Pricing for Profitability

Premise: The net profit potential of pricing deserves a long term strategic vision and dollar investment which demonstrates a significant ROI.

This article makes the heretical case that midst the confluence of technology, new delivery channels, blurred business sectors and shrinking geographies, alert firms have a very real opportunity to increase prices. That the opposite is much more often the case bespeaks an opportunity for clarifying competitive advantage and practical methods of obtaining them. It also signals the ongoing importance of investing in current and cost effective pricing vehicles technology.

We make these points not to be critical, but to highlight what we consider is many firms’ largest single profit opportunity. Most often Marketing departments (where pricing as a cornerstone of the four ‘P’s traditionally resides) must feel culpability for not successfully attracting company focus and resources in pricing technology over the years.

Companies spend millions of dollars improving their supply chains, logistic capabilities, purchasing systems, marketing campaigns, product innovation and delivery processes, customer relationships, and returns on bricks and mortar. But they invest little in the optimization of their most critical ‘P.’ Since price increases immediately fall to the bottom line, pricing systems deserve commensurate focus in processes and intelligent systems strategy and design.

IBM room, by the Library of Virginia on Flickr

Further, pricing systems must develop with eyes focused on the future, not only in the shadow of ever evolving computer legacy systems, but for the mish-mash of market complexity; internet, fee based services, demand driven channels, increased third party connectivity (on both ends of the chain), acquisitions, installation, brokerage, commissions, logistics itself as a fee-for-service, etc. There are literally thousands of ways to add value to customers and structure transactions, and over the last twenty years technology has quietly been making them all affordable and simple while adding value to the customer and extra profits for the company.

In every instance, absolute accuracy of pricing and real time profitability feedback in the face of sporadic and converging volumes are essential; these are established bars of doing business and 98% accuracy is no longer acceptable. The future is absolutely open, and world class product files and pricing engines are central and foundational to virtually every effort. Just last month Sears and Kmart agreed to pay out $1.1 million in a “civil lawsuit alleging the retailers engaged in dishonest business practices by charging customers more than the advertised prices.” These kinds of pricing errors, assuming basic systemic honesty, are impossible in integrated, technologically solid product databases.

To bring some urgency to the discussion, it is long past time that firms coalesce around long term strategy and resultant tactics that drive towards a nimbler, accurate, efficient, leaner, real time, connected and versatile future. It is a tall order, but it is being done. In most cases 2-4 extra percentage points produce huge paybacks, but margin improvements of 10% or more are in many cases very possible. Make no mistake; we are not talking about instituting pricing solutions as an expense reduction exercise, although effective design includes those benefits as well.

Pricing basics

While Marketing departments typically approach price determination from a variety of recipe depths, there are at least a bare minimum of variables that at any one time might make a critical difference in strategy and price optimization. These variables should be included in the foundation of world class pricing technologies whether they are always used or not. Following are general categories in no particular order.

Marketing Strategy

Any product analysis must begin with at least a rough segmentation, targeting, and positioning exercise. For many product categories, these analyses are almost intuitively known. Not many folks need a detailed mapping of the product categories they buy and sell every day. In fact it is this blunt awareness that often produces the fatalistic sense that nothing much can be done with pricing in the first place, which is of course incorrect.

Even if knowledge of the firm’s product lines are well known across the enterprise, the work it takes to compile this information is well worth the effort. First, it is surprising how much information does not meet consensus, and the resulting discussion is helpful in uncovering and disseminating knowledge. Second, the information changes over time, and ultimately strategies based on the trend produce real benefits even as Associates benefit from a central page of collaborated knowledge.

Mix Decisions

One of the principal reasons companies perform only limited quantitative analysis to identify margin and revenue opportunities is due to the perceived complexity of doing so. There are just too many combinations of products, customers, order types, and channels for dependable analyses. In fact, the complexity fundamentally explains why most firms end up with a strange and virtually unmanageable pricing process forming a combination of discretion and empowerment, broken processes and ultimately defined more by exception than rule.

