Painful and often done incorrectly.
Price increases are often driven by financial necessity to recover cost increases or to close margin gaps due to falling volumes. In some instances, price increases can be taken to capture more margin due to capacity constraints or substantial increases in demand.
Price increases are rarely welcomed or supported by the sales force. Increased market demands and cost volatility means price rises must be considered at least once per year and often need to be done 2-3x per year.
Customers often use the news of a price increase to obtain greater price concessions, or even obtain a price reduction by threatening to leave and take their business to a competitor.
Our experience working with over 100 companies in the past 10 years shows us that price increases undertaken in traditional ways often do substantial damage to profitability.
Here is what we discovered:
- Flat price increase percentages rarely succeed in achieving their financial objectives, often realising just 50-60% of the targeted price increase.
- Sales representatives feel great embarrassment and pressure when communicating a price increase to a customer, leading to even greater pressure on prices.
- Traditional price increase letters leave companies highly exposed to margin threats from customers, competitors and the sales force themselves who feel even more pressure to offer discounts/ rebate to ease the price into place.
- There is a way to take a price increase that is aligned to the value of your products and your customer’s willingness to pay that mitigates the risk of customer rejection.
The costs of getting a price increase wrong are substantial and come in 3 primary forms.
The first margin risk is the actual magnitude of the price increase. Many companies fail to cover costs or meet earnings targets because they don’t model the right pricing economics or they make assumptions about market conditions which are unrealistic.
The second margin risk is the application of a blanket % increase across all products / services and customers. This blanket approach whilst simple to understand, can create complex headaches for sales teams who are tasked with explaining the price increase to customers who may not appreciate, expect or be willing to accept such a price increase given their value profile.
The third margin risk is poor execution with a failure to manage the price rise process and inevitable exceptions and price overrides / adjustments that occur to offset the official price increase.
We find through our experience that there is often an unofficial price reduction program triggered because of the issuance of the price rise letter to market. Price increases often trigger changes to list prices, customer discounts, tactical or temporary discounts on single orders and performance rebate % and terms for managed supply contracts.
These adjustments have the effect of lowering net selling prices and hence margins and earnings.
These margins risks are often hidden from the CEO and the CFO until the end of the reporting quarter or half, by which time it is too late to fix to meet full year earnings guidance or expected budgets committed to the board and shareholders.
One of our clients had this very problem. They had a large range of products (over 10,000 active products) and large range of customers (over 5,000).
Typically, they would issue a blanket 2.5% price increase twice per year and receive less than 1.25% net increases, with often low to zero actual margin expansion once cost increases had been factored in. Competitors would often issue specials catalogues around the time of an announced price increase to capture market share.
There was frustration expressed by the Chief Operating Officer and the Chief Financial Officer that pricing was in fact a liability with unpredictable impacts to earnings results.
Through a diagnostic assessment, they could see:
- gaps in the understanding of value delivered to customers.
- gaps in the alignment and capability across staff to the right pricing strategy
- a weakness in systems, process and list price & discount structures.
A margin expansion roadmap was developed and a plan enacted to optimise prices across 5,352 individual items active on the item master.
Using a value based algorithmic approach to price setting [Project Blackbird], the company was able to set prices according to how the market valued the product and service offer and thereby create > 98% market acceptance of the price increase and fly the price increase under the radar.
The result was an EBITDA improvement of $6.8M in the first year of implementation. According to the CFO, over 3 years, the program generated an incremental $22M EBITDA result.
Companies need to realise we are in a world of market segments of one. Product value can no longer be determined by cost differentials set by suppliers.
Category based mark ups on cost leave enormous amounts of margin on the table or cause sales to be missed completely as % targets are used to set prices instead of customer value drivers/metrics.
What is needed is a systematic way to set prices by product and customer that considers a series of value drivers to identify the optimal price increase to take to market.
This is a complex decision making process and requires a sophisticated price algorithm to identify the correct price movements across products and customers.
A company must identify the right type of value drivers associated with each SKU or line item and customer.
It is deep and detailed work that requires substantial resources, skills and applied value based pricing techniques.
Pricing Insight has developed a unique price optimisation methodology called Project Blackbird. Named after the SR-71 Blackbird plane, this price methodology flies your next price increase under the radar, generating substantial margin expansion and earnings growth.
This methodology has been developed by the Pricing Insight team over the past 7 years while working with dozens of companies across many industries including: Building Materials, Business Outsourcing [incl. stationary & hygiene supplies], Capital Equipment, FMCG / Retail and Wholesalers and Distributors.
Our approach to help you improve margins mitigates risk at every stage.
The decision to engage 3rd party expert advice is not easy nor is it quick. Pricing Insight ensures that any engagement is set up correctly and objectives and outcomes will be realised. There is a due diligence that must be done to ensure that value can be realised from any engagement.
To this end, Pricing Insight employs a 4-step process outlined below to implement Project Blackbird in your business.
STEP ONE – Initial discussions
Initial enquiry + value analysis document issued + phone discovery session + proposal for diagnostic due diligence issued
STEP TWO – Diagnostic due diligence
Evaluation of sales data & pricing model + evaluation of systems capabilities + Blackbird PILOT trial / market acceptance testing + Go / No Go decision for Project Blackbird
STEP THREE – Project Blackbird
Project Plan & initiation document published + Blackbird algorithmic design & development + Blackbird price optimisation implemented on a wider scale across the business.
STEP FOUR – Track, Monitor, refine
Weekly results tracking + Monthly steering committee oversight + Evaluation of performance at line item level to identify price elasticities + Additional margin expansion opportunities identified
Here is a checklist to see if an algorithmic approach to pricing will work for your business.
- Do you have revenues of > than $30M per year?
- Do you have a product range > 500?
- Do you have a customer count > 100?
- Do you use an ERP system like SAP, Oracle, JD Edwards, Phocas or the like to manage sales history and invoicing?
- Do you have CEO sponsorship to make pricing a strategic capability within the business?
To find out more about how Project Blackbird will transform your current price increase process, please email firstname.lastname@example.org or call + 61 2 8226 8621 with your details and potential times for follow up call.