Harald L SchedlHarald L. Schedl, partner, Simon-Kucher & Partners
A startling statistic has been revealed by the results of the Simon-Kucher & Partners 2011 Global Pricing Study, which draws on the insights of almost 4,000 executive level managers. The study shows that only one third of industrial firms are able to capture more than 75% of a target price rise, with the average industrial firm capturing just 59% of their target.
Perhaps even more surprising is that firms selling similar products can achieve significantly different results, with certain firms realizing twice as much of their target price rise compared to their direct competitors despite facing the same market dynamics. The difference between these firms is to a large degree the pricing power in their sales organisation.
More and more companies realise that price is their most effective profit lever. Achieving just a 1% increase in realised price for the average industrial firm equates to an increase in profit of 5%-10%. In Industrials, with large, dispersed sales forces and where the majority of transactions are negotiated, the price level (target) is almost irrelevant without professional price execution. All too often, execution is the forgotten side of pricing.
Senior managers need to actively steer the actions of their sales organisation and arm their sales force with pricing power to extract the value they deserve from the market. Particularly in today’s inflationary environment where large price rises are required, achieving excellence in price execution is critical for protecting the profitability of companies.
The Price Execution Framework
We view pricing as a process, starting with Pricing Strategy (“setting the right direction”) through Price Setting (“setting the right price”) to Price Execution (“getting and keeping the right price”). To put it simply, Price Execution consists of minimizing the gap between the target price and the realised pocket price achieved by the sales force. The approach to achieving excellence in Price Execution requires mastery of three disciplines, which are represented in the diagram below.
Discipline 1: Provide Guidance
To minimize the price gap, it is imperative that senior management design processes, pricing policies and escalation schemes to guide and steer the behaviour of their sales force in the market on a day-to-day basis.
To steer the behaviour of your sales force it is necessary to monitor the true pocket prices achieved by your sales team in the market. This requires creating internal transparency.
There are traditionally two main areas that require focus to create this transparency: ‘de-averaging’ and ‘pocket price calculation’. The first, ‘de-averaging’, is relatively simple but often overlooked. For time-constrained managers, monitoring monthly averages in a spreadsheet is typical for Key Performance Indicators but this tells the manager nothing about the variance (or spread) of that indicator. Representing the data in a visual way, for example through a scatter diagram, will help identify interesting cases for further investigation and give more insight into actual behaviours.
The second area, ‘pocket price calculation’, can be more difficult to achieve but is worth the effort. In B2B, the realised price is often blurred by rebate agreements and discounts-in-kind. Unsurprisingly, these are aspects that usually lie outside of the physical invoice.
Calculating a projected rebate back to a transactional level is a challenging task, especially if complex performance oriented and tiered schemes are in place. A pragmatic and achievable first step can be to use the accrued percentage figure as an estimate, allocated to the invoiced (net) prices.
After any rebates have been accounted for, ‘discounts-in -kind’, or non-price related concessions, need to be allocated. The requirement for this can be clearly understood by considering two hypothetical sales people who achieve the same net price. However, one always throws in additional services such as free delivery, free aftersales service or installation support. Naturally, there is a significant difference between their true pocket prices.
Concessions are an ever-present part in the majority of negotiations, but are rarely made in a structured manner. Part of this problem needs to be addressed via specific training of the sales force. However, training alone is not usually sufficient and should be complemented by policies that are aimed to steer and guide the sales teams.
In most negotiations, a variety of factors are in play. In a recent workshop a list was generated of over 30 different concessions that may be asked of the company’s sales team during a negotiation.
With this many ‘balls in play’ and with sales teams often dealing with customers ranging from Small-to-Medium Enterprises right through to large multi-nationals, a customer segmentation approach needs to implemented with specific pricing policies for each of these customer segments. For example, it could be feasible to provide post deal product training free of charge for a large order from key account; however, it is probably not judicious to do this for an order from a smaller customer.
This, of course, may seem like common sense. Yet project experience has shown that these smaller customers account for an unexpectedly high proportion of the companies that are receiving concessions such as ‘product training’ and ‘free delivery’ and in some cases are even achieving the highest discount! This is pure margin leakage and policies must be in place to prevent this scenario.
Firms often overlook the importance of psychology when designing their discount escalation policy. An escalation scheme must be designed to counter the ‘5%’ increment trap. For example, requiring manager authorization below rather than above the 5% increments (e.g. at 24% rather than 25%) and displaying the impact a 5% price reduction has on the profitability of the deal is usually the first step to prevent this. A client recently said to us “when I am asked to approve a 3.8% discount I will know that the message has hit home!” Discounts are flexible and not obliged to be given in 5%’s.
Once the transparency has been created and the pricing policy rules defined, a monitoring process must be set up to track the adherence to these. Without this monitoring in place, we often observe ‘exception creep’ where sensible rules have been insufficiently enforced until the ‘exception has become the rule’. The level of adherence to these rules can be included in the sales teams’ targets. With the natural competitive spirit that is present in sales teams, an improvement in the ‘measured and internally communicated metric’ can sometimes be almost as strong as the improvement in the ‘financially incentivised’ metric! Use this natural competitive spirit to your advantage.