Understanding the value you provide to your customers is always important when you set prices, but it is even more crucial in commodity product industries.  Take this example of a European chemical manufacturer:

A large customer continued to pressure a sales rep of a chemical commodity products manufacturer for lower prices on a specific product line using “cheaper competition from Asia” as his leverage.  The manufacturer complied with many of these requests because it was a “commodity product” and the manufacturer felt they would lose the business if they did not lower prices. 

A year later, during performance reviews, it became apparent the product line was losing money, so the manufacturer decided to discontinue production.  To everyone’s surprise, once the customer was notified about this decision, the customer went into panic mode saying that their production would be impacted, as the Asian competitors could not provide the same level of product quality or JIT delivery service.  They were now willing to renegotiate the contract.  The end result was a renegotiated contract that included a 20% price increase that kept the product line alive.

In the commodity products industry, a distinction must be made between commodity product and a commodity offer.  While the product may be perceived as the commodity, the offer provides opportunity for differentiation and capitalizing on differentiation via product customization, service levels, product quality, delivery, marketing support, etc.  As evidenced by the story above, it’s essential that commodity products companies understand the value they provide to different customers and differentiate offers for each segment.

The key to optimal pricing decisions is understanding the value that you provide to your customers and then testing those findings in a real market place.  There are many analysis approaches, such as Economic Value Mapping, that intend to determine the value you provide your customers based on surveys, customer interviews, etc. The challenge with these types of approaches especially in commodity industries is that they can be difficult to implement in practice and, because they are static in nature, their results may become quickly outdated.  In most cases, the best answer to the value question lies in your data.  The right approach is to implement tools that (1) mine your data to understand the willingness to pay of different customers for your product and service offerings and (2) provide you a framework to make and evaluate your decisions in an automated fashion to support sustainable optimal pricing processes and decisions.  With pricing optimization tools, you can change the role of your pricing organization from price entry based on gut feel and sparse information to a continuous process of analyzing the business, testing new strategies, evaluating results and implementing across the board.

Regardless of where you are on your Roadmap to Pricing Excellence, whether just starting to define your future pricing processes and strategies or well on your way with processes and tools, you have to ask yourself three simple questions to judge the true effectiveness of your pricing initiatives in regards to your business:

·         How are we doing?

·         Why is this happening?

·         What should we be doing?

While these questions are simple, the answers to these questions require a Performance Management Framework in place to enable you to maximize the ample margin and revenue improvement opportunities out there.

How are we doing?

At first glance, this is the easiest question to answer.  The initial answer of most customers that I have worked with prior to our implementation would be that they have good visibility into their main business metrics such as revenues and margins.  The key here is that true visibility into “how you are doing” goes much deeper beyond the surface of traditional metrics.  It all starts with defining all the costs to serve, discounts, off-invoice rebates, only partially recovered costs such as freight in some cases and identifying the true pocket margin of every single transaction.  From there you can really focus on profitability analysis of your customers, contracts, product lines, business units and other aspects of your business.

Why is this happening?

Once you know the true performance of your business, you can start asking the “Why” question. 

·         Why has my margin declined by 5%? 

·         Why are the sales branches in the Northeast underperforming compared to others? 

·         Why did the last round of price changes not generate the expected results? 

·         Why are we losing money on this customer deal when we expected 10% margin?

Answers to these questions can be a bit more challenging and sometimes require more sophisticated tools for analysis.  The first question can be answered by tools such as a Margin Variance Mix Waterfall that explains the impact of key factors on margin such as customer acquisition and attrition, price changes, changing volume, cost changes, product mix, and even the impact of exchange rates.  Depending on specific business context, the other questions can be answered by analyzing sales rep adoption of price guidance, customer adoption of list price increases and number of exceptions, as well as tracking the expected costs and customer volume commitments at the time deal was negotiated to the actual costs and customer orders. 

What should we be doing?

The final step in defining the Performance Measurement Framework is to align the organization around your business goals and put the necessary processes in place to achieve those goals.  Here are some of the key factors that have worked best at customers that I interact with:

·         Align performance incentives with the desired behavior

·         Provide pricing envelopes driven by scientific segmentation and pricing guidance based on those segments

·         Put in an approval process that streamlines price changes and deals with desired behavior and put in a well-defined, enforceable process for exceptions

·         Monitor results and let pricers and sales know how they are being measured

·         Set up automated alerts that let you know when pricers, sales reps or branches are not compliant

In the end, the success of your pricing initiative depends on the people in the trenches that make pricing decisions every day.  It is vital to define the business objectives, strategy to achieve those objectives and then measure performance with a well defined Performance Measurement Framework.  The key is to make this information available to the pricers and sales so they can answer the three questions for themselves: ”How am I doing?”, “ Why is it so?” and  “What should I be doing?”