The Price Is Right But Is The Execution Wrong?

Executives at consumer products companies are facing a tough environment with huge pressures to deliver topline revenue and margin growth in mature and static markets where the principal retail customers are both consolidating and driving real price deflation in many categories. Additional requirements to manage costs but deliver innovation and brand investment highlight the urgent need to manage pricing effectively. A 1% improvement in the price you achieve can generate up to a 12% increase in operating profit for a typical consumer products company, where other factors remain constant¹. For companies with poor pricing performance, that improvement can be even more dramatic. So why are so many consumer products companies struggling to translate this opportunity into reality, especially when business leaders say that pricing pressure is their top concern?²

Despite the pressure on optimising margins, most traditional metrics used to evaluate operational performance often ignore the importance of pricing… and even more importantly, the effectiveness of managing ‘pricing execution’ – all the activities that take an agreed net price down to the real net net price.

Even consumer product companies that are top performers in almost every other aspect of their operations often fall down when it comes to pricing. Respected US industry analysts AMR calculate that fewer than 3% of companies effectively manage, communicate and enforce prices³.

And yet the potential returns from improving your pricing execution are virtually unparalleled. Our experience shows you can achieve significant margin benefits by analysing what is happening to your prices in the daily transactions in the marketplace, in detail, using a systematic and proven methodology. And addressing pricing execution can often highlight other opportunities such as improving pricing strategy and trading terms, optimising cost to serve or trade promotions, leading to even better performance⁴.

• Salesmen are not able to understand the real net effect on profitability of each transaction/deal and remain resolutely focused on selling on price or volume, despite your practical efforts to change their behaviour or reward structures.

• "We know who our most profitable customers are" – is this really true? What if you discovered that Tesco or Asda were actually your most profitable acount?

• You can’t be certain that your best customers are getting the best prices.

• You were caught out when Safeway and Morrisons merged, highlighting significant, perhaps indefensible, differences in pricing between the two accounts.

• Despite setting up conditional trade terms that reward certain retail behaviour, you still don’t really understand if you have made more money.

Even the best pricing strategy has to be properly executed to achieve both the right market impact and the right bottom-line return. But this is not always as straightforward as it might seem. The sheer volume of transactions, promotional overlays, complex market structures and a multitude of systems and deals can make it very hard to identify the net net price or to understand which are really your most profitable channels, territories or brands, let alone individual accounts or SKUs.

All too often, companies assume that successful pricing is all about setting the right price. Of course, it’s essential to understand the competitive landscape, develop an effective product strategy and customer segmentation, and set list prices that address this mix. But that’s only part of the picture.

A company can be outstanding at price setting, but still unwittingly lose money on many transactions, because their execution is flawed. Execution is the forgotten side of pricing. While so many consumer products businesses have successfully improved and streamlined the execution of their manufacturing and distribution, pricing execution has remained relatively untouched… a ripe fruit for picking.

• Significant increases in operating income and margins – with a direct impact on the bottom line.

• Typical payback on investment in around nine months – with some quick wins achievable in a matter of weeks.

• Redesigned processes and pricing models – delivering greater profit per segment, SKU, customer...

• Better understanding of pricing opportunities and how to manage them – across all the functions who have a part to play in determining net net price.

• Reduced exposure to market consolidation – because your pricing execution is better understood, more defensible and more consistent across your business.

Pricing is at the core of achieving commercial excellence. So what is stopping even well managed consumer product companies from managing it effectively and improving their profitability?

In our experience there are four main reasons why consumer product companies under-perform on their pricing execution.

Firstly, they lack the right information to effectively manage price/profitability at the transaction level, or even at the account, SKU or category level. Often the picture from their reporting systems is incomplete, and there is no real understanding of the many factors that erode the invoice price.

The complex nature of pricing means that it touches almost every part of the organisation and requires real cross-functional integration and information sharing to allow all the different factors to be controlled at the micro level and balanced overall to achieve the best results. And many companies quite simply have too many new SKUs coming on stream or changing too rapidly to keep effective control of pricing.

Measurement and metrics are often misaligned. So for instance, sales force incentives can actually drive down profitability even as they encourage growth in volumes. Reporting is often at the invoice level, rather than at net net price. Even when the sales team is rewarded on a more complex mix of factors, simply looking at gross margin in broad terms is a poor substitute for transaction-level insight: and it may even give misleading or wrong information about real profitability.

And finally, management is not focused on pricing execution, often because they don’t realise what a major opportunity this is to build bottom-line performance. Executives may have little idea of precisely what kinds of data they need to address the problem, and indeed that data is often hard to obtain: hidden in different systems and in salespeople’s heads.

To maximise the real price you are achieving, you need to understand the complete process and lifecycle of a transaction: how does a price make it from a list to actually goods or services sold to a customer?

The first step is to take apart your revenue and operating profits – by invoice line item/SKU, by customer, by salesperson, by channel, by region… to determine the real profitability of a specific transaction.

Based on this insight, you can focus on the small set of SKUs (typically the top 10-20%) that drive the majority of your business. You can start to challenge the traditional, size-based customer segmentation model that is so often used to set prices, and to understand the contribution margin by transaction so you can use this (rather than the blunt instrument of gross margin) to incentivise the sales force and inform pricing decisions. You may even be able to reduce some prices!

Most critically, you need to identify every source of margin leakage in a transaction, and manage those leaks to your advantage. After all, your revenue stream is built one transaction at a time: if you can manage it at that level, you can’t fail to improve your performance.

To help you get a good all-round understanding of what really drives your profitability, you need to focus on five key analyses:

• SKU ‘velocity analysis’: Which SKUs generate the majority of your revenues and volume? This uses a Pareto-based technique to clearly identify the top 10-20% of SKUs offering the greatest opportunities to make a financial difference. This vital first step typically leverages the company’s own understanding of which SKUs drive the business.

