Your sales team defines price as what’s on the invoice. Your CFO defines price as ‘what we take to the bank’. Your customer says price is too high. Your pricing manager says that price doesn’t match our standard terms. Your distributor says they can’t make any money on your line. And it’s still Monday morning!
What’s the right way to define and measure price? More importantly, how can you improve net price realization and take more money to the bank?
I define price as what goes to the bank, after all discounts, returns, warranties, commissions and other deductions are taken into account. There are several elements to price management. The first is achieving the optimal price for each good or service. The second is managing your product mix and services to achieve the optimal price for a set of customer transactions.
For many firms, the difference between what’s invoiced and what’s banked is over 10%, made up of co-op, early pay, volume rebates, freight allowances, returns and other factors, defined and imagined. The difference between list price and invoice price is often over 20%.
For a firm with a 10% operating profit, capturing a 1% price improvement falls through to operating profit and expands operating profits to 11%, a 10% improvement. Do you spend as much time thinking about price as you do thinking about costs?
Here are 6 steps to consider that can improve your pricing and profits.
1. Have a clear, executive level pricing owner.
Most organizations do an okay job of managing pricing execution and deals flow through the building smoothly. Where we break down is having a clear and experienced owner of pricing strategy. Your pricing manager may be doing a good job tactically, however they are not usually thinking strategically.
According to a study published in the MIT Sloan Review, fewer than 15% of companies have any systematic pricing review.
ACTION: Assign, goal and empower one of your executive team, most likely the VP of Marketing or CMO, with developing a pricing improvement plan and process.
2. Optimize your product range.
If you have segmented your customers and understand which ones are truly price sensitive, having a basic price fighter in your range will meet their needs without disrupting your full product line pricing. At the high end, are their additional products or services such as extended warranty or faster shipping or higher performance that a segment of customers values?
ACTION: Look at your product pricing strategy vs. your user segmentation again.
3. Align sales compensation with profit growth.
If your reps are compensated for revenue, and not for profits or price improvement, what incentive do they have to fight for the best price? If you were selling and could make 5% commission on $1000 with little effort, or 5% commission on a $1010 sale with some effort and risk, what would you do? The 1% price lift is worth a negligible amount to them, but a huge amount to your bottom line and exit multiple!
ACTION: Consider having, at a minimum, your sales leaders compensated on expansion of either average selling price or gross margin.
4. Revisit your ‘price waterfall’ annually.
Look at each deduction from your list price to the final, net/net price you bank. Are programs such as co-op still pulling their weight as you’ve shifted your mix to inbound marketing, away from relying on distributors to create demand? Do customers take an early pay discount when paying after the early pay period has expired?
Once you have established your price waterfall, compare it to your leading competitors. Odds are you are being pushed to match invoice price plus you have more attractive trade terms, which your customers and sales team aren’t discussing in a price negotiation. A good overview of this analysis is available from this McKinsey article.
ACTION: Conduct a review of you and your competitors, selling terms and price structure annually.
5. Understand what your customers’ value.
Do those who set pricing truly understand what your customers’ value? Do your selling tools and training continuously reinforce the value of your products? What was the last insight your team delivered about how to improve pricing?
ACTION: Ask your customers why they do, and don’t, buy from you.
6. Set expectations of annual price improvement.
Most of us are worried about the important issues of sales growth and market share. Creating a culture of price improvement will ensure pricing does not become an afterthought for a junior team member.
ACTION: Establish an annual price improvement goal, and measure it monthly.
Price optimization is not about selling less at a higher price; it’s about eliminating the leakages and practices that enable you to capture improvement in a systematic way in your net price realization.
How much time is your team thinking about these questions? How much time is it worth thinking about to get a 10% expansion in operating profit?
For more information, please see Atul Minocha’s ebook, Smart and Simple Price Adjustments for Higher Profit, Smart and Simple Price Adjustments
Which of these 6 steps will you take today?