This is the fifth in a series of posts based on a white paper titled “The Top 8 Myths of Pricing Optimization,” which is downloadable from the PROS website.

Myth #5: Price Optimization Requires Loss Data

Companies have struggled for years, burdened by the belief they must collect sales-loss data to understand a product’s market price.  As conventional wisdom goes, to understand winning price points in the market, companies must collect and analyze both win and loss data. Otherwise, how could they possibly know the market price if they don’t know which price points turn from wins to losses?

First of all, in my ten years in the pricing space, do you know how many companies I have come across that actually have reliable sales-loss collection mechanisms? Exactly two. Want to know how they did it? Both companies had less than 500 annual transactions, and every deal was scrutinized up and down the management chain. When they won, it was clearly visible; when they lost, it was equally as visible. Both companies’ environments operated where winning each and every deal had a material impact on revenues, margins and market share. They had to know why they won or lost every deal because the continuity of their business depended upon the information.

For many high-transaction environments, it’s simply not possible to analyze this level of detail. In fact, many companies don’t even agree what constitutes a win and a loss. For instance, if they quote a deal and the customer accepts their pricing but they’re the secondary supplier, does that constitute a win? If they quote a deal and the customer never makes a decision, is that a loss? Will the sales organization take the time to enter this information when it provides no value to them?

The truth is you don’t need loss information to determine market pricing.  Let me give you an example. When my wife and I purchased our current house, and we were considering an offer to the seller, how did we determine a “good” offer? We had our real estate agent compile all housing sales data in our new neighborhood for the last six months, focusing on houses of like-quality and lots of similar size. Using this data, we calculated the range and average price per-square-foot to gauge the prices likely to result in an accepted offer. As you would expect, the seller’s offer price was at the high end of the price per-square-foot range, and we made an offer at the lower end. After some back and forth – which was during the time of the mortgage crisis – we negotiated an offer much closer to the low end of the range, versus the high.

Using just “win” data from recent home sales, we developed the “pricing envelope” – the range of prices per-square-foot — based on the “market segmentation” – the neighborhood, building quality and lot size. At the low end of the price per square foot, we had a lower probability of closing on the house; at the high end, a higher probability. We had “optimized” our offer price based solely on “win” data.

All companies have this “win” data today – it’s their transaction history. To apply the principles, they must segment and calculate the market range of winning prices. Using this data gives salespeople guidance as to their probability of winning a bid at a quoted price point. Based on their confidence level – are they in a strong or weak negotiating position – they can quote a price that either has a strong probability of winning, or a higher-priced, lower-probability quote that leverages their strong negotiating position?

What would it mean to your business if you were calculating these today?

Patrick

Myth #4: Can I Really Understand Customer-Specific Willingness to Pay?

For years, sales leaders and pricing professionals have sought to understand exactly what a customer would be willing to pay for the products they sell. If a company understood customer willingness-to-pay before the negotiation, they could develop strategies to realize that price during the negotiation. In the absence of good willingness-to-pay information, salespeople have relied on their experience and selling skills to draw out that information during the sales process. Pricers have used historical data and value-based pricing methodologies to understand how a customer values their products. Companies like LeveragePoint have done a great job putting tools into the hands of many companies that help drive that value-based pricing.

At the Professional Pricing Society conference last year, one of the keynote speakers spoke of targeting pricing to market segments versus their previous one-size-fits-all pricing. He spoke of his company’s great returns as a result of their work. Finally, the speaker envisioned a future where not only customer segments but also each individual customer could be optimized based on their individual willingness-to-pay. In that speaker’s opinion, that was the future of pricing technology.

The future is here.

The principles of customer-specific segmentation – mapping customers based on their likeness in valuing your products – were covered in this blog post. And understanding where pricing is tomorrow, not just today, is as well. Once you’ve implemented the principles of customer-centric segmentation and market-based pricing forecasting, the final step in pricing optimization is to understand how individual customers in each segment value your product versus the market price. Take, for example, a customer, bucketed with its peer group during segmentation, who pays more than its peers by an average of 6%. Armed with that intelligence during the next negotiations, where would you price them? Certainly not at the market average. You’d be giving away value. Why not price them at a 6% premium? It seems pretty clear, doesn’t it? But why doesn’t everyone do it?

Complexity.

