The Need for Better Pricing
One of our customers eloquently said “If it ain’t broke, fix it anyway.” She was talking about pricing. She had inherited a pricing process from a former colleague that had to leave suddenly and had to get up to speed quickly. The process worked, but it was terribly inefficient and error prone.
What she was getting at was that she saw an internal opportunity to fix her pricing process and she recognized there where competitive threats on the horizon they were going to need to deal with. She needed to do something. The company’s margins were doing alright. They were consolidating and adjusting the mix of their stores, but overall doing ok. A new CEO, however, wanted more flexibility with pricing at the store level and she knew they would crack under the weight of the internal processes needed to support that level of pricing.
What precipitated the CEO’s desire for more local pricing? I didn’t talk to him about it and don’t have telepathy, so I can only reason that the conversation in his head went something like this:
- My margins are falling. Why?
- There is a slowdown in retail
- We also have a new competitor in the market
- OK, what do I do?
- I need to innovate or make myself more efficient
- OK, how?
- I have more inventory than I need at some stores, what if I allocate products better or improve my distribution?
- Do I need to forecast better so that I have a better understanding of what inventory I need?
- What about more flexibility with pricing at the store level? Localized pricing would help my margins.
- What now?
- How about starting with pricing? It would give us a quick win for improving margins and being able to compete
- What if I shift more sales online? It would help my distribution and inventory, plus my margins are better online since I don’t have full store operations supporting the sales
- How can I better forecast? A better process and science is the short answer.
- . . .
You can see where this simplified chain of reasoning is going.
Why were his margins falling? The dialogue alluded to a few of the possibilities. It might be an assortment issue or could be too much inventory. It could have been changing demographics at their store locations leading to under-performance or it could have been the state of the retail industry in general. The other big possibility was the competitive threat. Once stores are trimmed the next logical lever to pull is pricing. Localized pricing is a quick way to improve margins.
What is the competitive threat? In this case, other brands have always been around, but also Amazon is a major driver in almost every retail industry. Leading companies know if they don’t adjust, Amazon will just steamroll them. I saw a video recently that alluded to Amazon researching robots that would make to order any clothes you wanted. At SXSW 2018 I listened to a fashion panel where 3 leading retailers discussed the state of the industry. Their feeling was that Amazon was a marketplace and apparel was an emotional buy. A member of the audience stood up and started asking really pointed questions, then followed with “full disclosure, I’m the CTO of Amazon Fashion.” The panelist’s faces when white. Amazon is watching and learning.
If you wait until you have to do something, it’s probably too late.
Pricing excellence can improve profit
What is pricing excellence? In our experience it’s a collection of processes, data science, and automation that ensures you have the right price at the right time for you customer. Is the right price the best price for everyone? No, it’s the price that balances your business goals against market conditions like when you want to maximize profit using price elasticity. The right time means that your customers can get a relevant price in any channel they choose whether in a store, on-line, or through a partner eTailer. Pricing excellence encompasses the ability to optimize your price and ensure that you can deliver those prices to your customers.
For me, my education about pricing excellence started many years ago in one of my first jobs at Trilogy in Austin, TX. Trilogy was an energetic company with big ideas. One of which was a ‘pricing engine’ that would dynamically price products, such as computers or automobiles, when a user selected options for the product. It worked by providing a modeling environment where an administrator could construct the pricing calculations and conditions by which the product was priced without writing software code.
That certainly doesn’t sound particularly innovative today because it is common practice now, but back then many sales people would price in a spreadsheet or worse with a calculator and paper. The new method did it automatically. In working with different companies across industries, though, it highlighted that sales people and price administrators made mistakes when they manually calculated prices. These pricing errors cost the companies money. Interacting with these clients drove home how important it was to consistently give customers the right price and how important it was to institute a process to achieve pricing excellence.
I was describing pricing errors above, but when talking about pricing excellence many people automatically assume you mean optimization. And, yes, optimization is a big part of pricing excellence, but the other component is reducing pricing errors and providing a foundation to be able to accept recommendations from an optimization process. It’s like when I wanted solar panels and thought I could generate all the energy I needed. Austin Energy would pay for a portion of it but they said they wouldn’t approve funding until I fixed the energy leaks in my house first. I quickly found I was leaking more energy than I could ever generate, so set down the path of plugging those leaks. It’s the old metaphor walk before you run and it holds true with pricing excellence as well.
After Trilogy, I continued down the pricing path at i2 (later acquired by JDA), wrote a pricing application myself and implemented it for metals companies, then worked as a consultant on a Lenovo eCommerce project. Through it all, I saw that better pricing provided big benefits to customers. Now, as a principle in DoubleBlaze, I know pricing is an area we can deliver significant value and set out to evangelize the message. It is an area that many of our customers have yet to exploit. Some are still using spreadsheets to manage prices and others have unreliable price execution. Here are some examples of the opportunities that exist:
- Pricing errors. A steel company I worked with found a 5% error rate in pricing on their invoices which translated to hundreds of thousands of dollars in lost profit.
- Pricing efficiency. A leading retailer struggled to get prices out the door, often taking 4-8 hours and requiring hours of lost productivity to research the cause of the error. Here is another example on how pricing efficiency affected a retailer.
