The Virtuous Circle of Pricing

Successfully implementing a Pricing Programme to improve margins is incredibly difficult. There are lots of moving parts, which all need to be moving in harmony. If one of the moving parts isn’t turning properly the whole machine will fail. But if everything is properly tuned and working as it should, a virtuous circle can be created to drive up margins while supporting business growth.

For several years I led a Pricing Programme across several countries for a European wholesale distribution business. Overall, the programme was successful in improving the gross margin while improving sales, but along the way there were numerous setbacks and pitfalls. There are lots of things that can and do go wrong. Resolving these as soon as they arise, or better still, avoiding them in the first place, can make a huge difference to the success of the programme and the speed at which benefits are delivered.

Implementing a pricing programme effectively requires a recognition that it is in fact a comprehensive change management programme which touches every part of the business. I like to talk about a “Virtuous Circle of Pricing” model which helps the business to think about all the areas which need to be addressed to make the pricing programme work. This is represented simplistically in the diagram at the top of this article.

So what do all of these things mean?

Strategy

Let’s start with Strategy. There is no question that for a given level of sales, companies with a higher percentage return on sales have higher market valuations, more resilience in times of crisis, and more choices than those whose returns are lower. Of course, reducing the cost of sales and overheads can help enormously, but an increase in some selling prices, applied in the right way, can deliver a bigger benefit to the P&L with less pain. However, this does require acceptance from customers, and indeed from employees. To achieve this, the business needs a pricing strategy which is comprehensible to the organisation as a whole. It should be clear, simple, coherent and consistent, and set out the principles for how and where prices can be increased – or in some cases decreased – to optimise both revenue and the pricing opportunity.

The strategy should be supported by a commercial framework or matrix which defines who in the organisation will have ownership of pricing decisions, and the principles of how pricing will be determined and set for different ranges of product, and different types of customer.

As long as the strategic principles are clear and understood, the tactical execution can carry considerably more detail, supported by the businesses’ tools, data, processes and people.

Leadership

Conversion of the strategy into successful execution requires strong and effective leadership. The Board and Management need to be demonstrably clearly aligned around the strategic pricing approach. All the levels of management between the CEO and the salesperson who sets a price need to be aligned as well. Implementation of a new pricing strategy inevitably requires changes into the way that people do things, and depending on the culture of the organisation, may lead to considerable resistance. Proper training and communication are critical, ideally with support from an empowered and cross-functional Project Team with change management skills, cultural management skills and the bandwidth to make the changes to processes which are likely to be necessary.

In my experience, conversion of the pricing strategy into execution will only be effective when all levels of management are supportive of the strategic approach and able to convey their belief in the strategy to their teams.

Communication

The pricing strategy of the business can be very easily misunderstood, both internally and externally, with damage to the reputation of the business and risks of internal sabotage undermining the whole pricing initiative. Effective and regular communication is key. Thought needs to be given to how the strategy will be shared with stakeholders, and the perceptions which will be created in the minds of customers and employees as a result. In a time of increasing transparency, internal messaging never remains internal, and this needs to be reflected in the careful choice of words used in any communications.

Processes

Particularly in dispersed organisations with many small branches, the way things are done in one location can be very different from the way they are done in another location a few miles down the road. In the early part of my career, I once saw a Branch Process Manual of several hundred pages, which covered in detail every single activity that was meant to happen over the course of the day. Absolutely rigid manuals of this kind are good for holding doors open, but are rarely read, and can stifle creativity and innovation.

However, there are some core processes which do have to be absolutely consistent and follow best practice. The key is to establish which processes are critical for effective pricing, or indeed other business imperatives, and then to ensure that these are streamlined and made consistent, with input to the changes from staff who use them on a daily basis.

Training

It is very difficult to do enough training on price to ensure that everybody who has a pricing decision-making authority is able to price effectively. But it is also critical, and without enough training of the right quality, execution of the pricing process will be sub-optimal.

In a widely dispersed branch-based organisation, there are often hundreds of sales people who need to be able to set prices for non-core product sales at the moment of the transaction, and in this case they all need enough training to understand clearly what they have to do and why.

Training can take many forms. To be most effective, a combination of training tools is needed, both at the implementation stage of a new pricing programme and on an ongoing regular basis thereafter. Getting the right mix of just enough theory and more than enough practical training is also important.

Data

The old saying of “garbage in => garbage out” was never truer than when applied to data used for setting pricing. In a wholesale distribution business with hundreds of thousands of customers, tens of thousands of customers, and millions of annual transactions there is enormous potential for data to be incomplete or inaccurate. Historically, data governance has rarely been as rigorous as required for businesses to operate effectively in the digital era, with businesses continuing to use standards and processes for data capture and management which are no longer fit for purpose.