It takes a lot of time and effort, and for most large organizations it’s impossible without the technology to understand each customer’s segment, purchasing patterns and anticipated willingness to pay. In fact, understanding a customer’s specific willingness-to-pay versus its peers is a relatively simple exercise. It’s just one for which many companies don’t have the tools to use on a regular basis.

Ask yourself this question: If I had the tools to mine my company’s data, to segment along customer buying patterns, anticipate market-based pricing and then optimize based on a customer’s willingness to pay, how much would it be worth to me? Or more importantly, how much are you losing by not doing it?

Patrick

Pricing Tactics & Strategies Through Distribution

If your company sells through distribution, you’re well aware of the common challenges and issues. You’re likely to experience continual price pressures, a lack of understanding about how to sell the value of your company’s products or services, and demands for lucrative volume-discount programs. As a result, it can be daunting to keep price discounting in check, while trying to persuade distributors to sell the value of your product. To more effectively manage these challenges, there are several factors that should be taken into consideration, including distributor performance, negotiations and alternative pricing techniques.

Distributor Performance

First off, you’ll need to price well to motivate distributors to sell your products or services. You’ll also need to keep in mind that it’s important to adhere to your company’s pricing objectives: Is the goal to increase market-share or profitability? Whatever the objective, in pricing to distributors, you’ll want to allow them room to make a profit, which requires looking at a host of pricing factors. One area that should be considered in your analysis is the distributor’s performance. For example, carefully review two important factors:

• The product mix your distributors are selling and if it’s the right one.
• The distributor’s incentive programs, which may be too rich and disproportionately reward more low-value vs. high-value product sales.

Distributor Negotiations

The overall relationship between your company and its distributors is key, and can be a challenge depending on the distributor. As with any business relationship, some will use hard negotiating tactics to get what they want, while others may make unreasonable demands for deep discounts or allowances. It’s important to determine if they’re concerned about your business and whether they understand the value of your products, both of which will alleviate some of the challenges.

Working with distributors is a team-effort for the pricing group and the sales force, which is usually at the forefront of these encounters.

To work together effectively, you’ll need to understand the distributor’s challenges and issues, and also the negotiating tactics they may exhibit to obtain the best pricing. For example, a distributor may impose unreasonable timetables, claiming they need an immediate price and threatening to take business elsewhere if they don’t get it. They may also demand lower prices or claim your company’s pricing practices lack flexibility. To manage these common types of negotiations, it’s important to determine the following:

• Get to know your distributors well and make an effort to better understand the distributor’s challenges, issues and concerns.
• Determine if the distributor is generating significant and profitable sales revenue for your company, and whether the company is loyal and a true ally or simply an impediment to your business. These factors will determine the value of a long-term relationship.

Pricing Techniques

While the onus rests primarily with the sales force to develop and maintain a good working relationship with distributors, it’s also important that the pricing group be able to implement strategic pricing tactics. Distributors don’t typically pay list price; however, it’s important to control price discounting as the pricing waterfall chart below shows.

The chart illustrates the difference between list price and pocket-price and the result of a significant reduction to bottom-line profit. It’s important to understand this concept to help manage these discounts effectively.  (Concepts developed by McKinsey & Co.)

Pricing Waterfall

Educating the sales force about the price waterfall concept is an important factor in helping them more effectively manage discounts they offer. It can also encourage more thoughtful judgment as to how sales decisions will affect the company’s profitability.

Companies can attempt to minimize these revenue leaks by following these tips:

• Leverage your company’s advantage. If you’re the incumbent supplier, capitalize on that factor by selling or reminding distributors of your company’s excellent customer service and/or inventory supply. Offer additional value-added services, such as priority scheduling and delivery — but at a premium!

• Discount only on incremental sales volume. Entertain earned rather than negotiated discounts.

• Obtain something in return for price concessions. For instance, reward a change in distributor negotiations by offering discounts for using EDI or telephone service support, which reduces or eliminates on-site sales visits. You can also modify payment terms if the distributor continually asks for price reductions, particularly if you’re experiencing lengthy payment times.

Summary

These are some pricing tactics and strategies you can consider when pricing through distributors. Remember they’re in business to make a profit, just as you are. That said, it doesn’t mean you have to give your product away at sub-optimal prices. In working with distributors, develop an effective relationship.

