All companies want to improve their profitability and deliver more value to their shareholders, but the best ways to do that are often debated. Pricing is the most powerful lever available to companies striving to improve profitability, but how to effectively use that lever may be unclear. Over the years we have talked with many firms who have read about others extolling the virtues of using revenue management, revenue and profit optimization, big data analytics, dynamic pricing, and price optimization. However, those firms did not understand what the terms really meant, and they did not want to spend millions of dollars betting on something confusing. Our advice – start small and build your capabilities and returns from pricing incrementally.
We have no doubt that pricing is the best profit-improvement weapon available, and we regularly demonstrate the reason for that to clients and potential clients. But that is a little like demonstrating that investments in equities are required to build long-term wealth. You still have to know how to do it, and the road is littered with people and companies who swung for the fences with poorly understood investments that were supposed to yield big profits but failed. To improve profits through better pricing, we recommend companies start with smaller investments that identify where prices can be improved without sacrificing volume, and build organizational confidence in a more strategic pricing approach.
For simplicity, we think of four levels of investment in pricing improvement:
- Baby steps
- Low-cost optimization
- Enterprise tools
- Enhanced enterprise tools
Baby steps are the least difficult and least expensive actions you can take to begin a profit improvement journey. They involve using simple database tools to find outliers that you can begin to correct. For example, you can identify:
- Which customers have high incidences of manual prices overriding the price list for that customer?
- Which customers are receiving deliveries at no charge when other similar customers are paying freight charges?
- Which customers get across-the-board discounts, even on low-volume items?
- On which products do you set list prices by simply adding a target margin?
Once you have identified the potential problems, you can begin to make corrections and capture the lowest hanging fruit. However, you should also take baby steps in making the corrections. Don’t extrapolate a few outliers or problems into broad generalizations of action, or you could end up worse than you started. The profit improvement from your baby-step corrections will provide a return that is multiples of your investment in this level.
The second level, low-cost optimization involves building your own tools. Using a database plus statistical tools and simple data visualization, you would begin the optimization steps:
- Segment your customers
- Stratify your products
- Identify value levers
- Calculate relative price differences
- Build a target price model
- Compare existing prices to targets
- Implement a price management process to use the targets
- Measure and adjust
For more information on price optimization, download our free e-book, 8 Keys to Price Optimization.
By building your own tools, you will learn much about where your price improvement opportunities and risks lie, and your profit improvement should be 1 to 2% of sales. Equally important, you will learn how to integrate new target prices with your existing processes and order entry systems. This will save you time and money when you want to move to the next level of enterprise tools.
Enterprise tools
There are several suites of price-improvement software available in the market today. They are well developed with strong underpinnings in pricing strategy, analytics, and visualization. They are also not cheap to purchase, install and integrate. However, once your organization has built confidence in capturing more shareholder value through pricing more strategically, enterprise tools are often a logical next step. Price optimization software can improve your segmentation, enhance the identification of price improvement opportunities you have developed with your own tools, and integrate with your existing systems more robustly. They also have excellent user interfaces for laptops and mobile devices, and can be used by anyone in your organization who touches price management.
The fourth level of investing in pricing improvement is enhanced enterprise tools. This means adding additional analytical tools, such as big data analytics to your enterprise tools. In this level, you add customer data from more sources such as social media and the internet of things, plus cost-to-serve information from your activity based costing tools; and you begin to more finely segment customer behavior. These more granular segments can be targeted more specifically with differentiated customer service and acquisition approaches, and the pricing algorithms in your enterprise tools can be enhanced to accommodate these new segments and improve profits.
Each of the four levels of pricing capability investments is an incremental step of investment from the previous level. Each also requires more pricing expertise within your organization, but delivers incrementally more profits. No matter which step you are on, pricing strategically requires disciplined management and adherence to data-driven decision making and strategic pricing principles.
Before you make new investments, assess your organization’s pricing expertise and ability to manage more strategic pricing. It will often make sense to start small and build your capability incrementally. You can improve profits significantly in each step, and your probability of success improves as your confidence and capability to manage the changes grow.
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