Regular version - English
ROLAND BERGER PRICING EXCELLENCE:
How to become a profit champion by
optimizing sales management
Skills profile for the Marketing & Sales Competence Center
Ingmar P. Brunken
Düsseldorf, July 2006
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There are six reasons why price management is a major
challenge for most markets today
> Market saturation and overcapacity
> Strong price awareness through transparent knowledge
of competitors' prices and product quality
> Increasing concentration of buyer power (but with
decreasing willingness to pay)
> Increased competition due to deregulation and
internationalization of markets (globalization)
> Growing significance of services and secondary products
(e.g. replacement parts) for profit and market success,
although these are often neglected in pricing and in
communication
PRICE MANAGEMENT
OFFERS SIGNIFICANT
POTENTIAL FOR
IMPROVEMENT
> Decreasing effects of managing systems (oversaturation from
ads, flat discounts, etc.)
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Pricing excellence starts with the profit formula.
But if that statement is as trivial as its seems…
Top-line growth =
sales management
Profit
max. !
=
price
X
volume
–
costs
> Optimizing sales is more difficult than
optimizing costs, because two variables
have to be optimized simultaneously
> Price determines volume, but what
determines the price?
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…why do so few companies use this "trivial" formula?
Why do most decision-makers feel poorly informed?
PERCENTAGE OF RESPONDENTS WHO
BELIEVE THEY ARE WELL-INFORMED ON…
84%
Variable costs
81%
Fixed costs
Competitive prices
Customer product
benefits
Customer reaction to
price changes
Learning curve effects
Willingness to pay
75%
61%
34%
29%
21%
PERCENTAGE WHO FELT DECISION-MAKING
PRESSURE WITH REGARD TO …
Advertisement
After sales
Distribution
Internal staff/training
Market maturity
New competitors
Product quality/guarantee
Sales costs
Price (service)
Price (B2B goods)
Price (B2C goods)
1 = Very low pressure
Source: Market survey, published in "Power Pricing" (Campus)
2.5
2.75
3
3.1
3.2
3.4
3.5
3.5
4.1
4.5
4.2
5 = Very high pressure
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Answer: Pricing is subjective, not objective, which complicates
mathematical optimizing
"Top-line growth" =
sales management
Profit
max. !
=
price
X volume
–
costs
Price is a very subtle variable. The price does not affect volume (= sales)
objectively. Instead, the impact on volume depends on the following
four most important variables:
> Subjective price perception by customers (benefits, competition)
> Subjective willingness to pay of each customer (demand)
> Communication of prices (relative positioning, timing, setting, etc.)
> Modeling of prices (bundling, non-linear models, etc.)
Price optimizing is impossible without an awareness of subjective price
perception: PRICING EXCELLENCE!
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Since pricing is often based on the "cost-plus" or competitor
principles, profit potential remains untapped
1
Often a lack of
clarity about
> Actual willingness to pay for products – trust in past
experience, levels 1 and 2
> Structural relationships
> Necessary information
2
Too little
time, too few
resources
> Relation to impact on profit
> No intelligent customer monitoring
> No well-researched surveys of willingness to pay,
no use of intelligent pricing models
3
PROFITS ARE
LOST DUE TO
SUBOPTIMAL
PRICING
Unwritten rules
> "Cost-plus" pricing
and intuition used > Adapting to competition
for want of a
> Short-term rather than strategic view
better method
> "You can only survive on the market by cutting prices"
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We have developed a systematic process for optimizing prices
and revenue: the Roland Berger Pricing Process
Roland Berger Pricing Process and industry-specific levers
1
PRICING
STRATEGY
2
1.1 Define a clear target system
1.2 Ensure clear market/brand position
relative to the competition
1.3 Decide on an effective price timing
strategy (not too late/early)
1.4 Communicate prices appropriately
and consistently (brand, signaling)
1.5 Assess strengths and weaknesses
internally and externally
1.6 Design a consistent incentive
system that truly motivates people
5.1 Reduce complexity and speed
up pricing process
5.2 Increase speed of pricing
process
5.3 Create flexibility in pricing
process
5
PRICE
SETTING
2.1 Align price with customers'
willingness to pay
2.2 Create a consistent price structure
(across regions, customers,
channels, bundles, etc.)
