Roadmap to Pricing Excellence



The Pricing Excellence Cycle



I have worked with many companies in various capacities related to pricing.  Many have focused on pricing software, but of those, almost all included reviewing and refining the pricing strategies, processes, and procedures in place to support pricing excellence, also known as the "Roadmap to Pricing Excellence", or R2PE.  Although indicative of a journey with a specific end in mind, pricing is slightly different.  A "journey"... absolutely.  But in reality, there is no end state other than, "we must be better tomorrow than we are today."  Yes, we can put milestones along the way, but much like a youthful road trip, we may get sidetracked and discover new and novel milestones that are more relevant tomorrow than anything we planned on today.

First, we must understand where we are today.  Where is pricing effective?  Where is it not?  And while we are at it, what defines "effective" pricing?  Ultimately, we as a pricing community are here to maximize margin.  There are many more metrics, but using margin as the pinnacle measurement, we must be able to uncover quickly areas of profitable and not-so-profitable pricing.  Where is margin trending upwards or downwards?  What is the root cause of these trends and what can be done to either eliminate and fix or continue and replicate them?

Out of the "Analyze" phase, we have targeted areas on which to focus our pricing efforts.  Next comes the "Define" phase; in other words, what price should I be charging based on the empirical evidence at hand?  What is the impact of making these price changes?  Many times, after further analysis in this phase, our targeted audience for the price change slims down.

Up next, executing on these price changes.  Set the price up in SAP and get customers paying these new prices.  More importantly, we should now set the timetable for measurement of these price changes.  A simple metric known as "price realization" is very handy in situations like this, especially for price increases.  As the axiom goes, sales forces love price increases... higher discounting!  Joking aside, many price increases are countered by discounting, which is not a bad practice (even though at times, discounting can be the bane of a company's revenue and margin goals.  Price realization attempts to measure actual versus expected price gain.  100% should not be expected, but how much is realistic?  80%?  50%?  Different situations have different expectations.  By setting your goals properly, discounting practices can actually lead to pleasant surprises!  Additionally, margin variance is a better metric to set goals against, especially in instances where prices are both increasing and decreasing.  After all, if our ultimate goal is to maximize margin, understanding how price changes offset or complement other factors in the margin variance waterfall will lead to better price setting techniques.

Finally, we move into the "Monitor" phase.  Here, we are standing by our original hypotheses regarding our price changes and measuring to the KPIs we have put in place.  Right or wrong, every price change will have its actual outcome and these are important to learn from in order to behave differently in the future.  And most importantly, this phase provides the ability for pricers to "manage by exception".  This implies that we all do not have time to monitor every minute detail - who is buying what and at what specific price.  Instead, we should set thresholds on which we do wish to be alerted about, in case any specific transaction or aggregate of transactions crosses (i.e. avg margin week over week is down 5%, or 10%).  Setting these thresholds up allows the pricing community to turn their attention back to other areas identified in the "Analyze" phase, and take additional action on prior events if and when the need arises.

Price changes and the PLC in a B2B environment

Understanding the product life cycle (PLC) is critical to decisions made regarding price changes, especially in a Business-to-Business (B2B) environment.  Whether you are in the introductory, growth, maturity, or decline stages should alter your view on how price changes can impact revenues and margins.

First, I must give credit where credit is due.  The impetus for this post came from Reed Holden’s book, Pricing with Confidence.  If you have not read it yet, it is very well-written and provides practical examples of ways to improve pricing; find it on Amazon here.  After reading this book, the PLC discussions stuck with me.  How could I apply what I read to what I had experienced?  The below is the result of that though process.

For example, early on in the introductory stage, price plays an important baseline role.  Setting the price is crucial to the value perceived by the targeted audience.  What price to set is another topic for another day, but price too low and you are potentially forgoing future profits.  Price too high and you may never gain the adoption necessary to move into the growth stage.

