Shareholders Value Creation through Price Optimization (SVC-4)

Does your organization create appropriate value with Pricing Policy? Normally organization doesn’t give as importance to pricing as to Volume growth & Cost optimization however reality is that Price optimization creates more value than Volume growth & cost optimization.

 

 # Research by one of the top Consulting Firm

Irony is that price optimization is overlooked as key business driver though for many businesses price optimization plays major driver of growth than volume or cost optimization.

Now the question arises why haven’t more organizations use price optimization for value creation. Following are the challenges for not adopting price optimization-

• Belief that price is driven by external forces: Many businesses mistakenly believe that they must passively accept prices across all products, markets and channels 
• Sales force resistance: This is particularly the case when people are rewarded on the basis of sales volume 
• Information collection: Difficulty obtaining the necessary information from existing systems is a reason why companies may ignore potential value from price optimization
• Perceived complexity: It generally requires thoughtful manipulation, often at the level of individual transaction

Management’s challenge is to achieve optimum price in the existing market. Normally following approaches are dominated the pricing strategy-

Cost Plus: It has an advantage of simplicity in implementation & administration however there is a high risk of leaving value on the table if some customers are prepared to pay higher price

Customer Value: Pricing according to the customer value approach involves setting prices to capture the full value customers place on a product or service. The advantage of this approach versus cost plus pricing is higher profit margins can be achieved through the capture of the customer surplus. However the main drawbacks are complexities involved in implementation – how to determine customer utility for each product line and how to account for difference in the price a customer is ready to pay

Penetration Pricing: Pricing low to gain market share in anticipation of scale or experienced economies however with product lifecycles becoming shorter and shorter, the risk inherent in penetration pricing is that the product may not endure long enough to deliver the expected savings

Skimming:  A skimming strategy is essentially the opposite of penetration pricing — pricing high to maximize margin from customers ready to pay the most however success of skimming strategy depends on the ease of entry by competition, since high margins are an open invitation to new entrants

Company’s pricing strategy depends upon market position, stage of product life cycle & customer demand however pricing choice should be driven my marketing strategy & to maximize shareholders valueSupply & Demand

How will current and future supply, demand, and cost dynamics affect the overall industry price levels in the foreseeable future? Although managers are often well versed in monitoring demand drivers and attuned to responding to the threat of new entrants, market and customer strategies are typically less effectively managed. Therefore for many companies these last two hold the greatest potential for where additional value can be captured.

 Product & Marketing Strategy

The key issue in product and market strategy is determining the “list price,” the seller’s published price for a service, product line or SKU. The Stock Keeping Unit (SKU) is the level at which price optimization is most powerful, since customer price sensitivity can frequently be found to vary according to the colors, dimension or other variations in the characteristics of a product.

The psychology of list prices is an important factor, since the price acts as a reference point for customers and conveys a range of signals about the product. The list price must be set at a point that preserves a product’s price / benefit advantage in the eyes of customers while maximizing profitability.

The list price is generally the base against which discounts and allowances are taken. Therefore, it needs to be high enough to offset the expected discounts, freight recoveries and so on. A higher list price allows managers a greater degree of freedom in terms of offering a range of customer discounts. However, a list price too high may push the product into an inappropriately elevated price bracket in the eyes of customers.

Optimizing list price is easily grasped in principle, but in practice it is often ignored or not successfully implemented. Managers can identify the potential opportunities for value creation when they develop an improved understanding of the forces influencing achievable list prices. This requires investigation of factors such as: 

• Margin bands

• Regional variations in margin

• Freight rates

• Pricing conventions in the industry (early payment discounts)

• Distribution channels

Analysis of price sensitivity often reveals that the optimal list price can vary among geographic markets, products bundles or product lines within a category. Each of these areas represents an opportunity to enhance margins.

 Figure: A

 Figure A reveals that client was able to identify margin bands based on customer purchase volumes of a fast moving consumer product and to implement a new list price structure with the potential to add significantly to the value of the company.

The principal outcomes and benefits companies obtain through product and market price optimization strategies are:

• A restructured list price program that reflects the varying competitive intensity that enables the seller to capture more of the customer surplus

• Identification of opportunities to increase value through price differentiation between segments.

 Figure: B

Figure B shows the magnitude of margin increases available on low volume items in one market for fabricated products. Higher list prices were possible in this case due to a combination of lower customer price sensitivity on slow moving items purchased only infrequently and less intense competition in the supply of many low volume products. Previously, this manufacturer had maintained a standard margin as its pricing policy across all SKUs for each type of product. Analysis of price sensitivity revealed that while intense competition on high volume SKUs (D & E) required company to “meet the market” on price margins could be dramatically improved on low volume lines. This was because competition on low volume SKUs was typically less intense and infrequent purchases by customers made them less sensitive to the price. Higher margins on low volume SKUs produced a significantly higher contribution and helped ensure that the company could remain competitive on high volume products.