As a result, most pricing decisions are highly subjective if not simply guesswork. Intuition in pricing does not have a good track record. Happily, today’s technology is ably suited to define mix and channel and segmentation analyses, identifying cross-selling opportunities just as effectively as they define those for up-selling and optimal mix.

Effective pricing technologies analyze all combinations of the mix; not just product, but geography, types of orders, customer segments, and sales agent.

Estimate Demand Curve

There is always a relationship between price and quantity demanded. In certain channels, this relationship is not as direct as some may believe. Variations of margins between locations for the same product sku’s to the same customer segments bear out the truth of this statement, even after controlling for geographic pricing trends.

While price elasticity experiments are easily performed, especially where firms price uniquely to virtually every customer, mapping strategies along a variety of axes must be integral to any pricing tool. Pricing opportunities literally fall off the page if analyses are robust.

Calculate Costs

Of course a working knowledge of fixed and variable costs to procure, handle, ship, sell and support the product in question is imperative. Good pricing policy must understand detailed cost to serve statistics. ABC principles are by now easily embedded in legacy schematics.

Unfortunately all too often cost is still used as the principal determinant of pricing and in all too many instances, it is market segmentation that suffers. This preoccupation with cost is a hugely significant error, and more than one company has denigrated markets by pricing from cost, not only giving up hard fought manufacturing, purchasing and logistic channel advantages even while leaving precious profits on the table.

Environmental Factors

Competition and geography are significant variables. Setting prices too low sets up pricing wars and lowers markets that make it difficult to declare a winner at either, regardless of who got the order. The temptation to race to the bottom, the Wal-Mart mentality, is all too pervasive. After all, it is Nordstrom that is selling like it is 2007.

Further, low markets take years to recover. We have a theory that the Ohio Valley’s generally degraded pricing is still the result of once having been a major cradle of industrial production and therefore a major driver of volume. Twenty years later, the Rust Belt still has lower prices despite losing their volume advantages decades ago.

As another example, we theorize that many firms wish they had never agreed to private label. What began as a way to fill retail shelf space and utilize idle capacity has too often turned into a rampaging tiger which is impossible to re-cage. But now it is a factor that any market must consider. There are still advantages to be had with private label, but the idea back fires if approached without effective strategy.

Pricing Objectives

What are the goals with any given line? Possible choices include:

Profit maximization, assuming we are sitting in the sweet spot of the margin and demand graph. Refer to the Green line in Figure 1 for an example. The Red line represents declining demand in units purchased as price increases.
Revenue maximization, often at the expense of profit margin in an effort to increase market share and lower cost. Refer to the Blue line in Figure 1 for an example.
Maximize quantity, in order to reach lowest cost and often assuming there is a tough experience curve to fight through.
Maximize unit profit margin, realizing that quantities will be low.
Quality leadership, to signal high quality and prestige.
Partial cost recovery, or variable cost recovery, often to bundle other more profitable products or use the product in some other strategic way that earns the company even more profits in total.
Survival, where times of market decline or overcapacity demand a strategy to cover at least marginal cost and ride out the storm.
Status quo, where the firm seeks stabilization in order to avoid price wars and otherwise maintain a moderate but stable level of profit.
Skim pricing attempts to take the ‘cream’ off the top of a market by setting a high price and attracting only those customers who do not exhibit sensitivity to that strategy, or perhaps appreciate the service that may come with it.

Demand, revenues and profits at various price points

Determine Pricing

Depending on the objectives above, we deploy a pricing strategy until facts or strategy warrant a change.

Pricing concepts and processes

This general but relatively shallow article brings up a larger point; perhaps the company would benefit from some training. Are we ready as a company to get to the next level in profitability? In any given situation, are we pricing too high or too low? Do we have pricing processes in place to help us capture and measure the value we have in the marketplace? We’re not talking about activity based costing systems, but measuring our ‘value.’ Do we know how to build them? Pricing is the most critical profit driver in today’s competitive business environment. Yet how often do we think systematically about our pricing strategies or leverage them to capture maximum value?

