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The price is right at Hewlett-Packard.

Do you ever have a sneaking suspicion that your pricing might not be right on the money? If so, get some pointers from a financial executive who helped his company create a lean, mean pricing machine.

Recently, Hewlett-Packard took a long, hard look at its pricing methods and found that they no longer worked. Faced with a changing marketplace and product mix, the company opted to consolidate its pricing by adopting a global pricing initiative in November 1992. Steve Webb, controller of Hewlett-Packard's Software Business Unit, led the project and describes how the company accomplished this transformation.

Financial Executive: Can you explain Hewlett-Packard's pricing before the company's global pricing initiative?

STEVE WEBB: We split pricing responsibility and reported our revenue in two pieces. In addition, the base-product pricing was U.S.-oriented, while our international pricing was largely cost-based.

Each business that was responsible for a product established a base price for it that was usually identical to the U.S. list price. The international sales entities also used an uplift, which is added to the base price to recover the "incremental costs" of doing business overseas. Our internal reporting systems then tracked the two pieces of the price separately, measuring the sales entities, in part, by the cumulative international uplifts, which we called trading income.

In retrospect, these practices insulated the businesses from some of the complexities of international operations, and the decentralized pricing was appropriate -- or at least tolerable -- given the global environment in years past, when we sold big-ticket proprietary products through a direct sales force and had only a few multinational accounts.

Why did Hewlett-Packard decide to rethink these methods?

In 1991, we decided that we needed to change, primarily because the environment and our product mix both had changed dramatically. Today, we sell many more lower-priced, standards-based products to many global organizations, and we increasingly operate through resellers. Laserjet printers are a good example. When a company has significant price differences around the world, it's leaving itself open to arbitrage and cross-border buying. Even a $1 price difference in laserjet toner cartridge prices can shift a large percentage of worldwide purchases to the lower cost source. This would be very disruptive and costly for us. We -- not the geography -- must control the prices here.

At one point, our computer memory-board prices were so high in the United Kingdom that it was said customers could fly to New York on the Concorde, buy the boards, fly back to London and still have money left over for dinner. The price differential between the United States and the United Kingdom was that great. As our customers became aware of such differences, they began to shop the world for the best opportunities and prices.

For these reasons, the old cost-based mentality didn't cut it for us any more. If we could justify higher international prices in a way that added value for the customer, we wouldn't have had any problem. We could explain, "We've imported the product for you and paid the duty." In some cases, we might also be able to say that we'd bundled some local services into the U.K. price or that we offered more favorable payment terms.

For the customer, these are tolerable reasons for steeper prices because they save money in the long run. But if we were to say that our prices were high because our European salesforce was costly, for example, we'd justifiably get a glassy-eyed stare. Therefore, we could no longer just blindly pass along "incremental costs" to the customer. We had to justify prices on the basis of customer value.

Getting rid of the cost mentality was a healthy development for Hewlett-Packard. A European sales manager once chided me for criticizing our then-high selling costs. "Don't worry about it," he said, "because we price for it. High selling costs mean more revenue." He told me this with a straight face! What about the split reporting of revenue for internal management reporting?

That, too, became a problem when we decided we wanted more accountability for our gross margins. Various price-adjustment tools had evolved, some of which affected base price revenue, and some of which affected only the international uplifts or trading income. Because we split the reporting of our customer revenue, no single manager was responsible for gross margin in the form in which we report it externally. You can imagine the complications and finger-pointing problems this caused.

Our performance metrics also created a bias for high international uplifts. Imagine that you're the manager of a sales entity and that you're measured by the amount of trading income you generate. Let's say the base price for a certain H-P product is $1,000 and you are selling 5,000 of those items per year. Before our global pricing initiative, you might have decided to add a $200 uplift to the product even if that price increase meant a drop in annual volume to 4,000 per year, because it would add to your trading income -- to your scorecard -- even though it would decrease total Hewlett-Packard revenue.

Likewise, a sales entity manager could drop the price of an extremely price-sensitive product and dramatically increase the volume by pulling in sales from neighboring countries. This is just a way of shifting business to makeorder performance look better. Clearly we had a gap in our goals, but reasonable managers kept this problem to a minimum.

This same dynamic, however, led to the development of numerous local programs in the sales organizations that were "funded" by special uplifts. These programs may or may not have been valuable for the company, but it was faulty economics to assume that price uplifts could effortlessly fund sales programs, while investments inside the businesses were subject to rigorous return-on-investment analyses. Because the local programs weren't subjected to the same close scrutiny, we may not have been making the right investment decisions. Given these problems, how did you change your pricing methods?