Assume for this post that we are beyond the introductory stage of the PLC (new product pricing is another entire topic to cover).  Next up: the much-anticipated growth stage.  During this stage, increasing prices leads to higher revenues and higher profits.  However, we must pay special attention to competitor actions.  Is this product quickly converted into a commodity?  If so, the growth stage could be short-lived.  If competitors can quickly reproduce the product and your customer’s switching costs are low, raising prices too fast and too often can lead to declining revenues through lost volume.  Moreover, if the product cannot be easily reproduced or your customers’ switching costs are high, there is more value offered by TE that could be captured in the price.  By raising prices to match this value, we can increase our revenues and margins exponentially, due to increasing volumes during the growth stage.

To put this in context, I have seen this work well and fail spectacularly.  Focusing on the latter for the moment, when product managers at an industrial manufacturer failed to recognize the small switching costs of their customers, they ended up underestimating the duration of the growth stage.  The result?  They kept prices elevated; competition circled like hawks; and before they knew it, their products were an afterthought to their customers: priced too high with other, fully-substitutable products available to purchase.  However, the flip side is just as dramatic.  When those same product managers (on a different product line) were able to quantify the value their customers should achieve, and in this case, no other competitors could offer anything close to their product line, they priced to the value during the growth stage and helped secure other, ancillary business as well as dramatically exceeding profitability expectations.

Moving along, the maturity stage is next in line on the PLC curve.  During this stage, demand elasticity is commonly correlated to your customers’ switching costs.  Raise prices too much, and they will switch.  However, lowering prices is highly unlikely to increase demand.  This is a characteristic of the B2B environment.  TE’s customers are rarely, if ever, end-users.  Therefore, the demand for our products is not set by our customers, but by our customers’ customers (or ever further down the supply chain).  For example, if BMW is expected to make 500,000 X5 automobiles for Europe in 2011, this is not driven by the price of our wire assemblies.  Their demand is driven by their market analyst’s prediction of what their customers want.  Therefore, is we lower prices to BWM, all we are doing is giving away revenues and margins.  They will not purchase more from us, simply because the price went down.

This is why it is crucial to understand which stage of the PLC you are in for any given product.  Raising prices in the growth and maturity stages typically has a positive impact on revenues and margins.  Lowering prices typically only works in the decline stage in order to liquidate stock or manufacturing capacity as we move on to the next product evolution.  Recognizing in which stage we are operating, along with the competitive pressures and abilities, greatly enhance our ability to change prices to meet the market expectations, while maximizing revenue and margin potential (commonly known as price optimization).

And yes, there are always exceptions.  Where have you seen success (or failure) with pricing strategies and the PLC?

The role of sales, product, and pricing - can't we all just get along?

Many of us in pricing are tasked with what some may view as an unenviable responsibility: somehow get two distinct, separate roles to coordinate and execute on a strategy (commonly given by your management) that those roles might see in conflict with their own management's strategy.  In other words, "ignore them, listen to us!".

OK, it may not be that bleak of a picture, but it sometimes feels like it.  This is one of the reasons I wholeheartedly believe in conducting “day in the life” reviews of sales or product.  But as “pricing”, we must still manage the right expectations, execute on our strategies, and help others along the pricing chain do the same, even if those strategies are, at times, in conflict with our own.  And this is where we must work harder to get those commonly involved in the pricing chain (Sales and Product Management) involved.

Take a step back and look at where in the organization pricing is discussed.  Although in the day-to-day activities of pricing, we may forget that pricing decisions DO happen elsewhere, we cannot overlook this fact.  After all, how can we help evaluate our marketplace of pricing without prices that are already set or without prices that are being communicated to customers?  This is where Product Management and Sales are involved; and it is because of this fact we as “pricing”, must account for and include those roles for the overall betterment of the enterprise.

Let’s examine one situation I was involved in almost 5 years ago.  Pricing was tightly entwined with Product Management (in fact, both VPs reported directly to the CFO, who encouraged cooperation on pricing).  Whenever new products launched, products changed life cycles, or a market shift occurred, Product and Pricing worked side-by-side to understand the market and price accordingly.  However, they continually had issues with their price expectations vis-à-vis sales communications to customers.  The problem here was Sales.  It’s not that they were bad people or simply did not want to cooperate; it was that the Sales VP had a different vision of what his team was responsible for.  In addition, the Sales VP reported to a separate Chief Sales Officer, and therefore incentive programs were completely disparate.  Time and time again, Pricing and Product struggled to set and keep prices at a certain level.  Many times, they resulted to playing games within their own organization: setting prices unusually higher, knowing sales would discount.  While this may have lead to some reasonable price levels, it built distrust between Pricing and Sales… not a good working environment.

