It’s not uncommon for a successful pricing initiative to improve gross margins by two points or more. Because this improvement drops straight to the bottom line, the profit impact can be huge. Several clients told me that pricing projects literally saved their companies during the Great Recession.
Of course, nothing this good ever comes easy or without risk. Here are some of the most important lessons that our consulting firm, Indian River Consulting Group, has learned about effective pricing in distribution.
1. Think strategically.
Thinking strategically means taking a long-term market perspective rather than just an opportunistic profit-and-loss view. If your starting point is “How much more can I squeeze out of unsuspecting customers?” you will face a far higher risk of customer backlash. You are also less likely to realize sustained margin improvements.
Distributors generally rely on what is technically known as a customer intimacy strategy. This means that their success rests on long-standing relationships and maximizing the lifetime value of customers. A customer’s aggregate, ongoing revenue stream is more important than the profit from any particular order.
2. Ensure you are capturing the value you deliver.
You may be over-serving some of your customers, who would be willing to pay more to buy from you. But other customers may be all too happy to switch you out for a few pennies. Ultimately, more effective pricing requires that you have some way to differentiate between the two scenarios.
Fundamentally, pricing strategy should be based on ensuring that you are capturing the value you deliver. You could probably sneak in price increases on low-volume items and get away with it for a while, but at some point you will have to offer enough value to justify it.
Pricing projects are notorious for showing major margin gains upfront that melt away over time. The last thing you want is for a loyal customer to catch you speeding. You run the risk of destroying the trust you've built up over years for a small-dollar pricing gain, leaving you with a suspicious customer who now examines every invoice with a magnifying glass.
Pricing optimization is largely about finding the customers and situations for which you are not being paid market value for the services provided. It’s important to remember that “market value” is not what you think you’re worth, but what your customers think you’re worth. You may feel that superior technical knowledge at your counter or face-to-face field sales calls are really important, but if a customer chooses to buy from Amazon instead, she is telling you loud and clear that these services are not worth a price premium.
3. Develop a clear picture of the current state of your pricing.
Before starting any major pricing initiative, develop a clear picture of the current state of your pricing. Create a simple pie chart showing the percentage of order lines priced using each of the available methods (e.g. standard column or matrix, customer contract, special project deal, vendor-supported discount, sales rep override). Create a second chart showing the percentage of sales dollars broken into these same categories.
These pie charts ensure that you focus your pricing efforts in the right direction. For example, it’s pointless to invest in updating all the pricing columns or matrices in your ERP system if these are overridden most of the time. The following table summarizes the high-level implications of your pricing method breakdown:
4. Treat pricing as a process, not a one-time project.
If pricing responsibility falls to the financial side of the company, policies may be too strict or aggressive, leading to poor adoption with excessive overrides or exceptions. Because they don’t have daily customer interaction, internal accounting staff may be naïve about the level of competitive intensity or risk of customer alienation. On the other hand, giving the responsibility to the sales organization may lead to the opposite extreme: a timid implementation with loose rules that fade over time.
In fact, it’s common for a distributor’s sales force to be a far bigger impediment to improved profit through pricing initiatives than its customers. But this is just another reason to approach the opportunity strategically. If your sales team sees that you’ve done your homework and that the intention is for pricing to be consistent and fair, it will be far more receptive.
Class-leading distributors assign pricing responsibility at the executive level; invest resources to continuously monitor and improve pricing realization; and have systematic feedback loops to objectively measure the impact of changes. We’ve found the best results when the pricing owner is in a product management or product marketing role. If measured on product profitability, she will be well-placed to make appropriate trade-offs between gross margin percentage (speed) and revenue volume (altitude). Sometimes lowering prices will generate more total gross margin dollars, not to mention give the sales reps competitive weapons to open doors.
Get more information on smart pricing practices and market access strategy on our website, ircg.com/insights.
Steve Deist is a Partner with Indian River Consulting Group, an experienced-based firm that focuses exclusively on market access and distribution channels. Learn more about IRCG at ircg.com. He can be reached at mailto:email@example.com or 321-956-8617.