Price optimisation: need to take a price rise?
The #1 mistake most companies make when setting prices
Most companies try to improve their margins by taking a flat price increase across the whole product line. This traditional approach to implementing price increases leaves a business greatly exposed and at risk of revenue loss, margin erosion or customer flight.
In many instances, price increases are avoided for a number of years. This is frequently due to management perceiving that the risk to earnings outweighs the potential gains of the price increase. Having better information and an evidence-based price strategy removes the uncertainty. It allows management to make bolder and targeted pricing decisions.
What’s changed to create concern?
Our global monetary system is built upon the printing of money and lowering of interest rates to stimulate demand. The net result of this approach is inflation. In this model, price rises become a critical part of every company’s growth strategy.
If the pricing management is not an advanced capability in your business, the risk to gross margin is greatly increased. Most companies treat price increases as an annual or semi-annual event, regarded as an administrative exercise.
Immediate risks to profitability
Flat price increase methodology puts profit at risk in two ways:
Additional impact across the business
After a flat price increase has been implemented, there are further risks to margin erosion.
These margin risks come in the form of ad hoc customer exceptions to the price increase and additional discounts or rebates offered by sales representatives to placate upset customers.
In a number of instances, a price increase can actually lead to net margin contraction.
Poor execution of the price rise process often leads to unofficial price reduction programs put in place to “offset” the price increase. This can take the form of additional discounts on products or services and/or rebates that have no performance hurdles attached to them.
These margins risks are often hidden from the CEO and CFO until the end of the reporting quarter. By this time, it is too late to close the gap on full-year earnings or expected budgets.
In many companies, there is a culture of asking the sales force what price increase the market will accept. Often a customer exemptions list is created to identify customers who, in the eyes of the sales person, should not receive a price increase.
The exemptions list is often twice as long as the list of customers who do receive the price increase. The percentage of business represented on the exemptions list can be as high as 80% of total company revenues.
Customers quickly learn to push back on price increases and sales and marketing teams never learn the skills required to implement a successful price increase. The net result is failure by the company to implement a meaningful price increase.
The costly and painful process of recovery
At Pricing Insight, we have borne witness to nearly all types of pricing nightmares that leave a business exposed to margin erosion that put earnings at risk.
From over-inflated list prices, through to hidden one-off discounts that never expire, to low ball contract prices that were put in place without authorisation or alignment to any strategic rationale.
It can take 12 months to assess, design, develop and implement a new pricing strategy and price architecture. It can take a further 12-24 months to transform a culture from a cost-plus approach to one that is value-based and focused on profitability.
Whilst this transformation is underway, it is probable that between 1-2 percentage point of margin is being lost across total revenues. For a $500M per year business this could equate to between $400,000 – $800,000 per month in lost profit.
A perfect world of pricing excellence
Benefits of using value based pricing algorithms to optimise prices:
Accelerate your earnings growth
When your business sets prices based on value pricing principles, rather than cost, you can unlock new revenue streams and higher margins to drive earnings growth.
A strategic pricing architecture will allow you to run multiple hypothesis-led pricing experiments. Through structured testing and control you will be able to generate even greater margin realisation than previously thought possible.
In fact, companies like Amazon test and optimise prices every 15 minutes. Jeff Bezos, the founder and CEO of Amazon, has stated that his company is successful because Amazon conducts more experiments than any other business.
The solution – algorithmic pricing optimisation
Price algorithms are sophisticated formulas that optimise prices across all of your products and customers. Algorithmic pricing will enable you to identify margin opportunities to generate cash earnings growth without putting sales revenues at risk.
Algorithmic price optimisation works because it focuses on the line item or SKU level.
The pricing insight price optimisation process
How Corporate Express [Staples] found $6.8M on $80M of addressable revenue
How are you managing your most powerful profit lever?
Pricing is the most powerful profit lever in your business.
Strategically, it is one of the last frontiers of competitive advantage in business that is still to be optimised. In many respects, it is still a green field of opportunity that your competitors have not yet discovered.
Reach out to us today to arrange a confidential discussion to show you how you can optimise pricing to generate more margin for your business.