Systematic improvement of a business’s pricing capabilities can have a lasting positive impact on profitability.
An international provider of technical gases had a large, highly fragmented product portfolio of more than 500 SKUs, customers in a range of industries, and a broad segmentation of customers by size. As a result, its prices varied widely even for the same product. Managers felt that there was room to increase prices overall, but had no rational basis from which to challenge current pricing practices.
The company decided to completely revamp how it set prices and started with a pilot project. The centerpiece of this effort was the development of an analytical tool that pinpointed new price drivers, redrew customer segments, and recommended new prices. The tool enabled the salesforce to assess the impact of price changes on customer relationships and make any necessary adjustments. More importantly, the company supported the new approach with an intensive salesforce training program.
The pilot was so successful that the company rolled out the approach across seven diverse markets. In one, the analytic tool enabled decision makers to scan company records for 1.3 million transactions. Other markets used the tool to help develop value-pricing methods (systematically identifying the incremental value of a product to a given customer) and create transactional pricing analyses (the systematic analysis of price variances across products, regions, and customers). Overall, the company reset 100,000 prices for 150 SKUs—and saw return on sales (RoS) increase by 3–5 percentage points without significant changes in volume. The whole program took just three months.
This example of a well-implemented advanced analytics program to turn pricing power into profit comes at a time when companies across all B2B sectors are finding it hard to maintain, let alone improve, profitability. Companies can fight back in various ways, cost-cutting included. But our experience shows that systematic improvement of a business’s pricing capabilities can have a lasting positive impact on profitability. Our data, which cover more than 1,000 pricing-excellence and performance-improvement initiatives across a range of industries, clearly show that such initiatives typically translate into an uplift of RoS of 2–7 percentage points, depending on the sector.
Five steps to pricing growth
Pricing is an important source of revenue and profits, but only companies that increase their level of analytical rigor and practical know-how will unlock its full value. We believe companies need to do five things to turn pricing into a profit engine.
1. Provide meaningful transparency into pricing data
Pricing managers often lack a clear understanding of how profitability varies between regions and product lines, and know even less about how it can vary among individual customers or transactions. Yet these are all important influences on pricing and sales decisions.
To take one example: Volatile raw material prices have caused headaches for companies selling products on contract periods longer than the company’s own purchase contracts. When raw material prices rise, their sales reps don't know which prices should go up, by how much, and how quickly. Without that knowledge, profit opportunities evaporate. The front line needs meaningful transparency into price levels, discounts, and other leakages at different levels of granularity and over multiple time periods.
The key word is “meaningful.” The increased data availability and computing power provided by advanced analytics mean that, in theory at least, sales reps can make much better pricing decisions. But the very proliferation and complexity of data has more often than not overwhelmed rather than helped. In consequence, advanced pricing analytics are often ignored in favor of pricing decisions based on gut feeling, a one-size-fits-all model, past experience, or outdated analysis. The result is that companies either price too low and leave money on the table, or too high and lose customers.
In B2B companies, existing analytics capabilities are often not sophisticated enough to create the right kind of pricing opportunity algorithms to cope with the large amounts of data available. Too often, we see managers make broad pricing decisions (e.g. proportional price increases) armed with little more than an Excel spreadsheet.
A European steel producer, for example, lacked a system to collect relevant data at the level that sales reps cared about—that is, at the level of their individual customers. To address this, the manufacturer decided to combine financial data from several internal IT systems: sales reps’ systems, where orders were entered and invoices processed; the production teams’ systems, which allowed them to plan capacity, typically at machine level; and finance’s systems, which aggregated all this data into financial reports, but typically at higher levels, such as a plant or a product line. It then set up dashboards to analyze the combined data on a weekly basis. The new system helped identify new and critical insights, such as customers who were frequently unprofitable but too small to be noticed.
The best pricing analytics tools can help test and calibrate pricing drivers for each individual product-customer combination, as well as dig into customer revenue profiles at the product-volume, industry, and sales-channel levels to unearth new pricing options. They can also derive pricing recommendations based on complex calculations of what drives price differences between customer segments. Companies with good analytics capabilities can use the data and teams already in place to find significant growth in a matter of months.
2. Understand what customers really value
For all the sophistication provided by advanced analytics to master a complex array of prices, the price of a product or service ultimately depends on how much a customer thinks it’s worth. The best companies augment their pricing analytics with detailed customer insights to identify all the key buying factors that determine how much a product is worth to a given customer, understanding how those factors compare with competitors’ offers, and being able to quantify the value created for the customer.
At one company, a team of pricing and sales managers was asked to list the factors they thought determined the prices their customers were paying. It then tested and refined these hypotheses. The analysis revealed 14 significant drivers of pricing sensitivity that the sales reps had not identified. Many of the results were counterintuitive. In one case, it was the quality of the packaging rather than the quality of the product that was the single most important driver for customers’ willingness to pay a premium.