2.3 Introduce intelligent pricing models
for differentiation (e.g. non-linear
pricing)
2.4 Understand (internal/external)
customer purchasing criteria
2.5 Educate/train employees to
determine optimal prices
2.6 Design international pricing
2.7 Bundle products
5.4 Include balanced customer orientation
in pricing process
5.5 Define basic features and distribute
competencies for pricing
3
PRICING
IMPLEMENTATION
3.1 Develop a strict system of prices
and terms
3.2 Avoid price erosion (e.g. by
regularly monitoring promotions,
cash discounts, targets, etc.)
3.3 Avoid free services
3.4 Make prices opaque and find ways
to stand out from the (national/
international) competition
3.5 Organize customers/regions
without overlaps and establish
clear price competencies
3.6 Support price positions through
excellent secondary processes
(e.g. logistics, claims processing,
etc.)
3.7 Institute an annual review process
3.8 Develop guidelines for processing
orders and logistics
4
INFORMATION
MONITORING
Start
4.1 Standardize databases between
neighboring areas (e.g. regions,
departments)
4.2 Leverage internal experience
systematically (benchmarking, best
practices)
4.3 Apply knowledge of external best
practices
4.4 Manage offer and market
complexity using a suitable sales
information system
4.5 Be aware of how extra services
affect costs (e.g. packaging,
logistics, commissioning, special
orders, small-volume purchases,
etc.)
PRICING ORGANIZATION
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All aspects of cost, competition and willingness to pay are taken
into account in the Roland Berger Pricing Process analysis
General method of analysis
1
2
Pricing
structure
Initial offer/
list price
3
– Discounts
– Rebates
– Commissions
– Benefits
etc.
Real price
1
Minimize loss of willingness
to pay
2 Optimize price
components/models
Price
erosion
Margin
Cost
inflation
+ Free hotline
+ Special services
+ Good will, etc.
4
Unit price
Market pressure
Margin
Unit cost
Real unit
cost
Standard
unit cost
3
Minimize price erosion visà-vis competitors
4
Reduce free additional
offers (cost inflation)
Residual margin
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
A customer survey identifies customers' willingness to pay.
Indirect methods1) verify validity
Step 1: Identify willingness to pay – i.e. the number of customers who would buy in a given
price bracket
Percentage
of customers
60.0%
The mean amount that customers
are willing to pay is EUR 25
50.0%
40.0%
30.0%
EUR
25
20.0%
10.0%
0.0%
n = 76
up to 20
over 20 to 40
over 40 to 60
over 60 to 80
over 80
Acceptable price
brackets [EUR]
1) Indirect method: No direct questions are asked about prices. Instead, selection methods (such as the conjoint measurement method)
or by estimating corridors (e.g. using the Roland Berger method).
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
When we include the profit function, we see that the mean
value is (usually) not the optimal price
Step 3: Calculating the profit function
Volume/profit
OPTIMAL PRICE
46.1
50
The mean value is not the
optimal price
40
The optimal price is derived
from volume expectations as a
function of price
Profit
35.0
30
21.6
Mean value
20
This complex but extremely
important calculation can be
performed for any product
Volume
10
0
10
20
30
40
50
60
Price [EUR]
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
This is the theory you will find in textbooks and hear from price
theorists. However, if this were true in reality...
Volume/profit
OPTIMAL PRICE
46.1
50
Theory:
• The price/volume function is
a straight line, or at least a
continuous curve
40
Profit
• Price/volume changes occur
continuously along this curve
35.0
30
21.6
Mean value
20
• The profit function therefore
has only one optimal price
Volume
10
0
10
20
30
40
50
60
Price [EUR]
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
… then every salesperson could find the profit-maximizing price
in two easy steps: 1) Set the direction; and 2) Vary the price!