Unfortunately, by the time I stopped working with this client, the situation had not changed.  However, I have since heard that an organizational change resulted in more cooperation between the three groups, resulting in more profitability and a better working environment.

Regardless of what happened at that client, it does not have to take an organizational shift to create change.  Pricing may have an unenviable task, but a powerful one.  By working closely with Product and Sales, soliciting input, and helping define and demonstrate the “what’s in it for you” (WIIFY) for each group, many pricing teams have helped drive increase profitability for the enterprise… something all groups should share in.

I am interested to hear from others… what have your experiences been with “changing the pricing culture”?  What has it taken along the lines of organizational, policy, practice, or other change?

Small-scale success breeds large-scale results

Pricing software initiatives are not unlike other, enterprise-wide system projects... they require the careful steps of planning, from requirements (what is the process?) through to any necessary systems implementation and ultimately user change.  How then, can you better mitigate the risk that users fail to change?  Best practices dictate starting small.  If you apply this to software, think about all your retail, shrink-wrapped software... does it do everything you want it to?  No.  If Microsoft, Adobe, Intuit, and other developers waited until the software met 100% of their user needs, nothing would ever get released.

The best approach leaves users wanting more... no... the best approach leaves users demanding more because they see the immense value in what "little" they have.  And "little" is not referring to the amount of work or development that goes into the software; "little" is referencing the percentage of value that the user is now envisioning.  The key word in the last sentence is now.  They were not receiving any value before and now envision whole new ways to go about their business.  In short, simple and small releases begin the process of evolving the user into more than what they were before.  Trying to predict where that evolution will take them is a worthwhile activity, but should not prevent achieving short-term value.  In addition, software development is a journey that both developers and users must agree to take together.  It is a partnership.

In addition, releasing smaller, value-add functionality has several key points that should not be taken for granted:

• Learn where to adjust and tweak without changing (read: wasting) efforts
• Actual software does wonders to mitigate "perceived" risks; in a battle between facts and gut feelings, facts always win
• Creating case studies out of the initial results is a great way to socialize and promote future development

One of my previous customers took the above approach to their pricing systems.  Instead of requiring the system to meet 100% or even 70% of the stated needs, they asked each BU to list out their #1 pricing work flow.  They narrowed down the need list from more than 50 items to 6.  The pricing system was in place in 90 days, configured only to meet those 6 needs.  The response was overwhelming.  The users saw immense value in 90 days; ROI was more than 4x expectations; and the BUs started wanting more.  This "pull" situation, where users want to adopt the system and will "pull" it from you, is much better than the alternative of a "push" situation, where users are asked to adopt because you are "pushing" it upon them.

As stated above, software development is a journey.  To begin, you need to know where you are today and where you want to be tomorrow.  Anything after that is completely based on what you discover along the way.  You should know where you want to go, but allow for flexibility and change along the way.  It is the same for software.  Begin using it today to get value, discover more about your people and processes, and allow for evolution and change.  It is the quickest way to an assured ROI figure and the quickest time-to-value.

For those that have been involved in pricing software implementations, what have been some of the tactics you have utilized to gain traction quickly?  Any examples of when this has not had the desired results?

Pricing is a Business Process, Not Just a Function

Companies across the globe are realizing the value of pricing and doing whatever they can to reap the benefits from an increased focus on pricing.  However, it is truly the leading-edge companies out there that recognize the fact that pricing is not just a business function, performed by those that need to be involved.  Pricing is a complex business process that must have the correct support and guardrails around it.  You would not implement new SOPs without training, support, and feedback… why should pricing be any different?