While analytics can certainly help in determining value, developing insights often requires “softer” and more traditional skills, such as talking with customers and observing their operations.
One manufacturer of specialty tools, for example, was about to launch a series of products with much higher performance than either its own existing ones or their competitors’. By first interviewing distributors and then launching targeted market research, the company linked the entire set of key buying factors to what buyers would be willing to pay for, which enabled it to set a price point far higher than the marketers had anticipated.
A pragmatic approach to value pricing is “next-best alternative pricing.” This method involves researching what alternatives customers have to the company’s product or service. From the set of alternatives, the sales rep—often with help from experts in other functions, such as sales or customer service—determines which the customer would be most likely to choose. The price setter then analyzes all the customer's key buying factors and compares the company's product and the alternative against each one. Translating the relative performance into value for the buyer helps determine the right price.
3. Move from “sales reps” to “value negotiators”
Determining the best price means nothing if the sales rep can’t convince the customer to accept it. For this reason, it’s critical that price setters sharpen their business skills. Sound judgment to manage time, negotiate thoughtfully, and adjust pricing guidelines in order to maximize value and minimize the risk of customers defecting are important pricing capabilities to have.
Building negotiating skills in particular is critical. In practice, this often requires spending time understanding how the price recommendations are made and what the reasons for them are so that the rep has confidence that the price makes sense and is defensible. The sales rep—often with a manager’s help—also develops a set of arguments to support the price with particular focus on those elements that the customer values most. An important part of preparing for negotiation is identifying concessions, starting and walk-away points, and practicing to anticipate behavioral biases and develop sound skills.
One rep who took part in a pricing-excellence transformation explained, “It had become increasingly challenging to defend overall price increases to customers. After this program, it was much easier to understand and communicate the increases, and to actually succeed in the negotiations.”
4. Provide on-the-job training to build confidence
While most companies understand it’s important to build the pricing skills of their people, few move beyond basic training in classes or online. Successful companies, however, use adult-learning techniques, such as experiential learning, to embed the new skills in the front line. The most effective programs rely on a mixed model of education and implementation known as “field-and-forum.”
Forums consist of two- or three-day workshops. Participants learn theory and frameworks by reviewing case studies and using more interactive formats. After each forum there is a “field” stage, in which participants apply their new knowledge to real-life situations, accompanied by experts or senior managers who can provide feedback and guidance. This not only sustainably upgrades the company’s pricing capabilities; it also delivers sizable bottom-line impact throughout the program. With one or two successful price negotiations, the rep develops confidence in the new approach often becomes a convert to the new approach and advocates for it with his/her colleagues.
One company used coaches to help each person on the salesforce understand the new pricing process, including how to get the most from the pricing tool. This one-on-one support was intensive, but also crucial in ensuring pricing insights translated into higher prices—and higher profit. “This is the first time we can truly benchmark and understand the performance of our salesforce,” said its national sales manager. To reinforce the importance of building capabilities, employees need to see facts, not just anecdotes, about how ineffective pricing hurts the bottom line.
A global petrochemical company, for example, rolled out a pricing-excellence transformation program that included several intense training sessions on how to use the new system as well as group coaching sessions to analyze each sales manager's portfolio with the new toolkit. In roughly five months, sales managers in the pilot division identified more than 400 transactional pricing opportunities, contributing to a total bottom-line potential increase of EUR 10 million.
5. Sustaining long-term success
In our experience, even the best pricing programs will fail in the long term without a deliberate commitment to making necessary cultural changes. Companies need to overcome entrenched habits and shifting priorities that doom most change programs. Ingraining pricing success over the long term requires putting in place an “influence model” that includes: role modeling, fostering understanding and conviction, developing talent and skills, and implementing reinforcement mechanisms.
While all aspects of the influence model are important, pricing leaders should pay particular attention to developing talent and skills by providing coaching to their people. “The power of coaching was a critical success factor for our pricing transformation,” says Tom O‘Brien, group vice president and general manager for Marketing & Sales at Sasol. “We now want to improve the levels and capabilities of our people’s coaching so that they can coach each other. And that's going to lead to sustainability long term.”
The other aspect to focus on is the reinforcement mechanisms: key performance indicators (KPIs) across all commercial activities. While these performance-management systems can be detailed, the best ones automatically consolidate results into a single reporting system that allows management to monitor overall pricing performance as well as the individual sales rep’s performance against targets.
A pricing transformation that delivers the most impact is tightly integrated with a broader set of initiatives that improves commercial performance for the business overall. But at its core, pricing excellence is about combining effective analytics with relevant capabilities.
A longer version of this article appeared in Sales Management Review, 9/10, 2013.