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In this current economic climate, cost-reduction strategies that involve reducing work force, curtailing new investments or consolidating operations are the most tried and tested lever for protecting profit margins. However, for most companies today, additional cost-reduction opportunities-without significant negative impact on business performance and customer service-are no longer available. In this challenging environment, companies must turn to the most influential and yet under-leveraged driver of profits: active management of price.
A recent study makes clear the power of pricing: a small one percent increase in realized price can deliver up to a 10-percent increase in operating profits. The importance of pricing is further validated by the proven success of pricing investments by leading companies across industries. For example, a leading global manufacturer that invested strategically in pricing achieved substantial margin improvement. The strategic pricing investment included a combination of organizational pricing leadership, revamped pricing processes and the use of pricing software to enforce and support those new processes.
Another recent survey affirms the benefits of pricing initiatives and investments. The survey found that almost half of the respondents achieved a return on their pricing investments in a year or less. It is not uncommon for companies to realize profit improvement of up to one percent of sales (or $10 million in profits for every $1 billion in sales) in less than 6 months from short-term pricing opportunities. In the long term, companies can use pricing strategies to create a platform for ongoing pricing improvement.
In order to take advantage of the pricing lever to sustain profits in an economic downturn, companies must transform pricing practices from tactical to strategic, and they must elevate the pricing strategies to the highest levels in the organization. The following five best practices will help your company use pricing strategies to protect margins, survive the economic storm and emerge stronger then your competitors as the market recovers.
Best practice No. 1: Improve price responsiveness
Pricing “status quo” is the path of least resistance and is often adopted many companies. In highly-volatile markets where raw material and energy costs are fluctuating wildly, competitor pricing is changing quickly and overall buying environment is uncertain, one thing is certain: pricing status quo will result in continued margin erosion. Companies that want to sustain profits in a downturn need to be more responsive than ever before; they need proactively fine-tuned pricing across products and services to ensure that it is aligned with prevailing market conditions. Moreover, it is imperative for companies to efficiently communicate prices across the network of sales reps, partners and distributors, arming them with the pricing they need to be competitive.
Best practice No. 2: Identify and address low-margin business
Profitability analysis at a transactional level and on a deal-by-deal basis is the key to identifying hidden margin improvement opportunities. Most companies miss these opportunities as they analyze profitability at aggregate levels such as divisional, regional or channel. Transactional analysis provides insight into whether discount policies were consistently applied across deals or whether surcharges such as freight were recovered effectively. Armed with such insights, companies can make informed decisions about whether certain deals make strategic sense despite their low profitability or whether corrective action needs to be taken.
Tighten Cost-to-Serve Recovery
Best practice No. 3: Tighten cost-to-serve recovery
Many companies consider cost-to-serve items such as freight surcharges for expedited shipping, technical service costs for design and product support costs as the costs of doing business. Seldom are these costs recovered by companies. The result is significant, unnecessary margin erosion. In tough economic times, it is critical for companies to tighten the cost-to-serve policies. By classifying customers into categories such as strategic and opportunistic, companies need to tighten cost-to-serve policies, ensuring appropriate cost-to-serve recovery for opportunistic customers while effectively serving the needs of strategic customers.
Best practice No. 4: Set granular pricing
Most companies today use an average price approach, ignoring the differences in how the value of their products is perceived across different segments of the customer base. The result is unwarranted margin erosion. A better, more effective practice is to identify fine-grained customer segments based on relevant attributes, and then set optimal prices and negotiation guidance for each segment. The optimal prices should be set taking into account a segment’s Pricing Power (the indicator of a company’s ability to realize a price change) and its Pricing Risk (the measure of what is at stake for the business).
Best practice No. 5: Control maverick selling
“Maverick” selling by sales reps can lead to bad revenue or revenue resulting from low or negative-margin business. Factors such as non-existent negotiation policies or the lack of enforcement of current negotiation policies can drive this maverick behavior. The result is dramatic variance in margins across similar deals. By establishing target prices, approval levels and floors, companies can improve the consistency of negotiations to improve margins and price realization. For example, an industrial manufacturer used pricing strategies and the right price management and optimization software to tighten pricing guidelines and improve price realization by nine percent in less than a year.
Pricing strategies provide companies with an unparalleled opportunity to resist downward pricing pressure and preserve margins. By investing strategically in pricing, companies can dramatically improve profitability, even in the toughest economic conditions.