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How much focus does your business place on revenue, pricing and margin?
Do you have an integrated framework to manage pricing, protect your revenues and expand your margins?
In the last 20 years’ corporate businesses have focussed on cost down procurement programs, IT platform integrations and supply chain optimisations. These have been very successful.
The last frontier is really now revenue and value.
As business models disrupt due to the digitisation and globalisation of the marketplace, traditional pricing methodologies such as cost plus, looking at competitor price points and accepting what customers demand as price points are no longer tenable ways to set and manage your pricing. I remember a salesman said to me once, at a conference “If you look after the top line the bottom line will look after itself”.
I haven’t met a salesperson yet that now believes that. So I think the time has come for an integrative framework that a CEO can implement into a business that can meet their objectives of;
- delivering on their strategy to the right customers
- hit their financial numbers (their earnings before interest and tax budgets)
- ensure that CAPEX is spent the right way (and in this particular instance there is not a lot of CAPEX required to get your pricing right)
- build the right value based culture, where we communicate value, we define it to customers, and we capture it from customers
- build the right teams, the cross functional teams that are needed to make an effective value based pricing culture and capability within your business.
Now pricing can get very complicated. Quite often it starts with a spreadsheet and looking at margins, volumes and units. And it can get very complex very quickly.
However, I think pricing can be simplified into 3 key areas. Over the years we have been working on a number of pricing projects, and we have determined that there are 3 key areas that come up each and every time. These 3 key areas are Value, People and Structures.
Underneath those 3 areas (Value, People, Structures) there are some areas of focus that need to be embedded in the business and developed through cross functional team capability. I am going to take you through a couple of those now using some examples.
You may have seen in some of our other videos and templates that there is a value management framework that every business needs.
When we ask companies, “what is your value proposition?”, quite often we get a simplistic features and benefit statement.
We know from research with customers and research on products that have high margins and high revenues, that value is so much more.
So the question that needs to be asked is, “What is your value management system? How are you managing your value in use and your value at risk to customers, and building that into your pricing?
Which leads to our next key area of focus, customer segments. As we have seen in other videos and other research, one of the key resources of pricing power is not what you sell but who you sell to, and why. Most companies miss out on substantial revenue and margins because they spend time in the wrong areas, looking and talking to the wrong customers.
It’s the most crucial element to identify which customer segments value your offer the most. But you can see that if you don’t have a value management system that clearly articulates your value proposition you’ll never know which customer segments you truly need to be serving and investing your time, your assets, Capex and Opex in, creating your competitive advantage.
That leads to our third and final piece in the value proposition which is contract and trade agreements. This really is the term which says “What is the exchange? What is the tradeable value we are going to offer the customers? How are they going to buy from us? What is our revenue model?”
If you like, it’s a little bit like the razor and razor blade model. It’s not a business model, it’s a revenue model, and it’s a contract restructure. You buy the razor handset very cheaply, but then you pay more for the razor blade. It’s not so much a business model, it’s an agreement that the customer tacitly makes when they buy it.
So 3 areas, value management system, customer segments and contract and trade agreements. However, that is the strategic concept of running a business; importantly you need people to actually run it.
In many of the companies we have actually worked with the biggest weakness has been not so much that they don’t understand their value, or which segments they should be talking to, or contract and trade agreement structures that they have, but people actually don’t agree on the best way to run the business.
You can take a quick test and ask ten different people in your organisation the same questions. e.g.
- How to we take a price rise?
- What’s our value proposition?
- Do you think we understand value across the organisation? “And you will find that management is not aligned.
- Are we a volume focussed organisation or are we a profit focussed organisation?
- Are we managing towards covering fixed costs or are you trying to cover variable costs and make a contribution towards fixed costs?
All of these questions are often understood in the heads of one or two individuals but no one has the complete picture. So management alignment is a crucial capability that needs to be addressed and we all need to understand what it is we are trying to achieve.
The next piece is, if we understand what we are trying to achieve do we actually have the climate and the ability to do that. So do we actually have the skills? Quite often people don’t understand concepts like value based pricing.
They understand cost plus mark-up but they don’t understand margin on sell versus mark up.
So the skills and ability to even understand the basics of pricing are often overlooked. I can give you one example where a staff member was instructed to put a margin on sell of 30% into the system.
Let’s assume the cost was 100, that means the sell price should have been 150. But they misinterpreted that, and thought it was a mark-up and so the sell price was put in at 130, not 150. So you can instantly see that more than half the profit was lost on that particular item if you assume the SGA costs at 20. An EBIT result of 10 is realised instead of the targeted 30.
The skills and ability are crucial. But along with skills and ability is the ability to negotiate and sell. Sales and negotiation is going through a major transformation at the moment.
It used to be that you could walk in and negotiate with a customer but now you negotiate with procurement and they have a whole series of techniques to commoditise and reduce down your salesman’s effort.
Time and again, sales training that offers salespeople a certain methodology to sell but that methodology becomes ineffective when confronted with procurement techniques, cost down techniques. So a new form of sales and negotiation is needed. That form of sales and negotiation needs to link back to the value management system and the customer segments. It needs to be tailored.
Finally, the business needs to have the right structure in place. The business needs the right pricing architecture. In other words, if you don’t have your products and services aligned and matched to market you’ll either miss out on selling products or miss out on margin.
You need quality analytics and information to be able to understand where you are.
That analytics could be in the form of loss sales reports or quote to book ratios. It could be margin spreads across particular products.
There is a whole raft of data now available that you can use to evaluate the effectiveness of your pricing, revenue and margin improvement programs. Finally you need fast systems and toolsets. You need real time quoting. Quite often the business is won or lost on the speed in which the quote can be generated to the customer.
Quite often spreadsheets are used, and those spreadsheets contain errors. I am sure you have stories of where a spreadsheet was used to calculate price and mistakes were made.
This pricing framework is an architecture, ecosystem and resource under the frameworks of value, people and structures to help you manage your pricing, revenue, and margin improvement programs.
It [the framework] speaks to the need in corporate business to have a dedicated pricing function.
It speaks to the need to have that function report up and have the attention of the CEO, and if not report directly to the CEO, to report to someone in the executive leadership team.
For many businesses, pricing is still an immature discipline. It’s been relegated to that role of an analyst. So pricing is defined as simply analytics and information and systems and toolsets. You can see from the system that we have described here that pricing is so much more. It’s the sum total of your entire business assets at a truth point to market. It’s your most powerful profit lever.