Increase Profits by Using Value-Based Pricing
Pricing can have a dramatic impact on the bottom line extremely quickly, probably more quickly than any other business initiative.
Our method uses data analytics to identify value-levers for customizing pricing. These dramatic improvements do not come easy, they require putting resources on pricing analytics in-line with the value it can deliver.
Here’s an example of how it works:
Our client, a medium size manufacturer, was facing year over year EBITDA (earnings before interest, taxes, depreciation and amortization… also known as cash flow) erosion. We investigated their pricing methodology and identified significant opportunity to recover profit they were “giving away.”
In the initial discovery phase, we learned that the sales representatives owned the quoting process and pricing decisions. The sales teams’ incentives were based on top level dollar sales, not margin or profitability. The sales team was busy managing the sales relationship and growing the top line… they did not have pricing strategy training. Their quotes were based mainly on minimum margin requirements. While the sales team did not want to give away margin, they were often trying to get complex quotes out quickly while winning as much business as possible. This behavior manifested in consistently low prices across all products and customers.
To solve this problem, we worked to develop a quoting model which would incorporate customer and product characteristics to assist in determining the appropriate price. We analyzed the products and customer mix, which uncovered high and low value pockets of business. The next step was digging deeper into the manufacturing efficiencies and inefficiencies of each product group, the customer segments, and regional competitive pricing. The output was a dynamic analytical pricing model which could be used consistently across the business to develop value-based quotes.
The model was initially used to compare current prices against the value-based price. This identified key opportunities to increase price and expand margin on targeted business. The price increases focused on complex specialized products as well as small cumbersome customers and funded targeted price decreases on high velocity products for large, high value customers. These price decreases enabled the business to win new profitable business from existing customers.
A phased approach was used to implement the price increases. First, the model was used for all future quotes so that we would not continue to create non-value based prices. Next, prices for smaller customers, who were not on contracts, were adjusted up. These improvements were implemented very quickly. A small subset of price increases were executed in multiple waves because of the large price increase. Finally, prices for the larger contract customers were adjusted (up or down) during the standard annual contract review period.
The implementation included building an internal pricing team to manage the quote process. This took pricing decisions and quote management away from the sales team. The internal pricing team reported to both Sales and Finance allowing a balancing of revenue and margin goals. At first, this caused tension with the sales representatives as they worried that their customer’s prices would increase, and they would lose business.
In fact, some small customers who purchased specialized products chose to stop buying from this manufacturer. This was positive for the business as it reduced operational complexity and allowed for the organization to focus on more profitable customers and products. Price is an efficient way to encourage unprofitable business to leave or convert to profitable business.
We reviewed additional value levers outside of price that could be pulled to increase value for both the customers and the business. This included a charge for rushed orders. The rush charge varied depending on the product and the impact to lead time so that the additional cost to the customer aligned with the operational cost to reduce lead time. We also implemented a freight charge for orders below a certain level which resulted in some smaller customers converting to pick up.
Finally, we revamped the annual customer-rebate structure. The existing rebate structures did not incent customers to grow significantly in order to obtain the rebates. Rebates were changed to require customer growth to obtain the next level of rebates. Incentives increased as customer growth increased. This resulted in twofold benefit for the company: reducing financial commitment to stagnant and declining customers and increasing share from growing customers.
The business saw significant growth in EBITDA (cash flow) from implementing customized value-based pricing. Specifically, they achieve approximately 20% EBITDA growth, or $2MM annualized. And, the sales representatives ultimately benefited from this change. They were no longer bogged down with the administration of pricing activities which allowed them to refocus on customer relationship development. The business experienced improved manufacturing efficiency through better product mix, and growth with profitable customers.
If you want to talk to us more about dynamic customized value-based pricing email stacy@pricingvelocity.com