Pricing Isn’t an Event, it’s a Journey
Because it is. Pricing isn’t an event. It’s a journey.
Just consider one of the easier, early to deploy and more direct forms of pricing analysis — the net price to volume plot — and it becomes obvious why pricing improvements need to be part of a long-term strategy. And like other strategic initiatives, it will require investment overtime with the expectation of future returns.
The Price to Volume Plot
The price to volume plot shows the prices captured from individual customers as a function of their purchase volume.
On the vertical Y axis lies a metric of the average transactional price of a given customer. Shown below is the average net price captured as a percentage of list prices across a catalog of offerings and all the purchases of individual customers. Other metrics of price can be used but this one seems to be one of the more flexible metrics.
On the horizontal X axis lies a metric of the sales volume of a given customer. Shown below is the total purchase volume measured by revenue of individual customers. Again, other metrics of volume can be used but revenue is something business people readily understand.
Almost invariable, the first time a firm conducts this analysis, they find that prices and volumes are completely uncorrelated. They find some cone like shape like that shown below.
People are discomforted when shown their own price performance. They were expecting some downward sloping trend but they got a cone.
Managers wonder why low-volume accounts are getting huge discounts while higher volume accounts are getting smaller discounts. Salespeople wonder what would happen to their sales pipeline and commissions if they raised prices on their low volume customers. Executives fret over the risk of large customers demanding the same deep discounts as their lowest paying customers.
Discussions may even turn to the core business strategy of the firm: Does the firm need to go after market share or profits? If the firm is after profits, are executives willing to risk losing customers by raising their prices to improve profits?
These are sensitive questions. They can’t be answered by the pricing analyst alone. They need executive engagement.
The Obvious Solution Is Not Immediate
When I first fully plunged into the pricing field a decade ago, the pricing analyst of the day had an obvious solution: Make rules and stick to them. Seemed like a nice idea. Gurus even made big speeches about saying “No” when a customer or salesperson asks for a discount. But, in practice, this was a no-go strategy for most firms. Or, at least, a no-go on first try.
Consider the standard rule that firms would make in reaction to this price to volume analysis.
A stair-stepped discounting criteria: Customers with low sales volumes would not be allowed a discount lower than X% on anything. Customers with medium sales volumes would not be allowed discounts lower than X+Y% on anything. And finally, high volume customers would not be allowed discounts lower than X+Y+Z% on anything. The firm would attempt to shape their price to volume plots with lower bounds like the red lines shown below.
On the surface, this looks like a good discounting rule. But pricing is not a surface level issue. It’s a core strategy issue.
What would happen if the above firm really did institute the “recommended” rule overnight? Yes, profits would increase but they would be putting half of their transactions at risk of loss. Few businesses can survive loosing half of their transactions in a single year. The volatility in revenue and capacity utilization would cause a crises.
While the above rule may be a good goal, it isn’t something firms can achieve overnight. In fact, it isn’t something most firms can achieve even in a year. Rather, it takes years to move towards rational pricing.
Proof: Consider what happened at JC Penny under CEO Ron Johnson. Yes, he reined in discounts in an attempt to reshape JC Penny’s in the form of Apple. But, same-store revenue plunged by 32% by Q4 2012. Result: departure of the CEO and reversion to the prior discount-driven sales orientation.
Yet what should be done? Clearly, allowing low volume customers to routinely have greater discounts than high volume customers is unsustainable. Price contagion across accounts, incentive alignments within accounts, and value alignment across offering portfolios are all at risk when prices are captured willy-nilly across customers.
What wasn’t bad was the goal. What was bad was the time expectation. The goal may be fine but reaching that goal will take time and effort.
Time and Effort with High Returns
Instead of implementing rules like that shown above overnight, wise firms have taken an incremental approach towards better pricing and discount management. Constant improvement cycles and Six-Sigma Pricing is called in.
That is, leading firms have ditched the idea that price improvements are an event. They have embraced a long term journey towards continual pricing improvement.
In the price improvement strategy, firms develop the organizational capabilities to manage prices better. Pricing and discount management processes are developed. People are hired to drive those processes. Tools are acquired to accelerate achievements. Cultures are changed towards a profit and discount cautious mentality.
Pricing isn’t an event, it’s a journey. Treating pricing like an event either leads to destruction or to non-implementation. Treating it like a journey requires investment over time but offers strong returns, year over year.