True, leading-edge companies already have this figured out as they are investing in pricing for the long-haul.  You should be no different.  If you bring thought leadership to your customers through your products, why stop there?  You need to look at the support mechanisms, training programs, and business policies that must be enacted in order to have a successful pricing initiative.  This is not simple and it takes various business units agreeing to change for the mutual benefit of the company.  After all, if it were simple, you, as would have most companies, would have already figured it out and pricing would not have the immense returns that I have seen time and time again.

For example, one company I worked with forecasted profit improvements of $10 million (or 4%) in the first year after a project.  They had a complex algorithm designed to monitor and track results directly related to improved pricing process.  Well, like almost any initiative, delays crept in and the economy took a turn for the worse.  During a re-assessment period, they downgraded their expected returns to only $4 million in the first 7 months after go-live (due to the 5-month delay).  After only 6 months, they had tracked nearly $9 million in incremental profit!  Incredible!  These results were due to their constant drive for improvement, but also understanding that they needed trained, dedicated pricing resources to help find, articulate, and act upon pricing opportunities, with increased profitability in mind.

Simple question, what are you currently doing to realize ROI in 6 months and even 12 months?  Pricing initiatives have that return, and have proven this fact time and time again.  But the desire and determination must be there and it will not be simple.  However, with the right people, processes, and software in place, finding 150 basis point margin improvement in 6 months and sustaining that gain is not far-fetched.  In fact, it is probably understating the true gains.

Moving from cost- to value-based pricing

Throughout my travels, I have heard business describe their grandiose plans for moving towards "value-based pricing".  Great... this sounds wonderful... value is a good thing, you base your price off of this value... recipe for success!  Right? ... right?

Not exactly.  There are many questions you have to answer when talking about the "value" in "value-based pricing".  First and foremost, this is not your perceived value; it is your customers' perceived value.  But I will get to that in a second.  First, I want to address what is specifically NOT "value-based pricing": when determining if a price offered to us by your customers meets some pre-determined margin minimum, this is decidedly NOT "value-based pricing".  In fact, this is (everyone say it with me now): cost-based pricing (the clue are the words "margin" and "minimum").

Anytime you take a price based on margin (revenue less cost), you are taking a priced based on the one aspect you control... cost.  Cost-based pricing is good for two things: determining a floor price (which has its place in pricing strategies) and relying entirely upon your procurement department to drive your profitability.  After all, if they do their job better, profits increase!  Wait... you mean that is not the message you are sending to the Street?  Then you need to stop cost-based pricing methods from impacting the price delivered to customers.  Cost-based pricing is a disaster waiting to happen, just ask anyone who tried to compete with Walmart on price (oh, forgot, those places are not in business anymore).

When you price based on cost, you are not taking advantage of what the market has to offer.  You are looking at your own internal metrics and hoping for the best.  This will never move the needle of profitability.  In order to transform your profits, you must transform the ONLY element of the marketing mix that brings in revenue and profit - price!

So, back to my comment about how your customers perceive your products' value…  You have to get over your own egos and start thinking like your customers.  And this is not easy, because last time I checked, you are not your own customers.  So how do you get in their heads and start to think like your customers?  Unless sci-fi becomes a reality, this simply will not happen (and besides, all the sci-fi movies about miniaturization and being implanted in someone’s head never ends up pretty).  But you can forecast how customers might behave, given certain market characteristics.

To better forecast, you need to better segment your customers and products.  I'm not asking for a revolution for any current practices, I'm simply suggesting to break out of your current segments and start treating profitable customers like profitable customers and non-profitable customers like non-profitable customers, regardless if they are in the same country or not.  I cannot tell you how many times I have heard, "well, customer A and customer B are both in France; therefore, they should purchase the same".  OK, you are right, I have not heard that explicitly, but I see it all the time because many companies I have worked with price the same to all customers in France!  You have the data necessary to identify these segments, but you need to take the time to build these segments properly.  And this is a topic for another day.

Once you have those segments, you can begin to appreciate how those segments behave.  For example, a scatter plot of revenue and volume should look similar for all those customer/product combinations in one segment.  But there will still be variation.  Now, you can take this smaller amount of variation and quantify the gains made by forcing higher prices to the lower performers.  Will you achieve 100% of this improvement?  No, but 50% is reasonable.  One company I worked with simply stopped selling below market average for a week for specific product lines in specific areas.  The results?  15% improvement in profits against the baseline forecast for that week.  Imagine what you could achieve by implementing pricing strategies at this level?  The possibilities are almost endless.

