The Oracle of Omaha made some interesting comments recently when speaking to the Financial Crisis Inquiry Commission.  According to Mr. Buffett, “If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business and if you have to have a prayer session before raising the price by 10 percent, then you’ve got a terrible business.”¹

Warren Buffett’s key thesis is when you measure the quality of a company – you only need to look at their ability to raise prices and the corresponding market response.  Those companies that have built great branding or niche markets are great companies – with one impressive characteristic – the ability to raise price at will.

Are you selling only niche products with little/no competition?  Is your brand so strong, you can increase prices by 10% across the board without as much as a whimper from your customers?  If you are a B2B Manufacturer, Distributor or Service Provider then the answer is highly unlikely.  That’s because your products, customers and markets aren’t that simple, in fact, they are quite complex. 

Mr. Buffett’s comments probably hold true for some of your products.  There are certain products in your portfolio that your customer base is highly loyal too.  Other products are pure commodities.  Your markets are also complex.  You dominate the market in certain regions, while other geographies represent a challenge logistically and competitively.  In the end, your customers’ willingness-to-pay can change drastically by product, geography, industry and branding – for more information, see The Critical Variable in Pricing: Understanding Willingness-to-Pay in Business-to-Business Marketing.

Can you raise prices by 10% across the board without a prayer session?  Can you use science and fact-based analysis to make the best pricing decisions possible?  Absolutely – and that’s what good businesses do.

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¹Buffett Says Pricing Power More Important Than Good Management, A Frye and Dakin Campbell, Bloomberg, Feb 17th, 2011.

The term ”Willingness-to-Pay” (WTP) is often used by pricing professionals to discuss the spending limit of customers for products they buy.  The definition of WTP by author Christoph Breidert, a PhD in business and economics, says: 

Willingness-to-Pay is the highest price an individual is willing to accept to pay for some good or service.

Think about it. If you knew each of your customer’s precise “Willingness to Pay” (WTP) for each product, you could simply charge that price. The result would likely be a huge increase in your profit and market share…and maybe a bonus for you.

But, up to now, there’s been a problem with finding the ever-elusive willingness to pay.  Common consumer business pricing techniques typically used to determine WIP don’t apply very well in the business-to-business environment where prices are constantly negotiated.

That’s where your own B2B transaction data and pricing software technology comes in.  Because you can now use automated tools to mine your historical data and literally determine a WTP for every customer and every deal.  A lot of companies are already doing it. You can find out how in a new white paper I’ve written that explains what I’m talking about.  Download it free

I am not very good at poker. My friends say I have more “tells” than they can count. A tell in poker, is a facial expression or body position that gives away what kind of hand you have – a bad one, a good one and sometimes a really good one. The best poker players in the world don’t have a tell, but read others like an open book. Take a look at the embedded videos and watch Daniel Negreanu show off his amazing skills at reading his competitors and accurately guessing their hands – it’s downright freakish.

http://www.youtube.com/watch?v=Tbp_i8dOUvU&feature=related

http://www.youtube.com/watch?v=FhQjwdeViGk&feature=related

There is one aspect of poker I do understand well – calculating the probability of a winning hand. Without a doubt, the best poker players in the world can easily calculate the odds of winning a hand. They don’t have perfect information, but they know, right out of the gate, what their approximate chances of winning are. In Texas Hold ‘em, some cards are eventually exposed to give more information about your chances of winning and then betting continues. With each exposure, good players recalculate their odds and play accordingly. Mathematics and statistics play such a vital role in poker, you can’t even come close to competing at the highest level without it.

B2B negotiations aren’t that different from poker. The best sales people are like Daniel Negreanu in the video – they are able to read the customer. They negotiate better pricing, giving the company more profits and themselves fatter commission checks. 

But even the best negotiators don’t know the probabilities. The top sales people use their vast experience to determine pricing danger zones and winning strategies. What if you could give them, and other sales people with far less experience, a window into the probability that they will actually win the deal?  This is the heart of B2B pricing science – giving real-time analytics to sales people and negotiators to expose the pricing that wins while maximizing margin dollars. In poker, there are many different hands – straights, flushes, pairs, full-houses, etc. Depending on what you could put together, your strategy changes. In B2B, different types of customers, products and transactional environments change as well. Pricing science can tell you the “sweet spot” for every different scenario you can think of – often changing drastically (e.g. A large customer renewing a contract versus a small customer with a one-time rush order). 

Did you notice the “probability of win” in the video? That’s really powerful information. Pricing science does exactly that – it helps calculate the probability of winning a deal or contract acceptance. Our goal is to have B2B companies negotiate closer to the price that achieves the best probability of winning as well as getting the most margin dollars. This is where poker and pricing differ. Poker is about winning. Pricing is about winning and maximizing profits.

Are your sales people armed with the right analytics to help them win? Are your competitor’s sales people armed?

The other day, I had a very interesting conversation with one of our customers. They just completed a customer survey to help determine the core reasons their customers valued them as a supplier. Many items were listed – service level, relationships, ease of procurement, technology, price, market leadership, quality and much more. Price didn’t make the top 5 (according to this customer, it ranked 7th). So what does this mean? Could they charge whatever price they wanted? Probably not — it just means that product volumes change due to many other variables other than price.

