Putting a Price on Pricing
Is this the right time to improve your pricing capabilities, or should you focus all your attention on today’s immediate pricing challenges?
In this tough economy, pricing is more critical than ever. Yet many companies still follow a simplistic approach to setting prices. Using production costs and standard mark-ups. Looking at what competitors are charging. Relying on anecdotes and conjecture from the sales force to determine what customers will pay. And inadvertently creating a haphazard set of pricing policies and discounts that can take on a life of their own.
Here’s the debate:
|Now is the time to improve your pricing capabilities
Pricing is a strategic weapon that can improve performance now and in the long term
|Countless studies show that pricing improvements are the single best way to boost bottom-line business performance through better margins and revenue growth.||Improving your pricing capabilities can be complicated and expensive. You have your hands full just keeping the business afloat.|
|Improved pricing capabilities can help you execute your business strategy and strengthen your market position.||The traditional approach to pricing has served you well for years. Why change?|
|In a downturn, advanced pricing capabilities are more important than ever. They can improve short-term performance while positioning your business to capitalize on the recovery.||Only if you do it right. If not, changing how you handle pricing can do more harm than good.|
|Focus on short-term pricing challenges
Survival is your top priority. Advanced pricing capabilities can wait
|If you don’t improve your pricing performance in the short term, there might not be a long term. A sophisticated approach to pricing sounds complicated and could take too long to implement.||Sophisticated pricing is complicated, but it doesn’t have to take a long time to produce results. You can get a lot of what you need done in two or three months. And some of the best improvements can be made even more quickly – in just a few weeks.|
|Sales people get nervous about pricing changes. They will dig in their heels, or defect to the competition. That’s the last thing you need.||It’s human nature to resist change. A phased approach that protects existing incentive levels during the migration to a new, more aligned compensation structure can reduce the fear factor. Once sales people start seeing the benefits of improved pricing in their paychecks, they are likely to become its biggest supporters. Also, the current economic environment has created a unique situation; it has already established the need for change and severely limited the options for sales staff to jump ship. Making improvements now will be easier than in a strong economy.|
|It costs too much to develop improved pricing capabilities. In times like these, who can afford that kind of investment?||The business results of improved pricing are so large and immediate that it’s often possible to fund projects on a shared- value basis where vendors get paid from the benefits. Your out-of-pocket costs could be zero.|
Mike Simonetto, Principal, Deloitte Consulting LLP, Global Pricing and Profitability Management practice leader
Pricing is one of the most powerful and versatile tools in a company’s arsenal – both in good times and bad. Study after study has shown that the ROI for pricing projects is higher than for any other type of improvement initiative. Improved pricing capabilities can not only help boost your short-term margins, they can help you execute your business strategy and drive long-term revenue growth.
Given these benefits, why are so many companies reluctant to change? Ironically, one of the biggest obstacles is that pricing is considered so important that people are afraid to mess with it. Another big fear is that the sales force will push back. Sales people tend to resist anything that might affect their incentives and compensation and companies worry the best performers might mutiny or jump ship. Also, business leaders in different functions often have their own personal philosophies, methods and data for thinking about pricing and are reluctant to change. All of these forces can quietly conspire to preserve the traditional approach to pricing, even when the benefits of change are compelling. Here are some tips companies should consider in their efforts to overcome the hurdles and harness the full power of pricing:
Dig deeper. One of the first big barriers to improved pricing is lack of detailed, consistent data. The numbers used for financial reporting tend to be overly broad and inclusive. To be useful, existing data must be disaggregated down to the transaction level. Once this detailed fact base has been established, you can slice and dice the data any way you want (by customer, product, geography, etc.), so you can design better strategies and set prices that capture more value from each market segment.
Align pricing with strategy. Contrary to popular opinion, a detailed pricing analysis should be done before setting strategy – not after. Without a solid fact base, decision makers tend to default back to simplistic cost-plus pricing models, theoretical pricing, or haphazardly set prices based on anecdote and conjecture from the sales force about what customers are willing to pay.
Actively manage change. Organizational resistance is the single biggest obstacle to improved pricing capabilities. To increase the chances for success, actively manage the change process. Get stakeholders involved early and often. Roll improvement programs out in phases. Modify incentives to make sure top sales people don’t get short changed. Use the WIIFM model; for everyone affected by the change, explicitly define “What’s In It For Me?” The right approach can turn skeptics into supporters.
Consider culture. Every organization has a unique culture that influences how people think and behave. For example, organizations that are finance-driven will do anything to make their numbers. Organizations that are engineering-driven value technology and innovation above all else. And organizations that are sales-driven never met a deal they didn’t like. When trying to build a broad base of support for improved pricing capabilities, take these variations into account.
Don’t be afraid to lose a few customers. A detailed pricing analysis can help you understand which customers are profitable and which ones never will be. You can then use pricing as a lever to capture more value from your most profitable customers and weed out the deadbeats. The idea of losing customers might be a little scary – especially in this tough economy – but if you are not losing customers every once in a while, you probably are not using pricing to its full advantage. The bottom line is this: if you can’t make money on certain customers, odds are the competition can’t either. Send your competitors these bad customers, while consciously using your price and value proposition to poach their good customers. Not all volume is created equal. Use detailed analytics to know what really drives profitability and segment your customers by the value they create for you.