Miscarriages of data can lead to awful pricing recommendations, which in turn can undermine employee confidence in whatever price setting mechanism is being used, and lead to missed opportunities to price more appropriately and in line with the pricing strategy.

There is no quick fix for poor data. But there are some priorities as far as pricing is concerned, especially with regard to the way product master data is managed, and the way that historical transaction data is captured and stored for future reference. There are lots of businesses which specialise in data governance and management who can provide support for creating and implementing a data roadmap, and I would regard this as a vital step for most businesses who wish to be effective in their pricing.

Pricing Tools

The mechanics of setting prices for any combination of product and customer, consistent with the overall pricing strategy, will generally require some kind of pricing tool, probably with a managed commercial overlay to support tactical decision making in line with the wider pricing strategy. This can be an internal solution, but is better if provided as a third party service. There are now several very professional providers of predictive analytics and pricing science through Software as a Service, who will take time to understand the business and pricing strategy, and provide highly sophisticated price recommendations and implementation support through to solution delivery.

IT/ERP Tools

Most businesses will use an IT tool of some kind to capture and process quotations and transactions – whether it be an ERP such as SAP, or a CRM tool such as Salesforce. Generally, it would be undesirable to have salespeople switching between multiple different applications as they work. Much better to have everything in one place, with integration between different applications taking place behind the scenes. The implication of this is that prices, whether fixed or recommendations, generated by the pricing tools need to be presented to the end-user within the tool that they use for all their other activities.

The business needs to make sure that the IT integration is as seamless as possible, so that access to the price guidance presented to the end user is not a barrier to success.

Measurement

As with any change programme, measurement of the impact of the changes is important. For pricing, where some product pricing can be very elastic with sales volumes highly sensitive to price changes, this is especially important.

Measurement needs to be timely – ideally some focused kpi measurement on a daily basis, as well as more comprehensive reporting weekly and monthly. It also needs to be granular, so that changes in volumes and margins can be detected quickly at relatively small levels of aggregation of product or customer. It is easy to overwhelm people with excessive reporting, so attention needs to be given to defining, creating and honing a one page report which contains the key information that pricing decision-makers and their managers need to understand the impact of their decisions.

Third party providers of pricing solutions generally have a good range of reports available – but in my view these should be complemented by bespoke reports specific to the needs of the individual business.

Incentives

If the pricing strategy is to be delivered successfully, then salespeople's bonus schemes may need to be re-thought to ensure consistency of objectives. For example, rewarding salespeople only on absolute sales numbers, or only on gross margin dollars may not be consistent with an objective of profitable growth. Similarly, basing sales bonuses on the absolute gross margin percentage may discourage profitable sales of high volume but low margin product ranges.

There is no simple answer to the question of how to incentivise. But the principle should be that the scheme needs to be aligned with the pricing objectives of the business as well as to sales or GP values, and that whatever scheme is chosen, it should be simple and clear and supported by the measurements described above.

Feedback

Because implementing a new pricing regime in a business is complex, very often things will go wrong. It might be a process that doesn’t work, problems caused by poor data quality, lack of training, or IT issues – to name a few. Usually these problems are uncovered in the first first instance by salespeople working at the pricing coalface, and often at a moment of high pressure such as when concluding a sale. Human nature is such that people will forget the ninety-nine times that something worked well and remember the one time when it did not. So it is crucial that every single incidence of failure is tracked, remedied and reported on through easy-to-use feedback processes. There should be a simple system for a salesperson to escalate a problem, whether real or perceived. Once the cause and the fix have been identified, this should be fed back to the person who raised the problem initially to close the loop. Analysis of all the issues raised can then inform the business on work that needs to be done with systems, processes, data and training.

In more general terms, feedback from the business as a whole, and indeed from the market will then feed back into the strategy, which can be tweaked as necessary where adaptation is needed – and restart the circuit of the Virtuous Circle of Pricing.

 Summary

This is not meant to be a definitive list of all the topics which need to be addressed when implementing a pricing strategy and associated change programme. But I think it highlights the main topics that need to be thought about – many of which have nothing to do with the mechanics of setting the price. The key message is that businesses need to think holistically about the programme and manage all the topics above. Neglecting any one of them will lead to failure.

Over the coming weeks, I will be writing in more detail at each of the topics above and suggesting how they might be addressed most effectively.

Nigel Trend is a consultant specialising in helping companies to implement pricing programmes, having led successful and less successful programmes himself. He is interested in how technical and data science-driven solutions can be converted into successful execution of pricing strategies by people on the ground.