TM
How to Go from “Good” to “Great”
with Pricing Software
By Craig C. Zawada, Senior Vice President, Pricing Excellence, PROS
INTRODUCTION — GROWING COMPLEXITY DEMANDS
SOFTWARE SOLUTIONS
Over decades of experience advising companies about how to use pricing to their
advantage, we recently observed dramatic changes in the pricing environment that
suggest pricing software is a must have tool. The day is coming soon when most
companies will consider pricing software an essential part of company operations,
providing the foundation for sustained profitability.
The reason pricing software has become so critical is, in a word, complexity.
Complexity is occurring at every level of pricing management, from the formation of
market strategy to perceptions of customer value, and from decision making at the
transaction level to the foundations of every company’s pricing infrastructure.
Heightened pricing complexity at each level
Market strategy
•
•
Increasingly volatile
input costs
Multi-market
participation
Customer value
Transactions
•
•
•
•
More sophisticated
buyers
Proliferation of
segments
Shorter product
lifecycles
Market strategy
•
Customer value
Distributed
decision making
Customized/
complex deals
Transactions
Pricing
power
Pricing infrastructure
Pricing infrastructure
• Many different constituents, dynamic markets
Figure 1: Illustrates the four key areas of pricing power: market strategy, customer value,
transactions, pricing infrastructure
To understand the changes occurring, it is helpful to break down pricing into four
critical categories: (1) market strategy, (2) customer value, (3) transactions and (4)
pricing infrastructure. In this white paper, we will examine the major changes in
each of these categories that are shaping pricing practices today and explain how
pricing software can help you manage these forces to your competitive advantage.
Most important, we will show how pricing software can ultimately take you from
good to great when leveraging your unique pricing power to improve and sustain
margins and profitability.
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MARKET STRATEGY: COST VOLATILITY INCREASING AMIDST
MULTIPLE MARKET DYNAMICS
Most companies
today are not
equipped to
At the market strategy level, we’ve seen a dramatic increase in volatility for input
costs across all industries. In the last 10 years, according to our research, there’s
been a 40 percent increase in price volatility, and many companies simply don’t
have the systems or tools to identify and keep up with input cost fluctuations let
alone respond appropriately. See Figure 2.
identify and
6.3
take advantage
5.49
of geographic
market differences
4.64
3.84
4.09
3.82
Average Monthly
Price Change
through pricing
segmentation.
Std. Deviation
1981-1990 1991-2000 2001-2010
Source: Indexmundi.com, Pros Analysis
Figure 2: Research shows a 40 percent increase in price volatility over the past 10 years
The power to manage input cost volatility, however, can make a significant
difference. For example, a computer server company faced a major challenge
when an earthquake in Taiwan destroyed a major component supplier’s factory.
Because the server company knew the components were going to increase in
costs, they responded immediately to increase their prices while their competitors
lagged more than a month behind them. This server company was able to make
an additional $20 million in profit from that ability to respond more quickly to cost
changes.
The proliferation of multiple markets has also become a significant factor in pricing
market strategy. Our research indicates that the market dynamics of two different
city locations in the same European country, for example, can show wide variations
in competition, perceived value, and therefore sales success and profitability for the
same product. Most companies today, however, are not equipped to identify and
take advantage of geographic market differences through pricing segmentation.
The result is lost opportunities to improve margins and profitability.
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CUSTOMER VALUE: MORE SOPHISTICATED BUYERS, MORE
SEGMENTS, SHORTER CYCLES
The conventional
approach of
juggling mounds
of figures on
Another significant trend in pricing today stems from the power that purchasers
have gained over producers in the marketplace. Last year alone, companies spent
more than $3 billion to purchase e-procurement software to gain an advantage in
negotiations. See Figure 3.
Spend on software tools – ($ Millions)
3,200
Figure 3:
Buyers gaining power
over producers using
procurement technology
spreadsheets simply
can’t keep pace
with the frequency
and complexity of
various customer
~180
segments and
requirements for
customization and
E-Procurement
Pricing
Source: McKinsey & Company Research (2009), Gartner Research (2010)
deal negotiation.
