TM How to Go from Good to Great with Pricing Software By Craig C. Zawada, Senior Vice President, Pricing Excellence, PROS INTRODUCTION GROWING COMPLEXITY DEMANDS SOFTWARE SOLUTIONS Over decades of experience advising companies about how to use pricing to their advantage, we recently observed dramatic changes in the pricing environment that suggest pricing software is a must have tool. The day is coming soon when most companies will consider pricing software an essential part of company operations, providing the foundation for sustained profitability. The reason pricing software has become so critical is, in a word, complexity. Complexity is occurring at every level of pricing management, from the formation of market strategy to perceptions of customer value, and from decision making at the transaction level to the foundations of every company s pricing infrastructure. Heightened pricing complexity at each level Market strategy Customer value Transactions Increasingly volatile input costs Multi-market participation More sophisticated buyers Proliferation of segments Shorter product lifecycles Distributed decision making Customized/ complex deals Market strategy Customer value Transactions Pricing infrastructure Pricing power Pricing infrastructure Many different constituents, dynamic markets Figure 1: Illustrates the four key areas of pricing power: market strategy, customer value, transactions, pricing infrastructure To understand the changes occurring, it is helpful to break down pricing into four critical categories: (1) market strategy, (2) customer value, (3) transactions and (4) pricing infrastructure. In this white paper, we will examine the major changes in each of these categories that are shaping pricing practices today and explain how pricing software can help you manage these forces to your competitive advantage. Most important, we will show how pricing software can ultimately take you from good to great when leveraging your unique pricing power to improve and sustain margins and profitability. 2011 1
MARKET STRATEGY: COST VOLATILITY INCREASING AMIDST MULTIPLE MARKET DYNAMICS Most companies today are not equipped to At the market strategy level, we ve seen a dramatic increase in volatility for input costs across all industries. In the last 10 years, according to our research, there s been a 40 percent increase in price volatility, and many companies simply don t have the systems or tools to identify and keep up with input cost fluctuations let alone respond appropriately. See Figure 2. identify and take advantage of geographic market differences through pricing segmentation. 3.84 4.64 4.09 3.82 5.49 6.3 Average Monthly Price Change Std. Deviation 1981-1990 1991-2000 2001-2010 Source: Indexmundi.com, Pros Analysis Figure 2: Research shows a 40 percent increase in price volatility over the past 10 years The power to manage input cost volatility, however, can make a significant difference. For example, a computer server company faced a major challenge when an earthquake in Taiwan destroyed a major component supplier s factory. Because the server company knew the components were going to increase in costs, they responded immediately to increase their prices while their competitors lagged more than a month behind them. This server company was able to make an additional $20 million in profit from that ability to respond more quickly to cost changes. The proliferation of multiple markets has also become a significant factor in pricing market strategy. Our research indicates that the market dynamics of two different city locations in the same European country, for example, can show wide variations in competition, perceived value, and therefore sales success and profitability for the same product. Most companies today, however, are not equipped to identify and take advantage of geographic market differences through pricing segmentation. The result is lost opportunities to improve margins and profitability. 2011 2
CUSTOMER VALUE: MORE SOPHISTICATED BUYERS, MORE SEGMENTS, SHORTER CYCLES The conventional Another significant trend in pricing today stems from the power that purchasers have gained over producers in the marketplace. Last year alone, companies spent more than $3 billion to purchase e-procurement software to gain an advantage in negotiations. See Figure 3. approach of juggling mounds of figures on spreadsheets simply can t keep pace with the frequency and complexity of various customer segments and requirements for customization and deal negotiation. Spend on software tools ($ Millions) 3,200 ~180 E-Procurement Pricing Source: McKinsey & Company Research (2009), Gartner Research (2010) Figure 3: Buyers gaining power over producers using procurement technology At the same time, we ve seen an explosion in the number of product segments as consumers and businesses demand products and services that are customized to their wants and needs. This creates an enormous challenge for pricing, and makes a cost-plus approach obsolete. The conventional approach of juggling mounds of figures on spreadsheets simply can t keep pace with the frequency and complexity of various customer segments and requirements for customization and deal negotiation. Shorter product life cycles are also a factor in pricing. Products that once took years to develop are now introduced in a matter of months. From a pricing standpoint, companies need the ability to price correctly from the very beginning since there is no longer any margin for error. TRANSACTIONS: PRICING WIDELY DISTRIBUTED; DEALS GROW IN COMPLEXITY Much of the profit increases over the last few years have come from reducing variable and fixed costs. These cost-cutting measures, however have reached their limit, and savings are much more difficult to find. Plus, the elimination of layers of management has typically pushed pricing decisions much lower in the organization. Some companies now have hundreds or even thousands of people involved in making pricing decisions. The result is an explosion of complexity as pricing involves more people in highly complicated negotiations with buyers juggling a myriad of discounts and promotions. 2011 3
To manage the complexity of all the pricing variables involved, professionals are relying on pricing software to help capture, process and disseminate pricing guidance when and where it is needed. We have also seen that transaction pricing has become more complex because of the explosion of custom deals. Fifteen years ago, for most B2B companies, 80 percent of customer deals fell under standard discounts, terms and conditions and 20 percent were custom negotiated deals. Today, the opposite is true for most sellers. They must contend with an enormous amount of special terms, conditions and discount structures and most do not have the tools to manage this. PRICING INFRASTRUCTURE: MORE PRICING PROFESSIONALS, MORE SOPHISTICATED SOFTWARE TOOLS Given the changes described here, it s not surprising that we are seeing the growth of pricing departments and professionals devoted to pricing within many organizations. And, to manage the complexity of all the pricing variables involved, these professionals are relying on pricing software to help capture, process and disseminate pricing guidance when and where it is needed. Pricing software is critical to equipping sales people in the field with information needed during the process of negotiating prices. HARNESSING YOUR PRICING POWER WITH SOFTWARE: FROM GOOD TO GREAT! For companies that have cut costs as far as they can, boosting profits further demands they explore their potential pricing power. But, far too many companies today are using antiquated and inflexible tools to manage the complexity of today s pricing environment. They don t possess what we call an institutional memory of pricing. That is, the collective wisdom of pricing in the organization is not brought to each and every deal. This often leaves their sales people isolated and on their own when negotiating with both customers and suppliers. Companies today need to capture and bring the collective pricing experience, wisdom and memory of all corporate staff and sales people to bear on every transaction. The ultimate goal: Develop Pricing Power The single most important decision in evaluating a business is pricing power Warren Buffet February, 2011 Spectrum of ease Do no wrong (very few companies) Extremely hard work, and investment required (available to most companies) Figure 4: Pricing power is a critical component of business success 2011 4
The good news is that customer and pricing software technology has gotten much better in the past few years. Data on customers and transactions is much more available through ERP systems, while storage and computing costs are far less. Most important, pricing software has evolved to take advantage of this data and find the nuggets of margin opportunity by applying sophisticated science to finding opportunities. The proper implementation and use of pricing software creates pricing power for a company. Warren Buffet has said the number one thing he looks for in a company is pricing power. Some companies can exercise pricing power at will. But most companies have to work very hard at it and for them pricing software can make the difference between achieving it or not. GAIN SPEED AND AGILITY FOR CUSTOMIZING MARKET STRATEGIES Coping with the forces of input cost volatility and significant local market differences requires speed and agility in pricing. Software technology provides the means to take good strategies such as logically grouping local market areas by shared characteristics when pricing, to the development of price zones based on the scientific analysis of customer segments. This allows corporate office sales, marketing and pricing staff to clearly identify dynamic segments and react much faster to changes in local market conditions and competition. At the same time, pricing software enables companies to go from monthly or even weekly manual evaluations of cost inputs to making price adjustments in real time --- often in a matter of minutes or a few hours --- so that prices accurately and immediately reflect the fluctuations of input costs when it makes sense. For one distributor, we have seen this flexibility improve margins by over 100 basis points alone across an entire product line. Figure 5 highlights technology s advantages that can take companies from good to great pricing practices. Market strategy Customer value Transactions Pricing infrastructure Market strategy From good to great Good Practices Logically grouped local market areas on which to base prices Prices evaluated when major cost shifts Pricing Power with Software Price zones chosen and modified based on scientific segmentation Real-time adjustments to prices based on changing economics Figure 5: Technology advantages for market strategy 2011 5
FIND AND EXPLOIT KEY VARIABLES IN CUSTOMER VALUE Pricing software allows companies to set list prices for individual products based on a sophisticated analysis of each product s pricing history as well as comparisons with other products in similar categories. While many companies do a good job of making list price adjustments based on category-level analysis of pricing opportunities, they struggle with getting much more visibility into key differences among individual products. For example, a construction equipment company used to adjust its prices at a product category level. All hydraulic fittings would get the same price increase every year. However, they were missing the unique DNA of each SKU even by this category-level action. Some of the fittings were low-volume and difficult-to-find alternatives, whereas others were easily replaceable with off-the-shelf parts at a local supplier. In addition, some were already much higher priced than competitors, and others still had room for increases while remaining below competitive alternatives. As a result, the company was under and over pricing many of its hydraulic fittings. Pricing software can deliver a granular level of analysis that makes individual product pricing not only possible but a competitive necessity. Pricing software allows companies to set list prices for individual products based on a sophisticated analysis of each product s pricing history as well as comparisons with other products in similar categories. This capability enables companies to quickly and easily identify underpriced products and calculate the trade-off of margin to sales for specific list prices. See Figure 6. Market strategy Customer value Transactions Pricing infrastructure Market strategy Customer value From good to great Good Practices List price adjustments based on category-level analyses of pricing opportunity Pricing Power with Software List prices set based on sophisticated algorithms using data on» Pricing history/ momentum» Comparisons to like categories Figure 6: Using technology to enhance customer value PROVIDE MEASUREMENT AND GUIDANCE FOR EVERY TRANSACTION Despite the wealth of information generated by customer management systems, many companies are hard pressed to utilize it fully when developing price guidelines and decision rules for setting and negotiating prices. Pricing software technology provides a much more in-depth understanding of a customer s transactions and behavior so that underperformers can be identified and the biggest margin opportunities can be acted upon. Just as important, pricing software can provide ongoing access to an account s transaction profitability (taking into account all of the special terms and conditions and costs to serve) and compare it to other like customers to find potential improvement opportunities. 2011 6