This example illustrates how a better understanding of relative price sensitivity of customers enables a more sophisticated approach to list prices, and can result in significant potential for value creation.

Customer Strategy

The key to customer pricing is maintaining loyalty while achieving the highest prices possible that are appropriate to the volumes sold to the customer. It’s a delicate balance and is based largely on the psychology of discounting.

In many companies, senior management’s understanding of price variation at the customer level is poor with the actual price ultimately determined by the sales force. Management needs to carefully monitor and evaluate customer pricing. Without an appropriate pricing framework, specific discount schedules and aligned performance incentives, sales staff with too much autonomy can quickly erode company profits and even provoke competitive responses that destroy value through out the market.

The key issue is identifying and managing the factors that have the potential to erode list price. These include:

• Discount schedules

• Rebates

• Volume bonuses

• Promotional bonuses

• Cooperative advertising/marketing

• Allowances

• Payment terms

• Buybacks

Performing a transaction level analysis can be a powerful tool for value creation, enabling managers to tighten the relationship between volume and price. In particular, it helps companies increase the contribution from low volume customers that may have obtained discounts or favorable terms that are otherwise reserved for high volume purchaser. Transaction level analysis also allows managers to directly assess:

• The value of customer segments and accounts, therefore determining the appropriate allocation of sales effort

• The net effect on profit of discounts, bonuses and other incentives given to particular sales channels

One indirect benefit is the increased price discipline in the overall market that results form a rational and consistent approach by key players, thus reducing the risk of irrational competition destroying margins for all. Another application of a rational pricing strategy is to examine price differential between small and large companies. Often, small customer accounts can occupy a disproportional amount of sales force time and provide relatively small returns for effort.

Pricing Frameworks to Improve Shareholders Value

Managers are under increasing pressure to lift returns and to focus on improving shareholder value. Institutional investors are becoming increasingly vocal in demanding cost reductions and rationalization programs however they should devote extra attention to the revenue side and the potential for price optimization. A robust pricing framework has the potential to improve shareholders value through:

• Establishing and maintaining list prices that effectively balance profit maximization with product positioning

• Preventing erosion of prices at the customer level through a careful customer pricing and discount strategy.

Senior managers therefore need to regularly assess pricing policy and administration. Key questions to consider:

• Does the company pricing policy recognize differences in regional market dynamics? 

• Is pricing segmented to recognize the variations in perceived value among different customer groups? 

• Is there a transparent discount policy based on customer relationship value? 

• Who has discretion to modify prices? What criteria are required? 

If an organization can acknowledge the importance of price as a driver of shareholders value, part of the battle is won. Once managers and sales people incorporate this awareness price into their everyday monitoring of performance, the company will start to create long-term value for its shareholders.

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Reverse Innovation a “BLUE OCEAN STRATEGY” for US & EUROPEAN MNCs to survive

Glocalization is dominant today because it has delivered in the past. The model glocalization came to prominence when opportunities in emerging markets were pretty limited—when their economies had yet to take off and their middle or low-end customer segments didn’t exist. Therefore, it made sense for multinational manufacturers to simply offer them modifications of products for developed countries. Initially, GE, like other multinationals, was satisfied with the 15% to 20% growth rates it‘s business enjoyed in developing countries, thanks to glocalization.

However in a last decade or so developing countries are growing very fast particularly in Asia region. This has made global MNC to revisit their business model and start doing Reverse Innovation which is opposite of glocalization. In glocalization products traditionally are created in rich nations and repackaged for emerging ones. But in reverse innovation products are created in developing countries and repackaged for developed economy. General Electric, Nokia, and others are involved in reversing the process.

Largely because of glocalization and reverse innovation, GE’s revenues outside the United States soared from $4.8 billion, or 19% of total revenue, in 1980, to $97 billion, or more than half of the total, in 2008.

How GE did Reverse Innovation

GE Healthcare’s primary business is high-end medical-imaging equipment. The company aimed to be number one in ultrasound. Over the next decade, GE Healthcare expanded its presence in the market. It built an R&D facility for developing new ultrasound products near its headquarters, in Milwaukee, and made acquisitions and entered into joint ventures around the world. By 2000, GE Healthcare had established solid market positions in rich countries around the world.

GE could not sell this model to developing countries like India and China. Because these countries cost of living is not very high and this high cost model ultrasound requires sophisticated hospitals however in these countries have very few sophisticated hospitals. Maximum treatment was done at local clinic or low cost hospitals. But these countries are huge market for ultrasound.