First, we made businesses entirely responsible for their worldwide pricing. This doesn't mean that we have uniform pricing all over the world, and it doesn't mean that we have divisions in Boise, Idaho, blindly pricing products for the Taiwanese market without understanding the local competitive situation. Each business now has geographic outposts, called marketing centers, which advise it on the local marketplace and help formulate local prices. We took the sales organizations out of the pricing decision loop, although the administrativeorganizations in the countries provide valuable logistic support and information on freight and duty rates or local payment terms, which may be relevant to the local prices.

We also abandoned the notions of base price and uplift and now report the entire customer price, converted into U.S. dollars, back to the responsible business. Trading income is no longer in our vocabulary, and sales organizations are no longer evaluated as profit centers relative to trading income and trading expense, such as freight, duty and so on. This had become a dubious measure inany case. As more products became market-priced, the uplifts weren't necessarily related to the expenses.

Our whole system of performance measurement is now more simple and intuitive. Gone are the days when we had to teach new financial analysts about such things as "trade discount on uplift," and we no longer instruct our accountants to divide single-customer transactions, such as dealer price-protection credits, into two pieces, one for the business and one for the sales entity. We keep the customer transaction whole.

For instance, if a Japanese customer buys a 100,000-yen product and gets a 10 percent trade discount, we convert those amounts into dollars and show that as a single transaction in all Hewlett-Packard systems. Before, we'd divide that into a base price piece and an uplift piece and report them separately. We even had some extraordinary cases in which the sales entity might grant additional trade discounts only on the uplift portion of the price, so that a business never realized the actual trade discounts granted on its products. This made it difficult for us to assess the total "cost envelope" of using various sales channels, because we didn't have a complete picture.

You've spoken of changes in the company's management processes and internal performance measurements. Did you undergo changes on the legal side, between the parent company and the sales subsidiaries?

Yes. Because we moved pricing responsibility from the sales entities to the business, we could hardly hold the sales subsidiary manager entirely accountable for the legal profitability of the subsidiary. For example, a business might want to deliberately keep prices low in a certain geographic area for a certain period of time in order to build market share, regardless of the effect that decision might have on local legal revenues.

If you asked, then, who is responsible for subsidiary profitability, the answer might be no one. That's because we've changed our method of subsidiary funding to guarantee that the subsidiary receives an appropriate return on its value-added costs. We do that by varying the intercompany discount we grant the subsidiary. Does this remove the sales organizations' incentive to be efficient? No, because we use a system of management metrics, such as cost-per-orderdollar, instead of legal profit. This provides us with the proper incentives and control.

What were the biggest ramifications of the change?

Since we once insulated our businesses -- our product lines and individual divisions -- from many international business complexities, we now have to educate them. For example, swings in the exchange rates now directly affect their financial performance. If the U.S. dollar strengthens in Germany, should the product line raise deutsche mark prices in order to preserve unit dollar revenue, or should it hold local prices constant in hopes of building market share against U.S.-based competitors? Would an increased manufacturing presence in the country allow more stable local pricing?

This may be new territory for some of our businesses, but these are real-world issues and I'm happy to see that much of the talent and energy that used to be spent "dividing the pie" internally is now being directed toward effective competitive pricing, making the pie bigger for all.

Of course, we have more to do. Some of our systems are still lagging, and we're currently re-engineering our pricing systems to provide consistent algorithms for adjusting local prices. This will permit instant access to product prices worldwide. But by adopting our global pricing initiative, we've achieved much better consistency, control, and responsiveness in our international pricing, and that's a competitive advantage for Hewlett-Packard.

THE PRICE OF CHANGE

Until Hewlett-Packard adopted its global pricing initiative, it was pricing its products with an outdated corporate philosophy, and the company was beginning to feel the effects. Here's the rundown on why and how H-P brought its system up to speed.
Why We Needed A Pricing Makeover

The Trends What They Meant

Marketplace
Local |right arrow~ Global Markets Arbitrage

Product Mix
Proprietary |right arrow~ Standard Products Substitution

Distribution
Direct |right arrow~ Indirect Channels Gray Markets

Customer Attitudes
Cost |right arrow~ Value Mentality Customer Demands
How We Turned Things Around

What's Out What's In

In Corporate Culture...
Cost Mentality Value Mentality
Internal Focus External Focus
U.S. Focus Global Focus

In Pricing Authority...
Local Pricing Autonomy Business Control

In Investment Criteria...
Fragmented Uniform

In Corporate Reporting...
Complex, Divided Simple Revenue
 Reporting
COPYRIGHT 1994 Financial Executives International
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1994, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:International; interview with Software Business Unit controller Steve Webb
Publication:Financial Executive
Article Type:Interview
Date:Jan 1, 1994
Words:1890
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