimization model would factor in a balance that strives for both short- and long-term profitability.
Various optimization tools available in the marketplace include the Microsoft Excel (tool) Microsoft Excel - A spreadsheet program from Microsoft, part of their Microsoft Office suite of productivity tools for Microsoft Windows and Macintosh. Excel is probably the most widely used spreadsheet in the world.
Latest version: Excel 97, as of 1997-01-14. add-in Solver and SAS (1) (SAS Institute Inc., Cary, NC, www.sas.com) A software company that specializes in data warehousing and decision support software based on the SAS System. Founded in 1976, SAS is one of the world's largest privately held software companies. See SAS System. . It would be worthwhile as a CMA to learn Solver and begin to understand the inputs and constraints that go into optimization modeling (see Solver training link provided in the endnotes).
Level 5: Excellence in execution
As the pinnacle of the pricing framework is reached, there will be an increasingly strong sense of pricing synergy across all departments and channels. At this level, the benefits of pricing are a top-of-mind mentality for all managers and executives. Pricing is no longer considered a "battle," but rather, pricing excellence is integrated into the culture throughout the organization. Marketing, sales, operations, and accounting all have a stake in the world of pricing, and regularly ensure they: (a) review and improve upon key price audit tools within Level 2; (b) continuously strive to understand customer segments and value perceptions from Level 3; and (c) optimize the organization's offerings based on understanding customer behaviour in Level 4. As well, Level 5 CEOs recognize pricing is a core capability, and ensure the pricing mindset mind·set or mind-set
1. A fixed mental attitude or disposition that predetermines a person's responses to and interpretations of situations.
2. An inclination or a habit. is a priority across the entire organization.
A great example of Level 5 world-class pricing involves a well-known Fortune 100 hotel chain. This chain has over 150 revenue management analysts who are able to optimize room rates based on region, segments, room types, bookings, and forecasted vacancies. These analysts seek to optimize revenue and profitability, as well as key pricing indicators (i.e., revenue per available room, or RevPAR), by measuring, analyzing, and improving both prices and the pricing process itself. In addition, the company is constantly evaluating its value offerings and making changes in product offerings that strive to fully understand its customer segments and their purchasing behaviour. For example, various hotel regions tap into luxury segments, while others focus on conference and "guest experience" opportunities. Ultimately, the chain's pricing mindset and commitment to delivering value (price and value go hand in hand) has generated year-over-year growth in both earnings per share and return on invested capital). In its most recent financial statement, the chain said these results were "largely driven by pricing."
Building a pricing strategy road map, as well as expanding the CMA toolbox, is critical for pricing success and improving bottom-line results. The roadmap provides a plan of action and sets a vision for revenue and profitability improvement. However, it is important to understand that this is a step-based process that takes time. Some organizations try to rush from one level to another at the expense of not gaining internal buy-in, or not effectively integrating and implementing a new pricing process. It can take 12 to 18 months to achieve and consolidate a position at a new level before progressing to the next. Even exposure to new pricing tools requires sound training and buy-in from key stakeholders. One colleague uses what is termed "the seven times rule"--it can take seven times for stakeholders to be exposed to a new tool before they stop fighting the data and start using it to their advantage.
The benefits of using the five levels of world-class pricing are too great for any organization to ignore. Many companies are already reaping the rewards, while others remain stuck in first gear for their RPMs. CMAs have an excellent opportunity to improve their organization's pricing power Pricing Power
An economic term referring to the effect that a change in a firm's product price has on the quantity demanded of that product. Pricing power ties in with the "Price Elasticity of Demand. and take it to the next level. As one Fortune 100 CEO mentioned: "Nothing gets me more excited than someone providing me a detailed plan to generate an extra $2 million in profitability." If an organization is stuck in first gear, now is a better time than any to rev up Verb 1. rev up - speed up; "let's rev up production"
increase - make bigger or more; "The boss finally increased her salary"; "The university increased the number of students it admitted"
2. its RPMs by navigating the road map to pricing excellence.
Endnotes and Additional Valuable Pricing Resources
(1.) Introduction to Optimization with the Excel Solver Tool: http://office.microsoft.com/en-us/help/HA011245951033.aspx
(2.) Marn, M., Roegner, E. and C. Zawada. The Price Advantage. John Wiley John Wiley may refer to:
(3.) Professional Pricing Society (PPS (Packets Per Second) The measurement of activity in a local area network (LAN). In LANs such as Ethernet, Token Ring and FDDI, as well as the Internet, data is broken up and transmitted in packets (frames), each with a source and destination address. ). www.pricingsociety.com
(4.) Sodhi and Sodhi. Six Sigma Pricing. FT Press, 2007.
By Scott Miller Scott Miller may refer to:
Scott Miller, CMA, is a senior consultant with Toronto-based Pricing Solutions Ltd, He provides pricing-related management, research, strategic and training services for North American North American
named after North America.
North American blastomycosis
see North American blastomycosis.
North American cattle tick
see boophilusannulatus. and European clients and can be contacted at firstname.lastname@example.org.