In times like these, no company can afford to leave its most powerful weapon locked in the closet. Improved pricing capabilities can not only help you tackle today’s most pressing challenges, they can help you position your business for success when the economy bounces back.
A view from the consumer packaged goods sector
Nick Handrinos, Principal, Deloitte Consulting LLP, Consumer Products practice leader
The extraordinary price sensitivity that consumer packaged goods (CPG) manufacturers face today is highlighted by unprecedented consumer shifts across retail channels, pack sizes and from branded to private label. In response to these shifts, retailers are pressuring CPG companies to roll back recent price increases and provide more trade funds to aggressively lower shelf prices.
Savvy CPG manufacturers are not only examining price slopes and brand/category implications, they are increasingly looking at price setting in a holistic fashion net of trade and other allowances. In the face of structural shifts in consumer spending, CPG companies have recognized that they can no longer take a uniform approach to pricing that uses history to model the impact of price changes. Instead, they are looking at new approaches, including: isolating segments where historical trends may still apply (e.g., consumer staples), managing their price gap relative to competitive and private label products and reviewing and adjusting their strategies and models more frequently. Without this comprehensive approach, CPG companies usually find it difficult or impossible to understand the impact of pricing actions on the consumer and ultimately on revenue and profitability.
In addition to setting the right prices, CPG manufacturers are focusing on improving price execution and reducing leakage. Companies are calculating and managing the “pocket price” achieved after cash discounts, bracket efficiency discounts, incremental trade funds and other allowances (earned and unearned). These analyses are yielding opportunities to improve the bottom line without raising prices.
Given the marketplace volatility and complexity of pricing in CPG, it is more important than ever for CPG companies to establish an embedded capability to set prices and monitor execution and realization.
A view from the retail sector
Chris Goodin, Principal, Deloitte Consulting LLP
The well documented drop in consumer confidence and rise in unemployment translates into nervous shoppers with fewer disposable dollars. For retailers, the impact is a sharp decline in customer traffic and an increased dependency on promotions to lure shoppers into their stores. Many retail executives have not seen a climate like this in their entire careers and are struggling to decide which battle to fight. With all the distractions they face, it is hard for them to sift through the many initiatives on their desk and understand the return on investment for any particular one.
More than ever, successful retailers are those that have aligned their offerings and pricing tactics with customer needs and expectations. With advanced analytics, these retailers can tailor unique value propositions to different customer segments by understanding how price changes affect demand. Also, they can align their channels to support the new value message. Savvy retailers have found that cost-cutting alone is not enough to remain viable in an intensely competitive environment. Although few retailers are thriving in the current economic environment, those that deployed customer-centric strategies are outperforming the competition and positioning themselves well for the recovery.
Retailers with the ability to “own” valuable customers are in a much better position to entice further purchases and drive customer loyalty. On the other hand, retailers that refuse to embrace data-driven customer analytics and continue to rely on instincts and conjecture will likely face an increasingly challenging road ahead. To survive in this tough economy, it is essential for companies to understand which customers are good for their business -- and which customers they could do without.
A view from the process and industrial products sector
Jim Manocchi, Director, Deloitte Consulting LLP
These are challenging times for the capital-intensive companies in the process and industrial products (P&IP) sector. With the automotive and housing industries struggling, demand has fallen precipitously and there is great temptation for companies to play ‘let’s make a deal’ to try and capture volume to keep plants running at higher utilization. Although some price concessions may be necessary, lack of a clear pricing strategy -- and a solid means for managing prices -- could cause damage that might take many years to repair. The difficulty of doing this by the seat of your pants is demonstrated by the run-up in prices from 2004 to 2008 that was driven by skyrocketing raw material prices. These price movements, which were really just a form of inflation, created a false sense of wealth that came crashing back to reality all too quickly.
A look at price activities and impacts in previous downturns points to several important actions:
- Understand where you really are. Take a close look at competitor prices and customer value perceptions. The fact that prices may have risen by a large percentage over the last 4 years does not tell you if they are too high or too low. Declining raw material costs may give you some room to cut prices, but any potential action should be evaluated in light of the industry’s overall competitive situation.
- Determine which customers and products are critical to keep. Some may be critical to your current and future success, while others may not be worth the trouble. Looking ahead, there is likely to be an intense battle for customers and products. Do you know which ones you are willing to sacrifice and which ones are critical to keep? Also, do you know exactly what you are willing to do to keep the keepers? If not, in the heat of battle you might find yourself making excessive price concessions to hold on to the wrong parts of the business.
- Consider the long-term impact. Use rigorous analytics to balance the tradeoff between operating rates and average price realization. Capital-intensive businesses with high fixed costs often are willing to sacrifice a lot on price in order to keep their operating rate high. Unfortunately, the high leverage that pricing has on profitability usually overwhelms any positive impact on operating rates. Also, such price concessions are often quickly matched, thereby neutralizing the expected operating rate improvements. Remember that targeted pricing moves often become the new baseline. It could take a long time for price levels to recover, draining your profits for years to come.
- Stay disciplined. Establish mechanisms to enforce patience and restraint in order to avoid launching unintentional price wars. When trying to satisfy multiple business directives in a period of extreme pressure, it is easy to fall into the trap of trying to win every order at any price. Effective enforcement mechanisms can help you avoid purely reactive pricing decisions by bringing clarity and discipline to the pricing process.
Join the Debates
As used in this document, "Deloitte" means Deloitte LLP (and its subsidiaries.) Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries.