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Why focus on pricing?

By: Special Guest Author Patrick J. Taylor
March 2011 Pricing

How lean is your organization?  What processes are left to be optimized?  Can you really afford to cut more costs to drive your profitability?  And if you do attempt to drive even lower costs, how can you get them?  Can you possibly get more work out of your team?

 

While there is criticism that the United States governmental statistics do not truly show all the improvements and advancements in our worker’s efficiency, the data does demonstrate an improvement in productivity.  The government shows us as having a 13.4% compounded growth rate since the late 1940’s, an average .2% per year.

 

1947 – 73 1973-79 1979-90 1990-2000 2000-2007 2007-2010
2.80% 1.10% 1.40% 2.10% 2.60% 2.70%
Source: US Bureau of Labor and Statistics, Last Modified Date: February 03, 2011, http://www.bls.gov/lpc/prodybar.htm

 

From a professional history perspective, you too have most likely witnessed or been part of…

  • Implementing a an ERP, CRM, or some other accounting, inventory, or production planning system
  • Driving quality and service initiatives like ISO, NQF, Customer Value or Baldridge
  • Activity Based Cost initiatives
  • Purchasing, inventory (JIT),  and/or Supply Chain Management (SCM)
  • Improving speed to market for new products, like Agile, Project Management, Time to Market (TTM)
  • Outsourcing “non-core functions”; e.g. IT, mailroom/shipping, copier services, vehicle fleet management, break room and supplies
  • Squeezing out middle-management and increasing “Span of Control”
  • Restructuring the organization to centralized control, then to decentralized, then to a matrix and possibly back to where we started
  • Demanding quantifiable results from marketing and advertising campaigns
  • Implementing new HR efforts for evaluating and rewarding performance and cutting labor costs; e.g. SMART Objectives, salary banding and benchmarking salaries, migrating from pensions to 401K’s
  • And the list of Sales and General Administrative (SG&A) cost cutting goes on…

 

If your business is like many, the chances are high you have already done most everything you readily can do to run a lean, efficient, and well organized business. So what else can be done to improve profitability?

 

The profit equation is straight forward; revenue less cost equals profit.  So if we cannot improve the cost structure, then we must reevaluate revenue. Since revenue equals price times quantity, we must either increase our unit volume or we must increase our prices.

 

If we could increase our sales volume without reducing our prices, then we would incur only the variable cost of the extra units sold.  Thus we would further spread our fixed overhead costs across more units, effectively reducing our total cost per unit sold. This means we will reap a better improvement in our profitability by prioritizing our effort to drive more sales over finding ways to cut costs. So if you are trying to choose between bringing in a cost savings expert or a sales process guru, the answer should be the sales guru.  I know a few of these guys and what they can do for a lagging sales team is amazing. Many times they can help you increase sales without reducing your prices, so you can imagine they get a good endorsement from this pricing geek.

 

But interestingly, if we could simply raise our price on existing sales volume without losing any business, then we will see the full amount of the price increase in our gross margins. This is because we do not incur the variable cost of the additional units sold.  So, while it is better to focus on our sales efforts than cutting costs, focusing on increasing our prices has an ever greater impact on your bottom-line.

 

Having faced a few customers with price increases, I understand this is no simple suggestion.  And the idea is fraught with the dangerous assumption that you can increase prices without losing sales volume.  Further, if I am an advocate of market based pricing, how can I be so naïve as to assume we can just charge more?

 

To be fully candid, I have not witnessed customers being ready to accept a price increase just because our major raw material costs went up.  Only when my competitors announce an increase of about the same amount at the same time will my price increase be accepted.  Otherwise, we can either live with the old price or not sell our products.  A classic example of this working is when certain airline companies announce a new bag handling fee and the others all follow suit.

 

The answer is not to just do a simple across the board price increase. First we must understand our market prices. Then we need to determine where our existing prices are below market relative to what we are providing.

 

Many times we see all of our customers as being the same.  The fact is they are not.  Rarely do we have one market.  Rather, we have different segments that place different values on our solutions.  Some customers will care about personalized service, extra product features, prioritized delivery, being first with a new product, guaranteed service, etceteras.  Others will require special distribution due to being smaller and may cost us more to serve.  And yes, there are some companies who believe the lowest cost is all that matters.

 

What we must do then is determine which products and/or services generate the most profit and which ones are just contributors to spreading our overhead costs.  We need to make sure we focus on getting the prices for each offering right for each segment.  And we need to be ready to say “no” to selling more of the lower value items when demand is high. Thus, we are effectively raising our average price per unit.

 

So our job is to figure out who values what, and make sure they get only what they value and pay the most they are wiling for it. A pricing process will help you routinely track market pricing.  A study or pricing segmentation will help you assess more specifically which market prices are the right ones to benchmark against each of our offerings.  And ultimately, a pricing system can facilitate consistent and up to the hour (if you feel you need it) delivery of those prices to our customers.  It will also help us understand our profitability mix so we can focus on selling more of the right products; those with better margins.

 

What we are really talking about is putting a market focus in front of our business. Knowing what mix is most profitable and what the market pricing is for each item, means we will start driving our production, inventory, and/or labor allocations in the right direction.  Simply building it and hoping the market will buy it is not likely to yield an opportunity whereby we can command a better price. We must prioritize pricing as the vehicle for driving profits.

 

In sum, if you are running a lean organization, the chances are high there is very little left you can do to cut more costs and drive worker productivity.  Since we recognize we cannot “Cut ourselves to greatness”, we must turn our focus towards increasing revenue in order to improve profitability.  Thus, we must either increase our sales volumes or increase our prices.  Since raising our sales volumes will incur additional variable costs, the most impact may be realized from increasing our prices.  However, it is not realistic to assume we can do this as an across the board flat price increase.  We must increase our pricing by determining where our customers get value from our offering and where our pricing is relative to those of our competitors.  In reality we are discussing an average price increase by charging more for those units of value and deprioritizing support, production and sale of units that garner lower prices.  Thus, we are creating a vehicle for becoming more customer and market focused without demotivating our employees or sacrificing product/service quality.

 



About the author

Patrick J Taylor is a business and process improvement expert. Driving bottom-line results through focusing on pricing related. With 20 years of experience in both international and domestic engagements, he is now Managing Director of Strategy Process and Analysis LLC, an independent consulting firm.

Contact Patrick at +1-214-629-8383 or pjtaylor@strategyprocessanalysis-llc.com, or learn more about what Patrick can do for you at www.strategyprocessanalysis-llc.com

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