At the same time, we’ve seen an explosion in the number of product segments
as consumers and businesses demand products and services that are customized
to their wants and needs. This creates an enormous challenge for pricing, and
makes a cost-plus approach obsolete. The conventional approach of juggling
mounds of figures on spreadsheets simply can’t keep pace with the frequency and
complexity of various customer segments and requirements for customization and
deal negotiation. Shorter product life cycles are also a factor in pricing. Products
that once took years to develop are now introduced in a matter of months. From
a pricing standpoint, companies need the ability to price correctly from the very
beginning since there is no longer any margin for error.
TRANSACTIONS: PRICING WIDELY DISTRIBUTED; DEALS
GROW IN COMPLEXITY
Much of the profit increases over the last few years have come from reducing
variable and fixed costs. These cost-cutting measures, however have reached
their limit, and savings are much more difficult to find. Plus, the elimination of
layers of management has typically pushed pricing decisions much lower in the
organization. Some companies now have hundreds or even thousands of people
involved in making pricing decisions. The result is an explosion of complexity
as pricing involves more people in highly complicated negotiations with buyers
juggling a myriad of discounts and promotions.
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To manage the
complexity of
all the pricing
variables involved,
professionals are
relying on pricing
software to help
capture, process
and disseminate
pricing guidance
when and where it
is needed.
We have also seen that transaction pricing has become more complex because
of the explosion of custom deals. Fifteen years ago, for most B2B companies, 80
percent of customer deals fell under standard discounts, terms and conditions and
20 percent were custom negotiated deals. Today, the opposite is true for most
sellers. They must contend with an enormous amount of special terms, conditions
and discount structures – and most do not have the tools to manage this.
PRICING INFRASTRUCTURE: MORE PRICING
PROFESSIONALS, MORE SOPHISTICATED SOFTWARE
TOOLS
Given the changes described here, it’s not surprising that we are seeing the
growth of pricing departments and professionals devoted to pricing within many
organizations. And, to manage the complexity of all the pricing variables involved,
these professionals are relying on pricing software to help capture, process and
disseminate pricing guidance when and where it is needed. Pricing software is
critical to equipping sales people in the field with information needed during the
process of negotiating prices.
HARNESSING YOUR PRICING POWER WITH SOFTWARE:
FROM GOOD TO GREAT!
For companies that have cut costs as far as they can, boosting profits further
demands they explore their potential pricing power. But, far too many companies
today are using antiquated and inflexible tools to manage the complexity of today’s
pricing environment. They don’t possess what we call an “institutional memory of
pricing.” That is, the collective wisdom of pricing in the organization is not brought
to each and every deal. This often leaves their sales people isolated and on their
own when negotiating with both customers and suppliers. Companies today need
to capture and bring the collective pricing experience, wisdom and memory of all
corporate staff and sales people to bear on every transaction.
The ultimate goal: Develop “Pricing Power”
“The single most important decision in evaluating a
business is pricing power”
Warren Buffet – February, 2011
Spectrum of ease
“Do no wrong”
(very few companies)
Extremely hard work, and
investment required
(available to most
companies)
Figure 4: Pricing power is a critical component of business success
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The good news is that customer and pricing software technology has gotten much
better in the past few years. Data on customers and transactions is much more
available through ERP systems, while storage and computing costs are far less.
Most important, pricing software has evolved to take advantage of this data and
find the nuggets of margin opportunity by applying sophisticated science to finding
opportunities.
The proper implementation and use of pricing software creates pricing power for a
company. Warren Buffet has said the number one thing he looks for in a company
is pricing power. Some companies can exercise pricing power at will. But most
companies have to work very hard at it and for them pricing software can make the
difference between achieving it or not.
GAIN SPEED AND AGILITY FOR CUSTOMIZING MARKET
STRATEGIES
Coping with the forces of input cost volatility and significant local market
differences requires speed and agility in pricing. Software technology provides
the means to take good strategies such as logically grouping local market areas
by shared characteristics when pricing, to the development of “price zones” based
on the scientific analysis of customer segments. This allows corporate office sales,
marketing and pricing staff to clearly identify dynamic segments and react much
faster to changes in local market conditions and competition.