Determining the profit-maximizing price (according to the theory)
Volume/profit
OPTIMAL PRICE
46.1
50
Theory:
2
1• Vary the price: See what
happens to profits if you cut
the price, for example
40
1
30
Profit
35.0
2• Identify the direction toward
21.6
Initial price
20
the optimal price (a price
increase in this case) and
take the necessary action
until that price is reached
Volume
10
0
10
20
30
40
50
60
Price [EUR]
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
Roland Berger has developed a unique, proven method to drill
the PRF down to the level of the individual customer
Comparison of workable methods to determine the price/volume function
Method
ROLAND BERGER METHOD
CONJOINT MEASUREMENT
EXPERT WORKSHOPS
Benefit
> Fast: Only 4 indirect questions
on pricing per respondent
> Efficient, effective, transparent,
precise, reliable
> Can reveal customers'
willingness to pay for individual
product properties
> Extremely fast and simple
> Quantitative visualization of
existing market knowledge
Drawback
> Conjoint measurement is better
suited to breaking product
properties down into individual
price components
> Highly complex "black box",
difficult for customers to grasp,
vulnerable to errors
> Often too theoretical
> Very inaccurate, hard to
distinguish between correct
and incorrect statements
> Exclusively by Roland Berger
(in-house development)
> Widespread, although practical
application often plays a
subsidiary role to mathematics
> Widespread; Roland Berger
recommends this method as
a first step only
Outcome
Usage
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
Unfortunately, the reality is more complex: The PRF curve is not
constant, so jumps and spikes create the illusion of optimal prices
Real-world example, steps 2 and 3: Identifying the PRF and the profit function
Profit
[EUR '000] "Cheap"
"Expensive"
"Too expensive"
No. of buyers
200
90,000
180
80,000
160
70,000
140
60,000
120 Real PRF
calculated
100 by RBSC
> The volume-maximizing price of
EUR 20 should net 40,127 buyers and
profits of EUR 160,511
50,000
Profit [EUR]
80
60
40,000
LESSONS LEARNED
30,000
1) The volume-maximizing and profitmaximizing prices are different
2) There are a number of "optimal prices"
at which small price changes will drive
profits down. There is only one optimal
price that maximizes profits
20,000
20
10,000
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
40
0
> The optimal price is EUR 29. At this
price, 32,102 buyers and profits of EUR
186,192 can be expected
0
= Localized optimum (example)
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
Jumps in the PRF – caused by psychological barriers (e.g. EUR
9, 19 or 29 etc.) – give the profit function a saw tooth curve...
Real-world example, steps 2 and 3: Identifying the PRF and the profit function
Profit
[EUR '000] "Cheap"
"Expensive"
"Too expensive"
No. of buyers
200
90,000
180
80,000
160
70,000
140
60,000
120 Real PRF
calculated
100 by RBSC
50,000
Profit [EUR]
80
40,000
30,000
60
20,000
20
10,000
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
40
0
This supposedly
"optimal" price could,
for example, be
improved by 16.25%
0
= Localized optimum (example)
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
… and the spikes give the (misleading) impression that a
localized optimum is in fact a global optimum
Real-world example, steps 2 and 3: Identifying the PRF and the profit function
Profit
[EUR '000] "Cheap"
"Expensive"
"Too expensive"
No. of buyers
200
90,000
180
80,000
160
70,000
140
60,000
120 Real PRF
calculated
100 by RBSC
50,000
Profit [EUR]
80
40,000
30,000
60
20,000
20
10,000
0
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
49
52
55
58
61
64
67
40
This supposedly
"optimal" price could, for
example, be improved by
25.6%
This example also shows
that the profit-maximizing
price may in fact be lower
than the current price
0
= Localized optimum (example)
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
DETERMINING THE PRICE LEVEL FOR A NEW PRODUCT LAUNCH (BOOK)
Compared to conjoint measurement only, the Roland Berger
method taps 11% more profits
Example: Using the Roland Berger method in practice
Method
CONJOINT MEASUREMENT ONLY
ROLAND BERGER METHOD
Outcome
Lessons
learned
> Optimal price: EUR 23.50;
maximum profit: EUR 168,000
> Optimal price: EUR 29.00;
maximum profit: EUR 186,192
> Optimal price was over 20% too low!