GE develops a new R& D unit from the scratch in China and recruited local people to know the requirement and cost affordability etc. It develops the compact ultrasound system that can be connected to a laptop and sold at $15 k compare to $100k of sophisticated ultrasound. Now GE has developed huge market for these ultrasound in developing countries and simultaneously it transferred the technology to US where use of this compact machine is little different as compare to developing countries. In US these machines were used in emergency room & ambulance squads. However in India & China it is used in hospitals.

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What is Sales?

These definition of sales are accumulated from top professional of different fields & industries like Marketing, IT, Finance, Banking etc.

“The concept of sale arises due to various needs of each individual. Each individual can’t posses all goods that he requires to satisfy himself. In order to satisfy his all needs a person has to forgo something in order to get something and that is called sales.

In other words we can say Sales is a medium of exchange to garner value to each other in exchange for something. In olden times it was barter system where people use to exchange goods to goods like Rice to wheat etc to satisfy each others need.

Now sales are totally currency base where one people get currency in return of goods & service. In accounting terminology it is called Revenue where currency is generated by selling goods or services.”

“Sales is just an art to convince consumer that they will get full value for their money.”

“Sales is either convincing or confusing a contact and converting him as customer.”

“Sales is a natural process of energy-Cybernetics strategy where the tension or needs of buyers are met by the sellers of the items which satisfy those need.”

“Sales is a combination of Art, Skills and science and said to be happen when both the parties comes to the mutual unique agreement on the subject.”

“Sales is the art by which one could sell the product with less effort and minimum of arguments at the willing price.”

“Sales is a process in which a commodity or asset changes over from hand to hand for a definite consideration, popularly through currency.”

“Sales may be defined as the planning, direction and control of personal selling including recruiting, selecting, equipping, assigning, routing, supervising, motivating and paying as these tasks apply to the sales force. The major objectives being:

1. Increase sales volume
2. Contribute to profit
3. Growth.”

“Sales is a holistic process required to develop, manage and execute a mutually beneficial transaction of goods or services in exchange of currency that is equivalent to beneficial value!! In short it is an exchange of goods or services for money that is equal to the aspiration and value of the purchaser. It is not just an art, it has defined pools of skills. It requires skills from the SELLER which entail product knowledge, value for money and convincing power as against BUYER skills of UNDERSTANDING need, negotiations and Value for money aspiration. It has to meet this criterion!!”

“Sales are the pinnacle activity involved in selling products or services in return for money or other compensation. It is an act of completion of a commercial activity which is completed by the seller, starts with an agreement to an appropriation or request followed by the passing of property or ownership in the item and the application and due settlement of a price, the obligation for which arises due to the seller’s requirement to pass ownership, being a price the seller is happy to part with ownership of or any claim upon the item. The purchaser, though a party to the sales does not execute the sale, only the seller does that. To be precise the sale completes prior to the payment and gives rise to the obligation of payment. If the seller completes the first two above stages (consent and passing ownership) of the sale prior to settlement of the price, the sale is still valid and gives rise to an obligation to pay.”

“Sales is culmination or fulfillment of a genuine or sometimes not so genuine need generally existing aware fully or unaware fully (as a latent potential in seed form), in an individual and is brought about (or manifested) when the factors of approach by the salesman with his convincing power or otherwise, buying capacity or affordability by the buyer and buyer’s interest etc. are matched.”

“Sales is an Art where you should be able to sell a Comb to a bald man!”

“A sale is the pinnacle activity involved in selling products or services in return for money or other compensation. Sale – an agreement (or contract) in which property is transferred from the seller (vendor) to the buyer (vendee) for a fixed price in money (paid or agreed to be paid by the buyer).”

“Classic definition is exchange of goods / services with some value derived in the exchange mechanism which could be immediate or future. This began with barter, but now are contracts where one party derives or extracts value add from special customerized goods and / or services immediately, over a period of time in exchange for a currency value which again can be negotiated and put down in contract terms and conditions.”

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Sales Persons preparation & approach while meeting C-level Executives

Before meeting with C-level executive a sales guy must get all the information about the company and its competitor. Sales person should give more emphasis on how “the company will be benefited with the product rather than just showing common benefits of the product”.

Pitch should be made according to C-LEVEL executive’s functional discipline-

A CFO of a company will be more interested in ROI, Payback Period, Cash Flow generation etc.

CEO of a company will be more interested on, how the product will provide operation efficiency, Strategic advantage to the company as compare to his competitor etc.

One the other hand CIO officer would be more inclined to know about products technical details like Life cycle of the product, Availability of updation, Functionality of product & Product usability etc.

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