At the same time, pricing software enables companies to go from monthly or
even weekly manual evaluations of cost inputs to making price adjustments in real
time --- often in a matter of minutes or a few hours --- so that prices accurately and
immediately reflect the fluctuations of input costs when it makes sense. For one
distributor, we have seen this flexibility improve margins by over 100 basis points
alone across an entire product line. Figure 5 highlights technology’s advantages
that can take companies from good to great pricing practices.
Market strategy
Customer value
Transactions
From “good to great”
Good Practices
Pricing infrastructure
Market strategy
“Pricing Power”
with Software
•
Logically grouped local
market areas on which
to base prices
•
Price zones chosen
and modified based on
scientific segmentation
•
Prices evaluated when
major cost shifts
•
Real-time adjustments
to prices based on
changing economics
Figure 5: Technology advantages for market strategy
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FIND AND EXPLOIT KEY VARIABLES IN CUSTOMER VALUE
Pricing software
allows companies
to set list prices
for individual
products based
on a sophisticated
analysis of each
product’s pricing
history as well as
comparisons with
While many companies do a good job of making list price adjustments based on
category-level analysis of pricing opportunities, they struggle with getting much
more visibility into key differences among individual products. For example, a
construction equipment company used to adjust its prices at a product category
level. All hydraulic fittings would get the same price increase every year. However,
they were missing the unique “DNA” of each SKU even by this category-level action.
Some of the fittings were low-volume and difficult-to-find alternatives, whereas others
were easily replaceable with off-the-shelf parts at a local supplier. In addition, some
were already much higher priced than competitors, and others still had room for
increases while remaining below competitive alternatives. As a result, the company
was under and over pricing many of its hydraulic fittings. Pricing software can
deliver a granular level of analysis that makes individual product pricing not only
possible but a competitive necessity.
Pricing software allows companies to set list prices for individual products based on
a sophisticated analysis of each product’s pricing history as well as comparisons
with other products in similar categories. This capability enables companies to
quickly and easily identify underpriced products and calculate the trade-off of
margin to sales for specific list prices. See Figure 6.
other products in
similar categories.
Market strategy
Customer value
From “good to great”
Transactions
Good Practices
•
Market strategy
Pricing infrastructure
List price adjustments
based on category-level
analyses of pricing
opportunity
Customer value
“Pricing Power”
with Software
•
List prices set based on
sophisticated algorithms
using data on
» Pricing history/
momentum
» Comparisons to
like categories
Figure 6: Using technology to enhance customer value
PROVIDE MEASUREMENT AND GUIDANCE FOR EVERY
TRANSACTION
Despite the wealth of information generated by customer management systems,
many companies are hard pressed to utilize it fully when developing price guidelines
and decision rules for setting and negotiating prices. Pricing software technology
provides a much more in-depth understanding of a customer’s transactions and
behavior so that underperformers can be identified and the biggest margin
opportunities can be acted upon. Just as important, pricing software can provide
ongoing access to an account’s transaction profitability (taking into account all of
the special terms and conditions and costs to serve) and compare it to other like
customers to find potential improvement opportunities.
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Our experience has revealed, for example, that sophisticated transaction analysis
often shows the most potential for margin improvement exists among customers
in the middle range of the profitability distribution. Many companies have taken
tactical measures to find the extremely low or negative profit customers. Few have
applied the science to identify average profit customers that could do a little better
when comparing them to other like customers. This is where scientific segmentation
improves the negotiating confidence of the sales force in pushing for increases
in prices and margins when it makes sense. Pricing software can provide more
accurate floor, target and stretch price guidance at the point of negotiation and
empower the sales force while enforcing accountability. See Figure 7.