Performing the market research described above gives us a chance to train associates and develop processes that reward company efforts by customer segments and unique product mix. All Associates, not just Sales professionals, benefit from a fundamental understanding of the firm’s unique service offering. Processes buttressed by pricing technology vehicles act as reinforcement to retaining value, not as a constraint to it. Conversely, an ad-hoc pricing strategy or a trial-and-error approach to pricing will never realize bottom-line potential.

How detailed are your tools and framework for developing pricing strategies? Are your tools sophisticated enough? Do you have a deep enough understanding of pricing theory, technology, and practice to take advantage of the opportunities in the market place? Perhaps ongoing training for a core group of constituents on theoretical and empirical research could help imprint a deeper appreciation of issues and possible resolutions. The entire organization benefits from approaches and strategies for complex situations such as pricing new products, products with short lifecycles, dynamic pricing, and bundling products and services. A common language and deeper understanding is a great beginning.

Changing technology Landscape

In an almost never ending quest to optimize profits, pricing inevitably becomes more complex. This is not surprising; as sophistication and competition both increases and generally pervades an industry, and as channels mature and better align with customer needs, we must employ increasingly clever methods to improve margins. Many industries by now price their lines by sku, and have often ended up relying on service costs to survive. Some even regard their central product lines much the same way supermarkets view their bread and butter. We all want to avoid loss leaders as long as possible.

Here again an effective pricing vehicle adds value, segmenting pricing by type of sale; long term contracts, sales and promotions, matrix or list pricing, and spot and special situations. The good news is that the potential for competitive analysis and significant profit enhancement remains large even if the competitive landscape only allows evolutionary change.

Obviously more sophistication and complexity is made possible by technology; many systems today allow massive but very strategic and finessed changes with relatively little human investment. Certainly the potential to get much smarter while getting nimbler and leaner certainly exists with today’s technologies.

Current technology does not just provide for central product files regardless of channel, or simple sales price changes that ripple through the system. They provide for margin scorecards and red-light situations. They flag anomalies. They identify opportunities. They check validity and error while integrating both vendor and customer data.

Technical implications

What is your long term vision for pricing and profit enhancement? The article implies some technical parameters:

Direct vendor updates and automated integrity checks.
Multiple measurement systems.
Matrix and analysis divorced from the transactional system. Benefits include:
1. Lower transactional server loads.
2. Expanded portability and interface flexibility.
3. Central engine independence of the legacy system increases security for web based, end user, vendor and other third party interfaces.
Multiple pricing or discount groupings that are not mutually exclusive. Systemized analysis, bundled pricing, and efficient means of affecting ranges of key sku’s across lines are all enhanced when individual items are included in multiple groups with tiered priorities. This relational approach gives maximum pricing flexibility while decreasing maintenance effort.
Reporting capability built into database schemas as opposed to queries.

This list is in no way exhaustive, nor is it meant as a full checklist for third party purchase. But the illustration is well made that strategic pricing systems are not just cost effective methods of carrying on business as usual. It is entirely possible to move exponentially forward in pricing capability using current technology for very little cost. Such systems can provide for sku level pricing and monitoring in multi-dimensional space while maintenance and upkeep is provisioned by ground level, operating personnel.

Summary

What are the goals of your current pricing projects? What are your strategies to get there? What actions should you take now to ensure your future? What actions can you take now that won’t be undone by your future?

The potential monetary reward of strategic pricing systems is immense. The varying scenarios of an ever imminent future provide for many different profit alternatives built on existent business and infrastructure. Since product and pricing files represent central actors in all of them, utilizing intelligent technologies can provide a strategic advantage on a number of fronts; accuracy, training, communication, pricing and analysis. Do not allow pricing to constrain the business. It is an enabler. And with the proper focus its essence will rationalize the supply chain and integrate the enterprise.