Price optimisation is the single most effective lever for an improved bottom-line. A 1% price improvement is simply more efficient than 1% saving or a 1% turnover growth.
Raising prices is the most important profit lever
Example company (Contribution client)
If your prices have not been optimised lately, and please disregard the fixed annual index regulation, then there’s a good chance of strengthening the bottom-line considerably with price optimisation.
Price optimisation consists of several potential focus areas. The most important ones are presented below:
- Strengthening gross prices / recommended prices
- Discount reduction
- Cost to serve reductions / fees
- Operational support
Optimisation of recommended prices
An annual routine price increase of 2-3% is common practice within many companies. The reasoning for the adjustment is inflation and regular pay rises. At times the regulation may be higher, which is usually explained with considerable cost increases, for instance in commodities.
This form of price adjustment is made from a Cost+ consideration and does not enter into account that both the competition and the consumer’s preferences are dynamic.
Simultaneously sellers may inform you, that they are under constant pressure from buyers. “Your prices are too high”,” Your competitor just lowered their prices!”, and it is clear that buyers make it difficult to discuss value: “We’re experiencing problems with your products, not to mention the delay in delivery”.
Nonetheless, our experience tells us, that buyers play the game well, and that a solid price analysis documents, that your clients are much more content than they express and have a higher willingness to pay. Typically, it is proven that there is a basis for a 5-8% higher average price. Other pricing consultants share in our experience.
All this means that there are quick gains to be made, often over a period of 2- 4 months, provided the price strategy can be left unaltered. What can be difficult to predict though, is how much markets and product categories need to be adjusted, as there is always a dissimilarity in this area.
Discount management and optimisation often leave a great deal to be desired. Some of the problems to be faced are:
- Discounts are not monitored closely, partly due to lack of transparency. Many discounts or contributions are merely applied to joint accounts and are not allocated to the clients, who in fact benefit from them.
- Discount policies usually exist with sellers having considerable liberties. At the same time numerous exceptions from the polices are accepted.
- Discounts are usually volume driven and do not reward desired consumer behaviour.
- The seller’s discount focus is not motivated by bonus systems.
Consequences of lack of discount management:
- Discounts given to many clients are too high with serious differences and there is a lack of integrity in discounts given to identical client types.
- Clients are continuously offered discounts even though it is not justified by the extent of their current orders.
- Discounts are at times of historical reasoning and is given without the knowledge of either seller nor buyer.
- Earnings from client portfolio is not what the company expects, and it is surprising which clients that are indeed loss-giving.
- Management of consumer behaviour through discounts is not well-supported.
If you recognise any of these situations in your company there is no doubt, that discount optimisation would be a valuable investment.
The way to do it is through analyses, that are put into discount plots, giving a clear picture of the variation of discounts for clients with different turnover levels including a price waterfall, that uncovers how much each discount in total drains the earnings.
With analyses at hand you have a foundation for creating (new) discount goals, -structure, – policies etc. The discount optimisation will ultimately mean a change in terms for some clients. It is often associated with some level of fear, when explaining the reasoning. Our experience tells us, that clients are understanding if the case is well prepared and presented. Some have had the same experience in their own companies, and the few not understanding, may not be good clients after all.
Is discount optimisation worth it? Usually there is a 1-2% improvement on the average prices taken into effect and it is of course earnings that are seen on the bottom-line too. So, the answer is Yes.
As is the case with discount optimisation there is usually a potential for increased earnings in the whole cost-to-serve area, i.e. services provided more or less for free by the company. The change is usually around ½% in improved average prices; it may be worth the while nonetheless.
The cost-to-serve (CTS) area often lacks focus and strategy, something usually associated with lack of transparency. Some of the hidden problem areas are:
- Great differences in the consumer’s demand for CTS
- Possible cost allocations are unprecise thus the real cost is unknown
- The option to price CTS activities is not applied or they are priced too low
- Consumers are not directed toward inexpensive behaviour
The extent of cost-to-serve activities is broad (see illustration) depending on the company and its business.
Working on the analysis it is wise to apply the 80/20 rule and besides that, the same type of analysis method as with discount optimisation is used. Nevertheless, possible cost allocations in cost-to-serve connections usually demand more of an effort.
Optimisation of prices, discounts and cost-to-serve cannot stand alone if the adjustments are to be successful. Focus on the operational support is also imperative. At times small adjustments in operations alone create a remarkable difference, i.e. bonuses; is the seller’s bonus solely focused on earnings or is there a reasonable balance in accordance with earning targets.
Operational areas of application are primarily:
- List price processes
Price optimisation as a whole could mean a substantial potential increase in earnings, if your company is not already systematically focused on the area and the effort is usually returned within a matter of months.
If you would like to discuss your potential or a specific price optimisation effort, please contact us here.