Friday, April 15, 2011

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.

1 comment:

  1. Comment/question from LinkedIn, "Nice post Michael. I like the diagram too, does it relate to reproducible situations with high occurences? KPI for a high volume would indeed be of benefit.

    What's your views on a more case by case customized pricing?" - Gilles Daquin

    I would absolutely relate this to any reproducible situation and practices that breed success. As for more of a customize pricing approach, what I've done with success in the past is taken the roadmap as a template, then tailored in the details necessary. For example, each company I have worked with has had different KPIs. Although many have been similar, to say that any two have had 100% the same KPIs would be generalizing. How they measure, what they measure... will many times be different. An even more detailed example would be to focus the roadmap on one particular area of pricing within an organization: take deals (or agreements). Using the roadmap, I would know to start documenting my current processes: what are the entries into the process, what are my current approval mechanisms. then move onto how pricing gets set within this process, and of course, what metrics will be utilized to gauge improvement?. I recognize the above is still fairly generic, but working it into specific, detailed process has proven successful in the past.