> Profit-maximizing price was over 11% too low!
> 11% more profits than if the conjoint method had
been used in isolation
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PRACTICAL EXAMPLE 1.1 OPTIMIZING A PRICE LEVEL
SERVICE PRICE COMPONENTS
The conjoint method has its uses too, though.
Adjusting service price components sharply increased profits
Example: Using conjoint measurement in practice
INITIAL SITUATION
STRATEGY
Share of price
Replacement
parts
Response
time
Availability
= New
= Old
Share of price
Share of value
Repairs
Availability
OUTCOMES
Response
time
Replacement
parts
Availability
Response
time
Repairs
Repairs
Base price
> Service prices were calculated based
on cost components
> Repair work and replacement parts
incurred more costs than availability
and response times and were
therefore more expensive
Base price
> Analysis of customers' preferences
using the RB method found that, for
fear of prolonged idle times,
customers valued availability and
response times more highly and were
willing to pay a higher price
Repl.
parts
Base price
> Offer structures were adapted to
customers' value perceptions
> Revenue and profits increased
substantially
> Sales volumes dipped slightly
> RB method validated conjoint
outcomes (reality check)
> Profits rose by EUR 1,077,000 p.a.
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PRACTICAL EXAMPLE: QUANTIFYING PROFIT GROWTH
The full impact of the Pricing Excellence Process on profits is only
seen when all actions are added together. +3% ROS is not unusual
Actions in 10 areas
Remarks
Impact (% of Profit growth
ROS p.a.)
(EUR '000 p.a.)
A.1
Strategic pricing framework
Create rules and guidelines for consistent pricing (volume utilization
versus margins)
0.61
1,423
A.2
Price signaling
Implement signal actions by defining suitable content, media and timing
0.20
459
A.3
Market behavior
Define strategic framework for market behavior
B.1
Data harmonization
Create the necessary data and data structure for successful pricing
0.39
918
B.2
Customer value perception
Understand customer's value perception (by conducting conjoint
measurement interviews)
1.46
3,443
C.1
Price differentiation
Implement systematic price differentiation
C.2
Discount system
Revise the discount system (cash discounts, rebates)
D
Management support
system
Process and decision
structure
Incentive system for profit
and pricing
Implement a comprehensive, easy-to-use information system
(Pricing Pilot, market simulation tool, etc.)
Create the organizational conditions for successful pricing focused on
end customers
Create the organizational conditions for successful pricing focused on
end customers
E.1
E.2
Project payback = 1 month!
Source: Roland Berger Strategy Consultants, Pricing Excellence Group
Impact calculated together with
A.2
Impact calculated together with
B.2
0.38
895
Impact calculated together with
C.2
0.08
200*
0.29
689
+3.41%
EUR 8.03 m
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Bottom line: Checklist to assess the quality of a price
optimizing exercise
> A survey of experts should only be the first step in identifying upside price potential
> Where it is necessary to calculate individual price components, the conjoint measurement method
should be used. At the same time, it is important…
– …never to use the ACA (adaptive conjoint analysis) variant, because this method does not includes
a "no-buy" option and artificially inflates customers' supposed willingness to pay. One respected
pricing consultant still uses the ACA method and then "corrects" the findings by applying an "epsilon
factor" defined at random by a project manager – not exactly a reliable method!
– …to validate the outcomes of the conjoint method by applying a second method
> Whatever the case, the method used to calculate the price/volume function must be able to display
spikes and jumps in the function curve. Straight lines, smooth curves and single bends represent
theoretical values only and do not occur in practice
> The method is only tool to achieve the target. Basis for achieving this target however is to ask the right
questions (fields of profit potential) and to derive the right conclusions and actions from the answers
and to implement these actions with a secure buy-in approach within the organization
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The five greatest threats to any pricing project…
THE THREAT OF
FAILURE
… the wrong questions are asked
because …
… the wrong conclusions are drawn
… the wrong methods are used
… the wrong actions are taken
… defined actions encounter resistance from within the
organization and buy-in is not secured
("Optimize our prices? What do you mean? What have we
been doing wrong up to now?")