Our experience has revealed, for example, that sophisticated transaction analysis often shows the most potential for margin improvement exists among customers in the middle range of the profitability distribution. Many companies have taken tactical measures to find the extremely low or negative profit customers. Few have applied the science to identify average profit customers that could do a little better when comparing them to other like customers. This is where scientific segmentation improves the negotiating confidence of the sales force in pushing for increases in prices and margins when it makes sense. Pricing software can provide more accurate floor, target and stretch price guidance at the point of negotiation and empower the sales force while enforcing accountability. See Figure 7. Market strategy Customer value Transactions Pricing infrastructure Market strategy Customer value Transactions Pricin From good to great Good Practices Clearly defined and executed guidelines and decision rules for all price waterfall elements Pricing Power with Software Optimized pricing targets given at the point of negotiation Incorporate customerspecific cost-to-serve into price negotiations and in managing performance of accounts Figure 7: Advanced transaction analysis optimizes prices BUILD PERFORMANCE MEASURES INTO YOUR PRICING INFRASTRUCTURE To fully exploit the power of pricing software requires a company s pricing infrastructure be aligned with the capabilities inherent in the technology. That means moving from the usual categories of reporting and sales incentive structures to the use of true peer comparisons based on software tools that monitor and track accountability and compliance with pricing policies across all levels from executive management to field sales. With the increase in pricing departments and the number of professionals dedicated to pricing, and the phenomenal growth of available customer data, most organizations are poised to utilize their pricing power with readily available software tools. It makes little sense to try to recreate these reports in Excel or other generic reporting tools when there are already best practices built into leading pricing software tools. 2011 7
Market strategy Customer value Transactions Pricing infrastructure Market strategy Customer value Transactions Pricing infrastructure From good to great PROS has taken the lead in applying scientific analytics not only to manage, but actually help prescribe how and Good Practices Cascading reports on margins by region, customer, salesperson Sales incentives for improved margin performance Pricing Power with Software True peer comparisons Tools used to monitor and track compliance when products should be priced. Figure 8: Pricing software monitors and tracks performance accountability BEYOND PRICING MANAGEMENT TO PROFITABILITY More and more companies are recognizing the powerful potential of pricing s impact on margins and profitability. PROS has taken the lead in applying scientific analytics not only to manage, but actually help prescribe how and when products should be priced. PROS also has very powerful and flexible reporting and analytic tools that allow companies to conduct actionable dialogue around pricing. The advantages of adopting and implementing presciptive pricing software have never been greater. Here s what you can gain: React quickly to cost changes and changing local market dynamics Apply sophisticated science to identify underpriced products Adjust prices over the lifecycle Commensurately equip sellers with data Provide scientific guidance on willingness to pay Provide full transparency to deal economics Build integrity into processes Provide true transparency on relative performance Build pricing bench strength NEXT STEPS TO APPLYING THE POWER OF PRICING SOFTWARE The business case for pricing software is no longer a question of if, but of when. Those companies operating without pricing software will increasingly be at a competitive disadvantage. My favorite analogy describes these companies as attempting to land a commercial jet without instrument panels or controls. Pricing software is the means to gaining the visibility and control to successfully navigate the headwinds of marketing volatility and complexity. 2011 8
If you have not yet evaluated pricing software as a strategic tool for your business --- or are in the midst of considering a pricing software investment --- I suggest the following steps. 1. Assess where you are as a candidate for pricing software from the perspective of complexity and change in your own market environment. 2. Examine the three categories of pricing to determine where you can gain the most leverage or value. Is it in the realm of marketing strategy, customer value or transactions? 3. Finally, Put together a team of cross-functional professionals in your organization to evaluate the pricing power potential of software technology. Include an executive champion, sales and marketing management, finance, and field sales people to ensure you have buy in from all involved parties. There is a proven path to realizing your own pricing power potential. It s up to you to take the first step. To learn more about PROS prescriptive software solutions, visit our website at www.prospricing.com or contact us at info@prospricing.com. ABOUT THE AUTHOR Craig C. Zawada serves as Senior Vice President, Pricing Excellence, at PROS Pricing, the leading provider of price management and optimization software. Prior to joining PROS in 2010, Zawada was a partner and co-leader of the North American Pricing Practice at McKinsey & Company, gaining experience across a wide range of B2B and consumer products. He is a widely published author on the subject of pricing strategy, with articles featured in the Harvard Business Review, Mergers and Acquisitions and the McKinsey Quarterly. He has been interviewed and quoted in Fortune Magazine, CFO Magazine, Canadian Business and Business 2.0. Zawada is co-author of The Price Advantage, recognized as one of the most pragmatic books on pricing strategy available. 2011 9