Your pricing team should take the time to truly understand your distribution channels. Consider having them join your company’s sales force on account calls to understand the distributor’s challenges, issues and concerns. Ensure your sales team has a good understanding of your products and pricing tactics, and remember to:

• Control your discounting.
• Obtain something in return for price concessions.
• Leverage your company’s advantage.
• Evaluate every distributor’s performance.

In the end, everyone’s a winner, which ultimately makes for the best relationships.

Thanks,

Peter

Chris Jones is the Chief Sales Officer at PROS, a world leader in B2B pricing and revenue management software. He has led high-performance sales organizations for nearly 20 years and consistently outperforms his peers in the markets where he competes.

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In my work, I frequently meet with sales executives as part of the decision team for our products and services. In nine of my last ten meetings with VPs of sales, I’ve seen a recurring trend, based on a single concern:  declining average selling prices. There are accompanying themes that support this trend that I also hear from these executives:  Procurement is becoming far more carnivorous; more projects are competing for fewer capital dollars; and unnatural competitive tactics are becoming the new norm.

And then we see headlines like this:  Q1 Executive Guidance by Sales Leadership Roundtable CEO Tom Monahan:  How do you sell more when customers won’t pay more?

I have my own perspectives on selling, and I’m offering a three-step, get-well-plan to stem the tide, and grow your revenue and average selling price:

1.  Align compensation with discount performance – A sales VP at a medium- sized software company rolled out a compensation plan that tied commission accelerators to better discounting. Specifically, he set thresholds for both expert discounts and target discounts. The expert discount threshold was based on the prices at which the most expert sales reps were able to consistently sell the company’s solution. Who doesn’t want to be considered an expert? Tied to those thresholds were 30% and 15% base-commission accelerators. This simple adjustment – to what had previously been a pure revenue-based compensation plan – led to much tighter discounting around those targets and a 6% improvement in discounting in one year!

2. Execute your vision – Do you know if your sales team is getting the value they deserve on every transaction? A sales VP at a multibillion dollar distribution company developed a vision to grow market share more profitably. As part of his execution plan, he rolled out a new dynamic pricing system and contest called the Peer Pricing Challenge to drive adoption of his new guided-selling capabilities. He measured two components:

• Peer Price Attainment – the percent of products equal to or above the Target Peer Price
• Peer Price Improvement – the percent Peer Price Opportunity improved

The top performers in this quarterly contest were awarded their choice of cash or a two-year lease on a hot sports car. There is magic in stack-ranking competitive sales people! The early progress is far exceeding expectations.

3.  Equip your reps – Are you sending your reps into a gunfight with a pocket knife? How are your margins and prices compared with your primary competitors? The highest performing companies now equip their reps with these table-stakes capabilities:

• Price guidelines at their fingertips, based on the statistically derived analysis of other customers with the same buying patterns
• Compliments and substitutes at the time of quote
• Automated alerts when a customer’s buying patterns change
• The last price paid by that customer and its associated peer group

Gartner says these types of capabilities will lead, on average, to a 2-3% revenue lift. How do you expect your reps to compete and win at the best price without these?

Last week I spoke with a sales VP who equipped his sales force with these capabilities. He shared a conversation he had with one of his reps at a sales kickoff that underscores my point: “I increased my production by over $100,000 in 2011, which was a personal best and my best income year ever. Thank you!”

Yes, you can get customers to pay more for the value you deliver, and don’t let anyone tell you otherwise. The best performing sales VPs are doing it.

Take control of your average selling price by aligning compensation with discount performance; execute against your vision; and better equip your sales reps with the proper tools.

If you’ve got questions, drop me a line here at this blog. I’m happy to tell you more.

Thanks, Chris

Whether destined for emerging markets or developed markets, firms make similar mistakes when designing and pricing social innovations. First of all, they miss opportunities to respond to customer needs by over-engineering their offerings or making them too complex. Secondly, they over-price these offerings, thinking that customers will be willing to pay for “green” or sustainable products or for products that serve social needs in developing or under-developed markets. In other words, they over-design or over-price their products or services.

