In some business markets, there isn’t much differentiation between products. Sure, they may come from different suppliers and have different names, but the core product function or benefit is exactly the same. I have seen three or four multinationals, and four to six local suppliers sell the same core product in the same country, at roughly the same price. Because there is so much competition in these markets, customers ask for discounts and drive suppliers to bid against each other to win their business. It is hard to make a stable supplier business in these situations. How can one win? And, what does value-based pricing have to contribute to these markets?
Seems the same, but it’s not.
First, despite the intensity of the competition in these markets and the similarity of the core product, that doesn’t make the market a pure commodity market. There is some differentiation.
If a market is a pure commodity market, then any supplier that was so much as USD 0.001 per unit less than their competition would win all the business of the market. I have yet to observe that happening in business markets unless the product is sold on a market exchange like the Chicago Mercantile Exchange (CME). Hence, in the absence of a market exchange, most business products, even if they are relatively undifferentiated, do not follow the economic dynamics of commodities. If they don’t follow the economic dynamics of a commodity, then they aren’t economic commodities. Something must differentiate them.
Even highly similar products from different companies are, in some way, differentiated. It may not be the product exactly, but the company that delivers it drives this differentiation. For instance, a company may distinguish itself in the market though its product quality and reliability, or its approach to commercial relationships. One might say that makes the products different, but I prefer to think of the broader picture of a differentiated company than that of only differentiated products, because this shift in framing creates a bigger opportunity for differentiation and thus enables value-based pricing to enter the equation.
Differentiate the company when the product can’t.
Suppliers, even in the situation described above, are different. Every multinational is unique. And every local company is unique. They bring more to the table than simply products. Their uniqueness serves customers better in some cases, and worse in others.
For instance, return to the issue of product quality. Oftentimes, multinational suppliers spend more on ensuring high-quality products, with greater reliability, and more assured supply confidence than smaller local suppliers. Some business customers will care about these factors; others will only care about the lower price. But this factor alone enables companies to differentiate themselves, even in relatively undifferentiated product markets.
Then, we have issues of product portfolio breadth. Some companies will be niche suppliers of one or a few specific products while others will have a large portfolio of products to offer. Business customers that need a broad portfolio of products and would prefer not to have too much overlap in their product offerings—perhaps to lower the cost of holding inventory, purchase processing, or shipment receiving— may value relationships with companies that hold a broad portfolio. Other companies may not care about these issues. In any case, even with five to ten total suppliers in the same product market, business customers and their impetus for a product will differ. This applies to their differing interests in a suppliers’ product portfolio breadth, hence the suppliers are differentiated because of their eclectic customer base.
Then, we get to the great give-get. In commercial policy, suppliers will offer business customers various price reductions, discounts and rebates. The question is: what does the supplier get for giving a customer a lower price or deeper discount or rebate?
In the absence of a well-defined commercial policy, these may just be part of the back-and forth negotiation which leads closed sales and a little market share at the expense of lower margins. In the presence of a well-defined commercial policy, every discount or promotion is tied to a business goal. This is the “get”.
Of course commercial policy should consider volume, but it should also consider much more. Portfolio support, payment terms, freight terms, advertising coordination, product development, and many other issues define commercial policy. Some of these are product specific. Others define the supplier-customer relationship itself.
Each element of a well-defined commercial policy should be related to a business goal the value of achieving that goal should be well understood.
For instance, payment terms may be related to the goal of reducing late payments, accelerating cash flow, or reducing credit risk. Each of these has a measurable financial impact on the company and any payment terms policy can be measured for its effectiveness. Taking the specific example of late payments as the goal, the supplier may calculate their cost of capital and translate into the value of reducing the average accounts payable duration by a day and use this to set the rate of rebate for early payments, or the rate of surcharges for late payments. Concurrently, the goal of the financial terms policy might be stated in the form of “to reduce the average days of accounts receivables from 95 to 85.” At this point, we have a clear goal of the policy and a clear understanding of the value of that policy.
This same requirement clarity can be applied to many elements of the commercial policy.
For instance, an advertising rebated may be tied to specific types of advertising and advertising messages, for not all advertising is equally useful for the supplier. Freight terms may be tied to freight handling costs thus encouraging customers to purchase in a manner which reduces cost-to-serve.
A path I particularly find certain customers prefer, which can be very much profit enhancing is expanding product specific discounts and rebates into portfolio wide discounts and rebates. This does several things: One, the discount or rebate can be bigger if they buy a bigger overall portfolio of goods, as calculated by a volume hurdle. Two, it can reduce the risk of a customer stating they will buy a lot of one item only to learn they didn’t need it, by spreading that needing a single particular item to needing any one of several items. Three, it can encourage the customer to make the supplier the “supplier of choice” for a broader portfolio. And Four, it can be used to drive sales of high margin items in conjunction with routine sales of lower margin items.
The overall profit improvement of the customer relationship can be monitored along with the discount depth. The metric of this program might be stated as “to increase average wallet share from X to Y,” and the goal may be simply stated as to improve average customer profitability by Z%.
Treating the commercial policy in this manner, the company is defining what it is willing to give, what it must get in return, and then ensures that what it gets is worth more than what it gives, thus driving overall profitability. Moreover, once the commercial policy is defined with give-gets and measurable outcomes, it becomes easier to run that policy through some sort of Deming continuous improvement cycle, thus driving ongoing profit increases as discussed in Pricing Done Right.
“If a problem cannot be solved, enlarge it.” – Dwight D. Eisenhower
From a narrow definition of value-based pricing at the product level, this may not look like value-based pricing. But that misses the point. Value-based pricing isn’t just at the product level. It is also at the customer relationship level. Some customers are worth more because they give you more. If you can work that customer-relationship dynamic into the pricing strategy through the commercial policy, then you can possibly win and create a sustainable and growing business.