• Product and customer contributions: This builds a picture of the cumulative contribution (rather than revenues), and often produces surprising results. Companies typically discover that a number of products actually generate negative contribution! Used in conjunction with the SKU velocity analysis, this often identifies some significant opportunities for improvement.

• Price band analysis: focusing in on the SKUs with the highest impact, this plots how well your actual pricing performance aligns with your expected customer segmentation model: again often highlighting some unexpected findings. Your ‘best’ customers may well not be getting your best prices, while many of your lowest value customers could be getting your best prices!

• Customer segmentation performance: this analysis tests the effectiveness of your current segmentation scheme, helping to identify the actual financial value of the sacrifices you are making to achieve volume, at a transaction level.

• Price/profitability waterfall: this is the most valuable of the analyses in terms of potential benefits, but it is also the most labour-intensive as it involves building a detailed understanding of the economics and leverage points of each transaction, to identify each point where margin may be leaking away. Unfortunately, the data needed to carry out this analysis usually cannot be found in common systems, and often doesn’t exist at all. In the short term, some data requirements can be put together manually, or modelled: in the longer term, a sustainable and repeatable process needs to be put in place for collecting and analysing the ‘waterfall’ data. However, it’s an investment worth making. Many companies discover that they have misjudged who their most profitable customers are, because they have such an incomplete picture. Once in place, this on-going analysis becomes a powerful tool for managing the sales process, enabling your sales team to manage the profitability of their transactions using facts rather than intuition, and encouraging your whole business to start evaluating their activities in terms of how they affect profitability.

More effective pricing execution has a positive impact on the whole business, as well as ultimate, bottom-line benefits.

There are a number of ways to drive volume and revenue, to spur profitable growth.

In our experience, an initial analysis of the factors affecting pricing execution will typically identify three kinds of opportunities for improvement.

The short-term, quick wins – that can be implemented within three to six months – highlighting immediate ‘fix or flush’ candidates: accounts or categories that don’t comply with trade terms or promotional frameworks, or SKUs where the pricing is unfavourably positioned. Equally importantly, even at this early stage your sales team can start to use the data to counter price pressures from customers, and focus their efforts on the most profitable customers, SKUs and channels.

A major UK snack company splits the main elements of the pricing waterfall into two discrete segments. The first covers those deductions from list price that generate a net price - these allowances are based on volume, growth or brand objectives and cost to serve. For instance, knowing how much it costs a supplier to directly service a major customer can provide vital additional information for the account manager as he prepares for the next negotiating round. The second group of negotiated discounts, rebates and allowances are focused on the specific trade investment plan that is being discussed with each retail customer. Of course the ultimate net net price obtained by the retailer takes into account all of these deductions but splitting trade investment/promotional items from the core discounts gives this company a better negotiating basis to achieve optimal terms with the customer, and a consistent selling method across all accounts.

Another major consumer goods company splits the pricing waterfall into unconditional and conditional elements. This enables the supplier to discuss and agree factory gate / menu based pricing as required by some of the largest grocery accounts. Having a defensible discussion on supply chain costs (without necessarily having to move to full open-book pricing - only the truly customer-variable elements of cost are discussed) allows the supplier and retailer to agree which logistics option is optimal for both sides with a corresponding agreement on price. Again this separates cost to serve type discussions from the sometimes more emotive trade promotions negotiations.

You might also identify actions or projects to take advantage of specific opportunities highlighted by the pricing execution analysis; eg reviewing your whole approach to managing trade promotions, given the scale of investment that most consumer products companies now invest in the trade⁵.

Medium-term improvements, taking up to a year to implement, can include more effective customer segmentation, the development of targeted action plans for specific accounts and categories, and the revision of some of your promotional guidelines or policies. It is usually feasible to introduce some simple pricing analysis reporting, and to refine and clarify trade terms agreements to close any loopholes and ensure customers meet their volume commitments before being given agreed discounts.

Longer-term improvements could take between one and three years to put in place, and involve more deep-seated changes, such as the development of new business strategies to address any fundamentally non-compliant or difficult accounts, SKUs or categories. The result could lead to delisting, reviews of list prices, changes to packaging, new product development… Over this longer timeframe, you should also be able to implement more detailed reporting and analysis, and to establish a framework for continually reviewing your pricing policies, trade terms and promotional programmes.

To achieve sustainable long-term pricing improvements, the greatest challenge is to deploy workable measurement and control frameworks within your organisation. And of course, this has to be supported by fundamental behavioural change among the account teams and other groups within the business who have a direct or indirect impact on the achievable net net price: from finance to supply chain and marketing.

An important by-product of this work may be to highlight hidden opportunities to improve your pricing strategy, perhaps through using your consumer insight to drive increased value in the category. Work may also be needed to address the ‘cost to serve’ for your key customers, with many elements of this having a profound effect on your net net prices.

A major global soft drinks manufacturer set up a mechanism for understanding its pricing and transaction-level profitability and introduced standard pricing and reporting capabilities across all its US divisions. This was acknowledged as the major factor in a 71% increase in year-on-year operating income, in the first quarter following implementation.

Analysing transaction-level data from across 13 business units, and developing process, policy and transaction level improvements helped one global specialty chemicals manufacturer identify over £30 million in opportunities to improve its variable margin, in just four months.

A segment productivity and profitability analysis, coupled with the development of a ‘cost to serve’ model, enabled this worldwide package delivery company to drive down operating costs and align its pricing to the levels of service it was providing to key customers. Over the course of six months, redesigned critical processes and recommended pricing improvements resulted in a £230 million improvement in profitability within the first year of implementation.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.