Sustainability has received a lot of attention in recent years. Recent concepts of sustainable value for social innovation have been explored and introduced by experts such Cooperider, Ross Kanter, Laszlo or even Peter Drucker. They characterize sustainable offerings as designed around user needs, right-engineered for the sophistication of local markets, widely accessible to the target markets, simple in nature and presenting little trade-off with respect to quality. In other words, products and services that fall in the social innovation sphere, carefully crafted to local markets and subject to advanced, needs-based segmentation approaches. Johnson & Johnson, for example, has been very successful at entering the larger Indian hygiene market by designing simple and basic products that respond to the needs of a large market, and priced based on local willingness-to-pay.

Many companies have entered emerging and developing markets by adopting a local-local strategy: local products designed for local customers. They have embraced the fundamentals of the value-based pricing methodology: careful market segmentations, assessment of willingness-to-pay for value drivers, pricing based on this willingness-to-pay, and communication to the market of the sustainable value messages. Value-based pricing in that case does not mean high or premium prices. It means pricing sustainable and social innovations based on the local customers’ willingness-to-pay. Many companies complain they cannot get additional premiums in emerging markets for their “green” or sustainable technologies. They are looking at this the wrong way. By over-designing their offering or miscalculating willingness-to-pay, they over-price innovations and miss their market target.

Laszlo and Zhexembayeva define embedded sustainability as follows:

“Embedded Sustainability is the incorporation of environmental, health and social value into the company’s core business with no trade off in price or quality. The goal is not green or social responsibility for its own sake. It is meeting new market expectations in ways that strengthen the company’s current strategy or help it develop a better one.”

Yes, ladies and gentlemen, that means using the fundamentals of value-based pricing for emerging markets and for environmental offerings. Cell phone companies do it successfully on the African continent. GE and Interface have transformed their business models around sustainability and eco-imagination. Other Fortune 500 companies are extremely successful in the BRIC (Brazil, Russia, India, China) countries. The challenge resides in two critical elements of the innovation process: 1) right-engineering performance based on user needs; 2) pricing based on customer willingness-to-pay.

Be bold! Join the value-based pricing revolution!

Stephan Liozu

Today, we’re seeing a trend toward transparency surrounding pricing actions and strategies, where a broader range of groups are collaborating to make business decisions.  It’s clearly the case with pricing as these organizations – from marketing, sales, finance and pricing teams – align across the enterprise.

One of the critical operations missing in this collaboration is the rebate team, which typically operates as a separate unit.  Rebates are central to profitability and impact many groups in a company. With the advent of pricing software, our customers expressed a desire to align marketing, pricing, sales and rebate teams to create far greater transparency and increased communication to drive better business decisions.

It’s why I’m excited to write today about an innovative new product we’ve just announced. PROS Rebate Optimizer™ is the fourth solution in our PROS Pricing Solution Suite. Our customers expressed the need to add this important profitability lever to their PROS solution, and we took action. Through our user- centric product development process, we incorporated customer feedback to bring this product to market. Today’s announcement is a first step in adding more social collaboration centered on the decisions and levers that affect profitability.

With our new product, sales teams are better armed with enriched sales intelligence – and equipped with rebate information in advance of negotiations – which helps them win business more profitability.  This collaboration will drive better business decisions and enable companies to drive profitability. This is a monumental step forward for our customers and allows far greater interaction between pricing, sales and marketing.

At PROS, innovation is a strategic enabler for our company and one of our greatest strengths. Throughout our 26-year history, innovation has been at the heart of our business, evidenced by the fact we spend 25% of our revenue on R&D. This philosophy underscores the importance we place on helping our customers stay ahead of new business advances that enable them to compete more effectively.

One of the sources for PROS innovation comes from the close relationships we forge with customers. Working side-by-side with them in the field, we listen carefully and consider their requests for additions to our products and services. That’s the genesis for Rebate Optimizer, which offers a cohesive view of rebate profitability across the organization.

I encourage you to take a look at Rebate Optimizer and find out how it can enable your company to collaborate and win business more profitably.

Oscar

I recently reviewed a question posed on a LinkedIn pricing group regarding pricing in a service-related industry. The writer wanted to know how to “beat the commodity spiral” when pricing for B2B services industries. One of the first responders addressed the concept of understanding the key attributes of a company’s service to its customers and then how to monetize the services. He also pointed out the importance of understanding the competitive environment in which a company operates, and the strategies the company is willing to pursue to achieve its goals.