- Liquidating inventory. A customer of one of our technology partners found they could achieve their company goals of liquidating inventory while maximizing profit through better pricing (will publish details later).
- Increasing profit. Many years ago, a Harvard business review article Managing Price, Gaining Profit stated a 1% increase in price can yield an 11% gain in profit. Of course there are a lot of dependencies such as your margin and demand but the point is – good pricing is important.
- Driving revenue. AMR published a study that found promotions could drive a 1-12% improvement in revenue and a 5-20% improvement in margins.
These are just some examples of why pricing excellence is important. Bottom line is that pricing errors leak profit and better pricing can improve profit. Those two statements guide us when we work to deliver value to our customers. In this blog, we will explore the techniques we use to determine if a company has a pricing problem, how to address the problems in a project, and finally how to lay the foundation for optimization. I will draw from personal experience, our practice leaders experience, and partners to define the concepts and tease out the details.
Pricing Landscape as we see it
As a consulting company, we generally work with enterprise customers in the $500M to many billion-dollar range. It’s not that we won’t work with smaller companies, this is just where the majority of our contacts lie given our collective backgrounds in enterprise software and consulting. We operate mostly on the sell side of enterprise companies implementing eCommerce, master data management, configurators, pricing systems, CRM, and content management solutions and integrating them into our customer’s business processes. We consistently see that better pricing practices stand out as the area where we can provide the most value to the companies we service. Specifically, when we talk about Enterprise Pricing we are referring to large companies with complex pricing processes. As described in a previous article, fixing pricing errors and providing the foundation for optimization yields an enormous benefit.
In our work, we span both B2B and B2C pricing. We approach the pricing process differently for these channels. This is how we view the difference:
B2B. Business to business commerce is usually done through relationships and typically requires a sales person to negotiate contracts or deals. A target price or deal envelope can be used to drive sales people to the final price that is in line with a company’s goals.
B2C. Business to consumer commerce might have floor sales people but typically no negotiation. B2C pricing is usually done in a back office where a marketing or merchandising team determines the price. The price is then sent down to stores and the eCommerce site.
Supply chain management commonly refers to the planning funnel which flows from strategy to planning and then execution. Strategy is focused on activities for the next few years. Planning horizons deal with the next 6-12 months. Execution focuses on immediate actions taken over the next few weeks. I like to borrow this terminology when discussing pricing. In this blog, we will focus on the medium and short-term processes of planning and execution:
Planning. Planning, aka analysis and optimization, work in conjunction with each other to determine what the right price should be at a given location or for a particular channel. In B2C, the systems typically employ a forecast that shows both base demand and promotional lift. Price elasticity can be used to analyze secondary impacts of price changes such as cannibalization and halo effects to determine what the right price should be. B2B planning uses the same techniques, but also provides guidelines in the quoting process that direct the sales people towards the company goals. These tools also measure performance against those goals.
Execution. Execution takes the price from planning and gets the price to the place your customer will see it on an eCommerce site or to the POS. Execution can include systematic checks to ensure that actions taken by the different business functions such as marketing and merchandising don’t conflict. Also, store managers may need the authority to deal with unknowns such as local competitive actions. The optimized price coming from corporate may need to be overridden. In B2B, execution is really the quoting system. This is where prices are negotiated, contracts are managed, and price commitments are sent to customers.
When we talk to customers about pricing, one of the initial things we establish is where they fall on the spectrum of pricing needs between B2B and B2C. Companies that do both typically have different business units that handle marketing and pricing functions for the separate units. Sometimes the lines can be blurred but in general we see these business functions at the intersection of these categories:
|Planning||Lifecycle analysis and planning including promos, mark downs, and initial pricing. In general, optimization is based on a forecast which drives a price-elasticity curve to determine the best price.||Setting guidelines for sales people and targets that are in line with business goals. Measuring sales people against those goals. Setting tier discounts and negotiation parameters.|
|Execution||Execution is rules based pricing and verification. There may be different systems affecting price such as mark downs from merchandising and coupons from marketing. Execution is where it comes together.||Creating contracts, customer specific pricing, enforcing deal envelopes, creating quotes, approval processes, and spot quotes.|
In B2C we’ve seen that the execution system is usually different than the planning system, but in B2B we’ve seen the planning and execution systems can be a single system. I can only venture to guess why this is the case. B2B systems typically have a lot of interactive users and workflow whereas B2C systems seem to focus more heavily on transaction speed. I assume there’s enough of a market for these separate business problems that vendors have specialized in one or the other.
For analysis, the dividing line seems to be how much transaction data you have. When you have enough data, then you can apply science to determine the optimal price and be statistically confident in the recommendations. If you don’t have enough data, then you employ boundaries and reports to aid negotiation and rely on the sales person to ultimately make the decision.
The typical path we suggest to achieve pricing excellence is to first identify if you have a pricing problem and where you can improve on the process. For many companies the starting point could be a price execution system to stem the price errors and put controls around how the price is calculated. If this foundation is in place, you can progress to optimization.
In the next topics, we will cover the process we use to identify pricing problems and how big the opportunity is. Then, we will discuss how you go about fixing the process.