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… and Roland Berger's five specific responses
> The threat of failure because the wrong questions are asked
A systematic pricing process guarantees that the right questions will be identified
> The threat of failure because the wrong methods are used
The RB method validates conjoint outcomes while also enabling realistic
price/volume functions to be calculated
> The threat of failure because the wrong conclusions are drawn
The validity of conclusions can be validated by reference to the Roland Berger case library (crosscomparisons, benchmarking)
> The threat of failure because the wrong actions are taken
Defined actions are piloted before being applied to the whole organization
> The threat of failure because actions encounter resistance from within the organization and buy-in is
not secured ("Optimize our prices? What do you mean? What have we been doing wrong up to now?")
Actions are not defined in isolation from or against the will of the organization. On the contrary, the
organization is involved in the entire process. The organization must give its full backing to actions
before they are approved
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BEFORE THE PRICING PROJECT
The experts in almost all companies know that there is
potential in pricing. The only difficulty is leveraging it!
Selected representative statements from an interview round on identifying sales
and price potentials (phase 1)
"In the last few years we became
price followers instead of the price
leaders we used to be, where we were
able to set our own prices. There are
very aggressive players in the
market, and the structures changed
to our disadvantage."
"Our strategy does not translate into
effective price tactics. There is no
clear process. It is also partly a
problem of insufficient information."
Source: Interview results of a pricing project, Phase 1
"Even though customers may be
willing to pay more, it is very difficult
to get a certain price premium in the
market because the competition is
so tough."
"We have inconsistent prices, not
just in all the different sales levels
and channels, but also in between."
"Our prices do not reflect any
benefit to our customers."
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AFTER THE PRICING PROJECT
After the project, participants are convinced of its value and the
results are measurably implemented. See below for references
Selected representative statements from an interview round after the project
was concluded
"I was surprised at how many areas
we found for improvement. It was
also interesting to see that many of
these areas intersected and how they
could only be optimized in
conjunction with one another, for
example information gaps and price
decisions."
"I see now that there was a general
information gap, not simply a
personal one."
Source: Interview results of a pricing project, feedback round
"It's great that we can now systematically
coordinate interfaces between planning
and implementation. These should
mean fewer missteps in management."
"The results of this project were very
impressive. I wouldn't have thought that
it would be so successful."
"I always felt paralyzed when it came to
pricing – I thought that I was just a
puppet of the market. Now I know that I
have opportunities to exert influence."
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The initial phase delivers an in-depth understanding
of the need for change
Phase 1 of the pricing excellence project
PHASE
1 ASSESSMENT/QUICK WINS
Goals
>
>
>
>
Core
content
>
>
>
>
Ensure a common understanding of the target product range, brand positioning and distribution structure
Roughly analyze pricing and the system of prices/terms in order to prioritize improvement levers
Define the ongoing change roadmap and secure the backing of the organization
Pick out and immediately realize quick wins
Analyze past brand performance, future brand strategies and planned actions
Analyze the existing distribution structure, the need for change and the defined actions
Analyze existing pricing methods and the available room to maneuver
Apply a price/terms review tool (including selective customer interviews) to answer specific questions:
– What terms are in place?
– What budgets are in place for each customer and SKU?
– How are customers and SKUs actually performing relative to the budgeted terms?
> Prepare a review workshop
> Identify main areas for improvement and quick wins
– Define end-customer prices
– Pricing/terms system
– Pricing organization
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In phase 1, areas of high potential are identified and quantified
by means of benchmark comparison
Diagram of phase 1: assessment
Action
Assessment
workshop
Time
Decision
about how to
proceed
in phase 2
1
2
3
4
Lever
Profit effect p.a.
1
2
3
4 etc.
EUR 234,500 p.a.