I picked up on those themes and provided some specific tactical suggestions on how to beat the spiral. In my closing, I referenced an article that I have found particularly helpful since my days as a brand manager. At that time, I was responsible for launching new products, from identifying the opportunity to delivering on the bottom line. The article provides a how-to approach for differentiating low-differentiated products and achieving a price premium. A couple of people picked up on the article and I wanted to share it and also offer a few insights.

It’s interesting to note that the article I reference – titled “How to Brand Sand” – created a healthy discussion since it was published by Strategy & Business Magazine in 1998. Given the time that’s passed, there were questions about its relevance. On that front, my response is a definite yes; it’s clearly relevant and far more easily put into practice with the advent of pricing software, the availability of data and the lower cost of IT infrastructure.

The concepts surround segmentation, customers’ willingness to pay, differentiation, bundling and aligning business capabilities are still every bit relevant today. In fact, companies that pursue this approach to marketing low-differentiated products can now be far more effective in 2012 than they were in 1998, when much of the heavy lifting and monitoring of strategies would have been done by boutique management consulting firms.

We have seen a number of approaches taken by B2B services companies that help them outperform the market and avoid the commodity spiral. While perhaps more tactical, these companies operate within the same strategic parameters. Beyond understanding the value of a company’s services versus its competition, B2B companies should also ask the following questions to avoid attempts that commoditize their services:

1. What effort have you made to communicate the value differentiators of your service or brand?
2. Do the marketing and sales people responsible for price negotiations plainly understand the value, and can they confidently negotiate price with their customers and prospects?
3. Have you performed a rigorous customer segmentation to determine their willingness to pay for your services?
4. Is there is a true market need or does it make sense to create a lower-value, lower-priced service or brand offering to take advantage of the opportunity without tremendously impacting your existing service?
5. Which service offerings can your organization bundle to maintain or increase price?
6. Conversely, are you contributing to the commodity spiral by bundling valuable added services – which may be differentiators in your offering – without extracting a premium?
7. As an organization, do you truly understand the cost to serve your customers so you can make informed decisions around price?
8. Is the price of a commodity input a significant cost of your service? If so, have you considered a specific surcharge, rather than a price increase, to pass along the cost increases?
9. Do you have the tools and infrastructure to closely monitor the trends in costs, pricing and the competitive environment that impact your profitability?

The principles of customer segmentation and value differentiation in commodity-goods markets are well explained here. Examples of customers that have been able to put these principles into practice and answer the questions posed are available here. The common themes for those B2B companies that have been able to execute and are profiled in the article offer a vision of the benefits, from improved pricing and putting the people, processes and infrastructure in place to execute on that vision.

I encourage you to take a look at the “How to Brand Sand” at this link. What do you think? I welcome your comments.

Thanks,

Ralph

We recently conducted a webinar in conjunction with the Professional Pricing Society where we discussed the 8 Myths of Pricing Optimization. The webinar was so popular and highly rated that we decided to expand upon it in eight blog posts over the coming weeks.

If you missed the first or second blog posts on this topic, we offer the links for your convenience.

Myth #3:  Why Historical Data is Required – But Not Sufficient – for Pricing Optimization

One common question we often get pertains to whether historical data is good enough for pricing optimization. Customers ask how they can optimize the price that wins in the market tomorrow if they look only at historical data that won yesterday.

Good question.

There are entire industries that have built pricing models around the fact that they will NEVER get a better price tomorrow than they did today. The high-tech and medical device industries are two. Price erosion is a fact of life in these industries, as new and better technology cannibalizes legacy products. What can price optimization do for them?

If the ONLY thing you do is look at historical pricing, then you’d certainly be in trouble in many circumstances. But pricing optimization should focus on where prices are going – or price forecasting – versus price history. By analyzing trends in historical data, weighting more recent transactions more heavily than those that took place a quarter or six months ago, will help you understand where the market price will be tomorrow, not where it was yesterday. Historical pricing information can provide insights based not only on historical averages, but also on an analysis of trends and rates of change, which provides a more accurate picture of where prices are going.

Take, for example, a new server that was thought to be an evolutionary – not revolutionary – improvement upon the previous generation. That new server, however, provides its users with unique benefits in the marketplace, and may not follow historical pricing patterns. If historical pricing analysis shows that pricing has been held longer than previous generations of the product, the price forecasting capabilities will decelerate the rate of decline of pricing in the market place. Ultimately, that can mean millions of dollars of “found money” based on recovering lost-opportunity revenue.

