I recently spoke with the head of pricing for a multi-billion dollar, multi-division company about their goals for price improvement. His team leads the development of pricing strategy and management of the pricing process; and they provide analytics, and pricing targets for the divisions. Final pricing decisions are somewhat decentralized. He described the challenge he had been given to generate a 100-basis point margin improvement from better pricing. The challenge would be part of the goals he and his small team had to meet in 2017, but it would not be part of any other group’s goals. Unfortunately, it will be very difficult to reach their goals if no other group has skin in the game. Real pricing improvement requires the involvement of all those who make pricing decisions.
In most companies, annual plans include setting sales and profit targets for each business unit. Those targets are then cascaded down through the organization to each entity that has P&L responsibility. Senior management teams recognize they can’t hit their targets on their own. They need the help of the entire organization. They also recognize those targets are meaningless if each business unit is not accountable for doing their part. So divisions and branches are measured in part based on whether they reach their goals or not. There are often financial incentives to hit targets throughout the company. By doing this, companies force each business unit to make calculated choices about which opportunities will offer the greatest return, and how resources should be allocated.
Sales teams do not always have complete P&L responsibility. Often they are measured on their performance in growing sales, growing margin, and signing new customers. The annual plan will include specific goals in those areas, and those goals are generally broken down into specific targets for each sales person. Regardless of what the actual goals are, metrics are developed to measure how well or poorly the sales team is doing, and to measure the performance of each sales person versus their goals. Companies recognize they cannot reach their sales goals without each individual sales person being accountable for their part.
The same dynamic holds true for reducing costs. Organizations that embark on serious cost-reduction efforts, inevitably break those targets down into smaller cost-reduction goals for each business unit. To manage costs, they must involve the teams that make decisions to spend money.
In spite of those analogous examples, there are still companies who want to improve their overall price levels, but try to do so without involving people who make the final pricing decisions. These efforts are unlikely to be successful. It is certainly possible for central pricing teams to determine which customers and products offer the most opportunity for price improvement, and which opportunities are the riskiest. With sound analytics, pricing teams can determine which customers and transactions are likely to be the most sensitive to price and which are less likely to be so. But it still requires the teams and individuals who make the final pricing decisions to act. And if they don’t have any skin in the game, it can be very difficult for them to make the tough decisions on prices.
One of the most effective mechanisms for price improvement we have seen at Strategic Pricing Solutions is a cascaded annual price budget. Much like a sales plan, cost budget or an overall P&L budget, a price budget assigns price improvement targets throughout the organization. Armed with the analytical insights from the central pricing team, each business unit makes choices about where they should most aggressively pursue price improvement, and on which segments, customers, and products they should be most cautious.
One argument we have heard against price budgets is that local business units already have sales and margin goals and the prices they charge are a component of those goals. However, there is often a broad (and erroneous) consensus within local business units that higher prices lower the probability of closing a sale, and local teams usually err on the side of closing the sale even if prices are low. After all, “Any margin dollar is a good margin dollar.” But when the business units must reach certain price-improvement goals in addition to sales and margin goals, they are more likely to make the tradeoffs that deliver the optimal results. They are more likely to use the pricing team’s analytical insights about which situations have the greatest probability of accepting higher prices and not reducing volumes.
Senior management teams recognize that to hit their overall sales, margin and profit goals, they need their business units and employees to be aligned with those goals. The same is true for those trying to improve prices. When the business units have skin in the game and are aligned around all the common goals, that involvement results in the most improvement.