EUR 89,900 p.a.
EUR 788,200 p.a.
EUR 412,000 p.a. etc.
Quantification
Lever 4
x
x
etc.
Evaluation of the
price and market
situation
7
11
4
5
Discussion
and benchmarking of
assessment
results
P rofit im pact
hig h
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Profit im p act
high
Lever 3
1
12
Excellence
Excellence
High
MAX
Excellence
High
MAX
Excellence
High
Drivers
MAX
Excellence
High
Drivers High
MAX
Potentials
Excellence
High
Drivers
MAX
Potentials
Excellence
MAX
Drivers
MAXS
Potentials
High
Excellence
High
Excellence
Drivers
MAX
Potentials
Excellence
High
Drivers High
MAXSS
Potentials
SPotentials
Drivers
MAX
Potentials
ET
Drivers Drivers
Potentials
ET S
Drivers Potentials
Potentials
ET S
ET SS
M
ET
ET S ET M
ET S M MM Quick
ET
M Quick
ET
M Quick
MIN
NoGo's
Go's MIN
M Quick
No
M
MIN
Wins
Quick
NoGo's
Go's MINM Quick
Wins
No
MIN Quick
Wins
No
Go's
MIN Quick
Wins
NoGo's
Go's MIN
Wins
No
Wins
MIN Quick
No
Go's MIN
Wins
No
Go's
Wins
Wins
No Go's MIN
Wins
3.8
8
6
Low
2
Implementation
opportunities
13
High
low
low
low
low
low
low
low
low
low
l
Source: Roland Berger Strategy Consultants, Pricing Excellence Group
2.1
2.1
2.1
2.1
2.1
2.1
2.2
2.12.7
2.2
2.1
2.2
2.1 2.72.7
2.2
2.6
2.2
2.6 3.1
2.72.3
2.2
2.6
2.72.3
2.2
3.9
2.6
2.72.3
2.2
2.6
2.72.3 2.5
2.2
2.5
2.6
2.7
3.10 2.7 2.3
2.6
2.3 2.5
3.2 2.6
2.3 2.5
2.6
2.3 2.5
2.3 2.5
2.5
3.5
2.5
2.5
3.4
3.7
2.4
2.4
2.4
2.4
2.4
2.4
2.4
3.3
2.4
2.4
3.6
low
low
low
low
low
low
low
low
low
x
Lever 2
14
3
lo w
x
Roland Berger case library
FOCUS 10
Profit effect
Lever 1
Low
Assessment sheet
price process
High
Pricing assessment matrix
Implementability
Implementability
Implementability
Implementability
Implementability
Implementability
Implementability
Implementability
Implementability
Implementability
high
high
high
high
high
high
high
high
high
hi h
MUC-90006-043-09-01-G.ppt
26
After phase 1, the key improvement levers become
the focus of attention
Phases 2-4 of the pricing excellence project: examples
ROS
2 ANALYSIS/ROUGH STRATEGY 3 DETAILED PLANNING
4 IMPLEMENTATION
Define
endcustomer
price
> Survey customers' willingness to pay
> Calculate competitor response
scenarios
> Define pricing models
> Define target margin structure
> Calculate financial effects
> Describe pricing levers in detail
> Draft internal and external
implementation roadmap
> Conduct trial runs
(where appropriate)
> Talk to customers about
implementation
> Verify implementation and validate
effects
Pricing/
terms
system
> Analysis budget terms in detail
> Compare with competitor benchmarks
> Define basic principles of pricing/terms
system
> Define future terms
> Quantify possible bottom line effects
(scenarios)
> Validate legal aspects
> Present system to selected customers
> Make necessary modifications
> Draft an internal implementation
roadmap (e.g. for IT and KAMs)
> Formulate detailed arguments as a
guideline for talks with customers and
the external implementation roadmap
> Talk to customers about
implementation
> Verify implementation and validate
effects
PHASE
MUC-90006-043-09-01-G.ppt
+3%
27
Delivering results!
MUC-90006-043-09-01-G.ppt
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