Despite the emergence of a recent wave of strategic pricing vendors, there’s a fundamental problem with using simple analytics to improve margins. The underlying mathematics of most pricing analytics packages don’t adequately capture the real world sources of higher margins.
Strategic Pricing 1.0 – Getting A Handle on Variance & Price Elasticity
Most strategic pricing software packages are built around one of several big ideas:
- Customer Segmentation – use analytics to find customers who will pay more
- Product Segmentation – use analytics to find products where higher prices are tolerated
- Process Control – ensure pricing policies are fully implemented
- Price Elasticity – get the right balance of margin vs. volume
These are well regarded ideas in economics and process optimization theory. There is a risk of overdoing them to the annoyance of your best accounts. But in the aggregate, these are worth implementing.
The funny thing is…. your best customers usually came from other approaches….
Using data points from real customers and products, we’re going to explore how high margins occur in the real world. The cases you are about to hear are real, drawn from pricing and sourcing adventures.
Case Study #1 – Understand (and remove) middlemen
Many distribution channels have several layers between the producer and the ultimate consumer. Each layer adds cost, between the services provided and the overhead of operating an independent business. Anything you can do to simplify the path to the customer and remove cost is a potential opportunity.
Consider the following example, three different possible ways to buy the same website:
- $1,500 for ‘friends & family’ development (where you know the programmer)
- $5,000 if you’re going to hire an independent consultant who builds websites
- $15,000 for a digital agency
These are a fair market price for the same basic website. With a 10 x spread in price.
Of course the level of service and solution resiliency varies dramatically between these three levels. Cutting costs and directly hiring your own developer requires a certain level of technical expertise. Concerned about your ability to ensure quality? Hire a professional consultant. Don’t want to bother with solution design and project management? Perhaps a full service digital agency is what you need.
But then again, maybe you don’t need all of those services. You could certainly reduce the total cost if you consolidated all of these services under the same roof, reducing hand-offs within the team. A similar approach works for wholesale distribution, restructuring logistics to reduce shipping and handling.
The effects of these changes are not often fully transparent to a customer. Thus, you can often pocket a portion of the savings and increase your overall profitability on the account – while staying competitive.
Case Study #2 – Understand Solution Value
Looking beyond distribution dynamics, there are more reasons that similar products can be reasonably priced at very different levels. The next one we’re going to look at is optimizing the value of a solution.
Our example for this case study comes from a packaging distributor. One of the neat things about many packaging products is the degree of value offered beyond the product. For example, the customer’s total cost of packaging includes:
- The cost of the box
- The materials required to seal, cushion, and label it
- The labor involved in filling it
- The inventory carried – both at the manufacturer and wholesaler
- Reorder frequency and lead time
- Freight cost of the packaging
- Damage caused by poor packaging
- Incremental retail impact of good packaging or expanded reach
The business was originally offered as a straightforward deal on cardboard packaging, a custom box that cost about $1 per unit. But as you can see above, there were many ways to create value for this customer. First, the team put the cardboard box out to bid, adjusting the specifications and squeezing suppliers to increase our margins from this account. Next, modifying order frequency to get a better cost on the item and align purchases of similar items, so the boxes can be produced in one giant batch. Finally, working with the customer to build the case to install new equipment with faster throughput.
The endgame is good for everyone. The customer has a lower average packaging and labor cost. The distributor is enjoying higher margins on the customer’s full bundle of business, not to mention some additional revenue from supporting the new packaging equipment and various consumables.
Case Study #3 – Focus on Highly Profitable Products
Almost every business has a sweet spot, a few products or service options that it does particularly well. Maybe you have a highly efficient machine that can crank out the item at top speed. Perhaps you enjoy excellent freight rates in a particular region. Or identified a particular product that good customers buy.
I’ve seen this a couple of times in my career. In one case, at a wholesale distributor, our best customers tended to purchase a full bundle of products from us. In addition to increasing our average order size, this also ensured a diverse mix of high margin and “bulk commodities” for a well balanced shipment. Another example, in publishing, involved identifying that audiences attracted by a particular type of content were more valuable than other visitors to the site. In either case, guess what we pushed…
This approach often means doing less rather than more. Define what good looks like. Identify which accounts can be moved to that product mix, based on selling time and relationship experience. Reduce time spent pursuing other business. The net effect is an improvement in your return on selling time.
Case Study #4 – Bridge Gaps in the Customer’s Organization
We had just merged with another business unit and were comparing notes on costs. This vendor was very high, charging double the typical price. Our ask was simple: a 50% reduction, a $1.5 million cut.
They declined, of course, prompting us to move the business. Within a week, we understood the price. Our vendor manager didn’t have a clue how to manage the process. The supplier had been covering for them for years, loading up the bill with additional services, taking every price increase, and pocketing any savings. They had correctly figured out that their recipe for survival was making him look good. We finally had to swap out team members to make this work.
In retrospect, the vendor’s biggest mistake was aiming too high. Had they padded their margins by a mere 10% – 15%, it wouldn’t have been worth the time and effort to sort through this mess.
While this is an extreme example, the principles can be applied a little more broadly and ethically. Suppliers who can elevate their standing to “trusted advisers” can earn higher margins than less sophisticated providers. This is particularly true if the offering has a high switching cost.
Case Study #5 – Leverage Scale and Experience
The cost of manufacturing a product consists of the “setup time” for the manufacturing process and the variable cost per unit produced. A similar model can be applied to many service processes, particularly ones which involve solution design and knowledge transfer between team members. With longer “production runs”, you have the opportunity to spread the cost of your set up across a larger number of units. In retail and distribution, there are efficiencies in inventory – inventory turns improve as you convince additional buyers to purchase that product.
In all of the above, the starting point is a clear understanding of which products and services you want to promote as the company’s core offering. Through moving as many customers as possible into those products, you reduce the average cost of each unit while maintaining a market price.
Simple? Yes, in theory. Although you need good discipline around product recommendations to ensure this works.