To understand the price to volume relationship, let’s look at two very different extremes – captive vs. commodity. On the captive side, let’s consider a highly customized enterprise software solution. Because it’s totally customized to your company – every change, upgrade or enhancement is subject to a work order, statement of work, or new contract. High tech companies who offer customized solutions know this fact all too well. A vital component of your business is in their hands. Their pricing for follow-up on services, maintenance and upgrades can border on egregious.

On the other extreme we have pure commodities. A great example is downstream petroleum products. After initial refinement, oil companies sell unbranded gasoline on an open market. Location, availability, competitive landscape and price are the only variables that need consideration. The lower the price, the more volume – it’s just that simple. Optimized pricing is all about understanding your competitive position and desired volumes at each terminal.

Chances are, your products fall somewhere between these two extremes. You’ve got legacy products that competitors have begun to commoditize. You also have innovative products and contracts that give you pricing power. Many companies struggle to understand which products have a captive audience and those products that have very low switching costs.

Despite this daunting task, there is good news – pricing science can mine your data across all of your products to determine their price sensitivity. By factoring out key variables (economic indicators, complementary products, seasonality and more), it’s possible to uncover the true price-demand relationship. With this knowledge, you can develop value pricing strategies by product line with confidence and understand how the market will react.

B2B Manufacturers and Distributors are departing from mass price increases and embracing targeted price changes based on market sensitivities. How are you making pricing changes?

Pricing science is often an over-used term. True pricing science is the use of fundamental scientific methodologies and logic that help companies attain remarkable returns on their investment. These algorithms are cutting edge, but still rely on fundamental principles that can be traced back through history.

 

In 1906, Sir Francis Galton (widely known for his infamous eugenics research and responsible for the term “reversion to the mean”) visited a livestock fair where commoners were asked to guess the weight of an ox. There were 800 guesses at its weight – and Galton recorded each meticulously. Nobody guessed the ox’s weight correctly and many were quite off — so Galton used this fact to try and prove that commoners cannot be relied upon to make important decisions (e.g. voting in elections). Interestingly enough, the average guess was almost dead on – the ox weighed 1,198 pounds while the average was 1,197 (source: NOVA Science NOW aired on PBS).

 

Here’s the important point — each individual has a unique perspective that added to the entire group’s collective intelligence. Your sales force, pricers and negotiators aren’t that different from the crowd at the livestock show over 100 years ago. As they negotiate deals and make important pricing decisions, they bring their unique understanding of the marketplace. Each transaction adds information about what the market is doing, where it’s going, how much your brand is worth and how much people are willing to pay for your products. Hidden in your transactional data, lies the collective conscious of the market as well as the comprehensive expertise of your sales force.

 

PROS helps B2B companies around the world mine their data and capture this collective conscious. Do you have a fleet of negotiators or sales personnel with the ability to set price? If so, it may be time to mine your transactional data to truly learn what the market is telling you about the price of your products – or in the good old days, the weight of an ox.

 

John Salch recently posted a great blog about removing the boundaries of technology – allowing your sales force to use tools they are already comfortable with, yet still providing key information to make great pricing decisions. One of the most important pieces of information you can provide is knowledge about a specific customer, the product their buying and what other customers, just like this one, are willing to pay.

 

Most B2B Manufacturers and Distributors provide their sales forces with limited information. Sometimes it’s just the cost. There is almost always a hard floor (e.g. 10% margin). In more sophisticated companies there is access to the average sale price for a product across all customers. Finally, peer performance is ultimately used to benchmark one sales person to another, regardless of product or customer mix.

 

A better way to measure your sales force, as well as empower them, is to give guidance on where the price should be as it relates to similar products and customers. Some of your customers require deep discounts due to their large volumes, industry, competition and purchasing behavior. Other customers cherry-pick. Others use you as fodder to get better pricing from their preferred vendor. Sales people know this instinctively, yet management has yet to measure them appropriately on these key factors.

 

Segmentation allows companies to correctly classify different customers and the product they buy. Each unique sales situation can be correctly identified. Moreover, the historical patterns for similar customers buying similar products are used to generate pricing guidelines that make sense given the current selling environment.

 

I’ve had the privilege of seeing companies use a science based approach to classify customers, product and purchasing environments. Interviews with sales people and those that approve pricing reveal the appreciation for intelligence behind guidelines. Here are some actual quotes:

 

• “I’ve been using the target price more often than the stretch, mostly on new items not ordered previously. Nothing drastically different than normal pricing. No customer’s have called me on changes. Depending on the customer, I’m much more likely to use the tool…”

   

• “The software has some clear logic behind it. As I change the quantity and buying situation, I see very different pricing.”

   

• “I am using PROS daily and finding that I usually am increasing pricing based on Target and Stretch data. It is also a big help when I am quoting or ordering a new product because I am finding that I would usually price below target without the data so now I am not leaving money on the table. Periodically I will lower a price if it is higher than stretch for a customer. I believe the system is very valuable.”

   

• “I’ve always priced this part at 14% GP, but the floor is at 17% so I’ll definitely be increasing the price.”

In today’s market, all companies are looking for ways to protect margin and drive incremental profits – why not empower your sales force at the same time?