For sales people not involved in pricing, here is a way to quickly understand one of the most important pricing issues that many companies face.
Pricing by a sales person is like blowing up a party balloon… let me explain. The average parent who blows up balloons for a party is much like your typical sales person who’s pricing a customer deal. The parent tries to blow up the party balloons quickly so they can move on to the next balloon and get everything done before the mass of kids arrive. They know that bigger balloons with more air in them are more fun for the kids so they put in just enough air so it’s nice and full but not too much that it bursts. They don’t exactly know where the bursting point is but it doesn’t matter. The parent will use a mix of gut feel and personal experience and that’s good enough.
So how exactly is that like a sales person you ask? Well, your typical sales person is trying to quickly price a deal so it wins the customer over and they can move on to the next deal. Complete enough of these transactions by the end of the quarter, when their boss arrives, and they have made their numbers. They want to price it well so that there is a good margin but not so high that they lose the deal and potentially the customer. He doesn’t know exactly where the bursting point for the deal may be but it doesn’t matter because he’ll use his experience to set a price that will be good enough to win the deal and then move on to the next.
Sure, there are professional clowns and party organisers who regularly blow up balloons for parties, just as there are very experienced, skilled sales people who possess a lot of knowledge about their markets and their products. And yes, some people are better at it than others.
Perhaps most importantly, in neither example are these people employed specifically to ‘blow up balloons’ – it just happens to be part of their job. In the case of the sales person, even if they were dedicated to pricing, there are different products, different customers and different deal situations, so no two deals have the same bursting point.
To further complicate the matter, sales people are too often incentivised on overall revenue, not on margin. So, then, why should they bother trying to get the maximum amount of air into that deal when ‘good enough’ will do? In a revenue incentive situation, the risk of losing the deal is always greater than the gain of pushing the price a little bit further to make a small bit of additional commission.
The result is that party balloons are constantly under inflated and companies that depend on sales people negotiating deals are constantly leaving money on the table. Now, you might ask, “does it matter?” One slightly bigger balloon doesn’t make that much difference and nor does one slightly better priced deal.
In my experience, I would argue that if you can squeeze one extra breath into each balloon you will fill up the room faster. And if the sales team can squeeze just a 1% better price into every deal it can make an enormous difference to a company’s financial results.
For a typical company this 1% improvement in price results in between 8-12% improvement in operating profit. Even more interesting is that many businesses with large field-based sales forces have smaller-than-average net margins. Distributors, for example, have smaller- than-average net margins and a 1% improvement in price can result in an improvement in operating margin of more than 25%.
By thinking in detail about the role of pricing within sales, companies can improve their overall performance. Similarly, understanding the role that little improvements can play will lead top a bigger overall return.
About the author: Alex Smith is a senior manager within the Strategic Consulting group at PROS (www.pros.com). He focuses on vertical issues for sales professionals in manufacturing, distribution and services.