I'll leave you today with the reiteration of one of my statements above and encourage you to comment: price is the ONLY element of the marketing mix that brings in revenue, hence profits.  All others only bring costs to the table.  Why then is SO much time devoted to the other elements, with so little attention being paid to price?

Price Strategy Proliferation

Many companies recognize the importance of having multiple business strategies in place for how they will approach the market.  Do they want market share, or do they want to be the prestige brand?  Are they trying to launch new products and/or sunset others?  Each business strategy requires the tactical plans in place to execute, and therein lies the need for mixing up your pricing strategies.

Why is it that many companies recognize the need for multiple business strategies, but then execute through one or two “tried and true” pricing strategies?  Each different market approach can be achieved through different pricing strategies, but with vastly different results.  If your brand is positioned as the “prestige” brand in the market, don’t expect the same pricing policies that keep that image in place to work for market penetration.  The same can be said for the typical commodity markets – applying value based pricing to those products in those markets simply will not produce similar results to value based pricing for specialty products.  Yet company after company will re-apply “proven” pricing strategies in new markets for new products, without fully analyzing all alternatives.  And why is that?  It’s not because they don’t want to; typically, it’s related to a company’s inability to project and forecast multiple strategies and manage them once they are in place.

This is where a robust pricing execution tool shines.  The ability to forecast properly price changes using a library (meaning more than two or three) of B2B price strategies is invaluable.  In addition, companies need to realize that since business is dynamic, so too must be your pricing libraries.  A true price execution tool will allow for price change modeling using proven price strategies, but with the necessary tweaks to meet changing market conditions.  And so, a new price strategy may be added to the ever-growing library for use elsewhere.  The value of such a price execution tool is the reusability of what works, the elimination of what does not, and the proliferation of pricing success throughout the entire organization.

Pricing Best Practices – How Do I Get There?

As more and more businesses are looking at pricing, they are asking themselves, “what can we do to jump start the process?”  Ultimately, it’s understanding how you price.  The process must, at some level, be understood, before you can begin to enhance and evolve.

Pricing process improvements would not be complete without what I'll term a “Day in the Life” of users.  I used to call this “riding in the truck” as a reminder – because I have actually ridden in the sales truck to a job site!  This is the only true way to fully understand the pricing practices of, empathize with, and appreciate the pains of potential users.  If pricing is such a strategic lever that can make a significant difference in profitability, you should be willing to invest the time to understand all the corners of your organization’s pricing practices in order to squeeze out as much ROI as possible.  And what better place to start than with the front line of price communication?

The question is: how do you conduct these Day in the Life sessions?  I can start by stating what not to do… don’t just ask questions!  You must put yourselves in your employees’ shoes… if they are called into a room and must answer a bunch of questions about how they do their job, what do you think they are imagining?  No matter how well you prep them, how you preface your message, or how you triage any malcontent, they will be nervous.  Unfortunately, that feeling will result in them answering the questions they way they “think” you want them to answer.  Anyone can put concepts on paper, which is what their answers will no doubt provide; you are trying to get at the dark and ugly truth about price and profit leakage.  Therefore, take the “interview” to the next level… go ride in the truck.

But don’t just observe in the “white lab coat, clipboard, and one-way mirror” sort of way… observe AND interact.  You should ask “why did you [insert activity here]” until you fully understand – don’t assume anything.  Then go beyond observation and interaction: solicit their feedback for how they would improve their processes.  What else do they need?  What could they do without?  What typically causes them to sit around and wait for three days while competitors steal your business?  Get them to believe they will have an impact on the outcome, the new process that they will be asked to follow… BECAUSE THEY DO!  Once you have this buy-in and belief instilled in your employees (that you want them to do better and are willing to give your time and efforts to help them), the truth comes out.  It’s only then you can work with your cross-functional team to improve your pricing processes in a way beneficial to all… because you know how your organization really prices.