Any pricing technology that claims to do pricing optimization must have a foundation in price forecasting. If not, your pricing is destined to move backward.

Thanks,

Patrick

We often hear from customers that one of their concerns is increased price transparency. It certainly is troubling when a company’s pricing isn’t completely defensible: The lower the defensibility, the greater the fear of price transparency. Most transparency risks are local, though in some cases it can be regional. As a result, the transparency damage can be minimized. For widespread price transparency to occur, there has to be a catalyst. For medical-device manufacturers, the impact of exposing indefensible pricing at a national level can lead to a devastating impact on ASPs and margins.

The catalyst for full-blown transparency appears to exist for the medical device industry. Last month, the Government Accountability Organization (GAO) released a report titled “Lack of Price Transparency May Hamper Hospitals’ Ability to Be Prudent Purchasers of Implantable Medical Devices.” Senator Max Baucus (D-Montana) picked up on the report and is now calling for increased transparency to bring costs in line and minimize the wide pricing spread hospitals pay for the same device around the country.  If these companies weren’t concerned about the far-reaching effects of transparency before, they should be now.

Pricing leaders in the medical device industry know there are many factors that drive ASP differentials. Among these are teaching vs. non-teaching hospitals; revenue or share commitments; and rebates. Whether or not this report and Senator Baucus’ comments lead to real action is yet to be known. Medical device manufacturers should be prepared, however, for the possibility. This means ensuring they don’t repeat the past by adding more skeletons to their pricing closets. These companies need to consider putting their organizations in a position to defend all pricing decisions, in the event the Federal Government comes knocking on their doors and asking for all contracts. In other words, are they confident their organizations could pass the “red face test” or would they need to do some creative explaining?

PROS is here to help the medical device industry build a framework of price defensibility. With thousands of pricing decisions made every week, these organizations need peace of mind knowing that all of their pricing follows a consistent model, and exceptions are managed with a systematic methodology. Ultimately these companies will position themselves to pass the “red face test” and not dread the day the federal government requests copies of all pricing and contracts.

Phil Holladay

We recently conducted a webinar in conjunction with the Professional Pricing Society where we discussed the 8 Myths of Pricing Optimization.  The webinar was so popular and highly rated that we decided to expand upon it in eight blog posts over the coming weeks.

If you missed the first blog post on this topic, we offer the link for your convenience.

Based on Myth #2: Rules or Policy-Based Optimization is Not Really Optimization

Every company operates with “rules of thumb” for customer pricing. For example, a healthcare distribution company may know that plastic surgeons are generally less price sensitive than general practitioners. Or a delivery service may know that legal offices are more price-sensitive when they send letters – which they do a lot – versus sending large packages. In the pricing community, the most generic version of this rule of thumb is that changing pricing for larger customers is more risky than smaller customers since they have more negotiating power. While all of these rules-of-thumb seem intuitive and, in general may even have some basis in truth, they fail to recognize the individual customer differences.

Let’s say I’m a large industrial manufacturer that produces rivets for a number of industries.  My rivets are used in many applications, and I have customers large and small. Conventional wisdom tells me that the larger the customer the more I should discount my products.

But take an example of a smaller company that uses my rivets in its machines that produce a single, commoditized product. To drive down costs, its procurement department makes sure to price-shop each and every purchase. I am constantly price-shopped, and since my rivet is a commodity itself, I can never get more than a 5% margin. Contrast that with a large, multi-national company that I supply machines and hundreds of parts to on an annual basis.  The rivets are a critical part of their operations, but represent a small purchase that’s never scrutinized when it’s time for re-ordering.

Which one sounds like the more price-sensitive customer to you?

If I used conventional wisdom, I’d bucket the larger customer into a group that receives a lower price or a lower-price increase.  How does that make sense?  This rules-based methodology, also known as heuristics, is often misnamed as pricing optimization by a cadre of consultants and technology providers who have no idea how to help you – other than automating your existing process.

If you just automate and speed sub-optimal pricing in your business, what happens when your competition uses true customer-centric optimization against you in the marketplace?  Better get your resume ready.

So exactly how do you optimize, based on an individual company’s willingness to pay?  Stay tuned for the answer in Part Six of this series.

Patrick