Measuring the Impact of Pricing Initiatives

Pricing professionals are generally hired to accomplish a simple goal: improve profits. But how do you measure the impact of pricing on profitability?

Sales and marketing communications are often measured by the quantity they sell and the price associated with these sales. Product development and innovation are often measured by the impact new products have on revenue and profits. But how do you measure a pricing professional’s performance?

Two key issues must be addressed:

• What decision areas are pricing professionals intended to impact that will drive profits, and
• How do you measure those impacts?

I recently published an academic peer-reviewed paper on this subject that provides the math and reasoning behind a profit bridge.  It can be found here in my paper “Normative Decomposition of the Profit Bridge into the Impact of Changes in Marketing Variables” published with @SpringerNature in The Journal of Revenue and Pricing Management.

What follows is an explanation of how a profit bridge with proper attribution can be used to both guide pricing efforts and also measure pricing performance.

Pricing’s Impact on Profits.

There are three overarching routes to improving profits through improving pricing:

• Raise Prices
• Improve Mix
• Inform Offering Launches

Each is highlighted in Green in the profit bridge shown below. 

I am well aware that sometimes better pricing may call for lowering prices to drive greater volume.  I am also experienced enough to know that pricing departments are rarely called upon to help executives lower prices and then measured on how well they lowered prices.  So, let’s focus on these three areas.

One:  Raise prices on offerings with no impact or a maximally acceptable impact on sales volumes.

This is often the outcome of an effort to reduce negotiated discounts or rebates or to provide salespeople with clear and realistic pricing guidance (guiderails) for engaging in negotiation.  Both of those are the bread-and-butter outcomes of performing a historical price performance analysis and driving intelligence augmented pricing decisions.

It also arises in annual price reviews where select offerings are chosen for a price increase.  Velocity Pricing, Elasticity Metrics, Price Image Management, and other techniques are used to identify specific offerings where it is suspected that a price increase will have a positive impact on profits and potentially on revenue as well.

And we can also see a pocket price improvement by improving commercial policy.  Changes to the strategic discounting and rebate rules, such as identifying a specific rebate for large volume customers over small volume customers or charging more for freight and delivery while lowering list prices, can also improve price capture overall.

The profit bridge with proper attribution of my research isolates these impacts within a measurement of the impact of changes in specific prices on profits.  (PI for price impact in my academic paper is found in equation 21.)  Conceptually, it is the average quantity sold times the change in price using the average mix across the two periods.  Other derivations of this metric have been offered. Yet, as demonstrated in my academic paper, they fall short of being accurate and meaningful.

Two: Improve the mix of offerings sold towards higher margin offerings with no impact or a maximally acceptable impact on sales volumes.

This can be often be accomplished through a variety of paths.

Pricing can work on sales incentives to increase the impetus to sell higher margin items.  This usually comes in the form of replacing volume and revenue-based incentives with profit-based incentives.  A documented approach can be found in our white paper “Adopting Profit-Based Sales KPI.”

Alternatively, pricing can work on marketing communications to improve the sales of higher margin offerings over lower-margin offerings.  Movistar, a subsidiary of Telfonica Spain, had strong success in driving more profitable sales simply by using behavioral economics in determining how to present their plans on their website.  In this effort, they reversed the order of listing offerings, starting with highest-priced and leading to lowest-priced, as behavioral economics would suggest. The result was that a lot more customers chose to purchase a more expensive and profitable plan.

And it is also possible that pricing can work on the price structure itself. Good-Better-Best pricing has long been known to bias sales toward the “Better” offering and away from the others.  More recent experiments with Good-Better-Best-SuperBest pricing has demonstrated success in shifting sales even further up the ladder, even if very few customers buy the “SuperBest” offering.

The profit bridge with proper attribution of my research isolates these impacts within a measurement of the impact of changes in offering mix sold on profits.  (MI for mix impact in my academic paper is found in equation 23.)  Conceptually, it is the average quantity sold times the difference in the average prices and variable costs across the two periods times the changes in mix.  Other derivations of this metric have been offered. Yet, as demonstrated in my academic paper, they fall short of being accurate and meaningful.

Three:  Support an offering launch with appropriate pricing which delivers an appropriate tradeoff between market penetration and margin improvement.

The third general area where pricing supports profitability is in ensuring the right price is placed on new offerings at the time of launch.  We have discussed the role of pricing research and new product development in our white paper “Pricing and New Product Development.”

Here, pricing is working with product managers, sales executives, marketing executives, and innovation teams to set proper price and sales volume expectations.  Using economic value to customer, price sensitivity meters, Gabor-Granger techniques, and sometimes conjoint analysis, pricing can inform sales and marketing of the willingness to pay of different market segments, the addressable size of those segments, and therefore the optimal price at launch.

Again, the profit bridge with proper attribution of my research isolates these impacts within a measurement of the impact of new products on profits.  (ENT for entrance in my academic paper is found in equation 24.)  Conceptually, it is the product of the quantity sold and the difference in prices and variable costs of the new offerings.

The Profit Bridge with Proper Attribution

The profit bridge with proper attribution also delivers other metrics.  It measures the impact of sales and marketing on delivered offerings in a quantity sold term.  (QI for quantity impact in my academic paper is found in equation 20.)  It also measures the impact of operations and the supply change on delivering cost savings in a variable cost term.  (VI for variable cost impact in my academic paper is found in equation 22.)  It even measures the impact of product retirements.  (EXT for exits in my academic paper is found in equation 25.)

Profit bridges can be expanded to include various forms of fixed costs and investment decisions as well.  Moreover, the profit bridge with proper attribution can be expanded to include factors like the impact of currency exchange rates on global profitability or the impact of a price index (think of chemicals being indexed to the price of crude oil).

There have been competing derivations of the profit bridge, yet these were demonstrated to deliver unclear and often inaccurate measurements of the impacts of decisions on profits.

But, the next time someone asks “How do you measure the impact of pricing decisions on profitability?”, you can answer “Use the Profit Bridge with Proper Attribution found in Smith’s paper.”