Market strategy
Customer value
Transactions
From “good to great”
Pricing infrastructure
Market strategy
Good Practices
•
Clearly defined and
executed guidelines and
decision rules for all price
waterfall elements
Customer value
Transactions
“Pricing Power”
with Software
•
“Optimized” pricing
targets given at the point
of negotiation
•
Incorporate customerspecific cost-to-serve into
price negotiations and in
managing performance of
accounts
Figure 7: Advanced transaction analysis optimizes prices
BUILD PERFORMANCE MEASURES INTO YOUR PRICING
INFRASTRUCTURE
To fully exploit the power of pricing software requires a company’s pricing
infrastructure be aligned with the capabilities inherent in the technology. That
means moving from the usual categories of reporting and sales incentive structures
to the use of true peer comparisons based on software tools that monitor and track
accountability and compliance with pricing policies across all levels from executive
management to field sales.
With the increase in pricing departments and the number of professionals
dedicated to pricing, and the phenomenal growth of available customer data,
most organizations are poised to utilize their pricing power with readily available
software tools. It makes little sense to try to recreate these reports in Excel or other
generic reporting tools when there are already best practices built into leading
pricing software tools.
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Pricin
Market strategy
Customer value
Transactions
Pricing infrastructure
From “good to great”
Market strategy
Good Practices
PROS has taken the
lead in applying
•
scientific analytics
not only to manage,
•
but actually help
prescribe how and
when products
Cascading reports on
margins by region,
customer, salesperson
Customer value
Transactions
Pricing infrastructure
“Pricing Power”
with Software
•
True “peer comparisons”
•
Tools used to monitor and
track compliance
Sales incentives for
improved margin
performance
Figure 8: Pricing software monitors and tracks performance accountability
should be priced.
BEYOND PRICING MANAGEMENT TO PROFITABILITY
More and more companies are recognizing the powerful potential of pricing’s
impact on margins and profitability. PROS has taken the lead in applying
scientific analytics not only to manage, but actually help prescribe how and
when products should be priced. PROS also has very powerful and flexible
reporting and analytic tools that allow companies to conduct actionable
dialogue around pricing. The advantages of adopting and implementing
presciptive pricing software have never been greater. Here’s what you can
gain:
•
•
•
•
•
•
•
•
•
React quickly to cost changes and changing local market dynamics
Apply sophisticated science to identify underpriced products
Adjust prices over the lifecycle
Commensurately equip sellers with data
Provide scientific guidance on willingness to pay
Provide full transparency to deal economics
Build integrity into processes
Provide true transparency on relative performance
Build pricing bench strength
NEXT STEPS TO APPLYING THE POWER OF PRICING
SOFTWARE
The business case for pricing software is no longer a question of “if,” but of
“when.” Those companies operating without pricing software will increasingly
be at a competitive disadvantage. My favorite analogy describes these
companies as attempting to land a commercial jet without instrument panels or
controls. Pricing software is the means to gaining the visibility and control to
successfully navigate the headwinds of marketing volatility and complexity.
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If you have not yet evaluated pricing software as a strategic tool for your business
--- or are in the midst of considering a pricing software investment --- I suggest the
following steps.
1. Assess where you are as a candidate for pricing software from the
perspective of complexity and change in your own market environment.
2. Examine the three categories of pricing to determine where you can
gain the most leverage or value. Is it in the realm of marketing strategy,
customer value or transactions?
3. Finally, Put together a team of cross-functional professionals in your
organization to evaluate the pricing power potential of software
technology. Include an executive champion, sales and marketing
management, finance, and field sales people to ensure you have buy in
from all involved parties.
There is a proven path to realizing your own pricing power potential. It’s up to you
to take the first step.
To learn more about PROS prescriptive software solutions, visit our website at
www.prospricing.com or contact us at [email protected].
ABOUT THE AUTHOR
Craig C. Zawada serves as Senior Vice President, Pricing Excellence, at PROS
Pricing, the leading provider of price management and optimization software.
Prior to joining PROS in 2010, Zawada was a partner and co-leader of the North
American Pricing Practice at McKinsey & Company, gaining experience across a
wide range of B2B and consumer products. He is a widely published author on the
subject of pricing strategy, with articles featured in the Harvard Business Review,
Mergers and Acquisitions and the McKinsey Quarterly. He has been interviewed
and quoted in Fortune Magazine, CFO Magazine, Canadian Business and Business
2.0. Zawada is co-author of The Price Advantage, recognized as one of the most
pragmatic books on pricing strategy available.
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