Dramatically Growing Profits Through Improved Pricing

Paul Hunt, PresidentSeptember 11, 2019

2

3

4

The Business Impact of a 2% ROS Improvement

Current Future

Revenue $200M $204M

COGS $100M $100M

Gross Profit $100M $104M

Operating Expenses $84M $84M

ROS (EBITDA) $16M $20M

25% Gain

+ 2%

5

World Class Pricing Maturity

The journey to Pricing Excellence begins with gaining control over your pricing strategy and processes and establishing the foundation for value-based pricing.

ROS: Return on Sales

50%

5%

15%

30%

<1%

% of companies

6

Inseparable

7

Pricing

Value

Two Types of Value

– Economic Value

– Perceived Value

8

Economic Value Tradeoffs

– Size

– Certainty

– Speed

9

10

CUSTOMERS WANT A CHECK THEY CAN CASH

Pick One

$14,000,000EXACTLY

70% 95%

$7,000,000EXACTLY

11

12

TireCase Study

13

14

15

16

Howdy

17

Level 2 – Quick Wins

ROS: Return on Sales 18

Start at Level 2

Stop the pricing leaks!

19

$

Price Dispersion

20

Median Price

Segment & Fix Outliers

It’s not the best customers who get the best price. It’s the best negotiators.

Pricing Waterfall - Watch Your T&C’s!

Price Leakage Analysis

Invoice Price

• Price Reduction• Customer Rebate• Volume Discount • End of Year Promotion

• Programs• Allowances• Billbacks• Payment Terms

It’s not what you get that matters. It’s what you keep.

21

Pocket Price

Waterfall Elements

Customer Discounts Freight Payment Terms Returns & Samples Other

– Channel Discount– Order Level

Volume Discounts– Invoice Level

Volume Discounts– Competitive

Discounts – One Time

– Rebates– Change Order

– Freight Terms– Freight Invoicing – Expedite Carrier

Fees – Air Shipment – Selection of

Shipment Type (LTL/ FedEx/ Pickup)

– Minimum Order Size

– Fuel Surcharges

– Terms Authority & Controls

– Terms Clarity & Complexity

– Grace Period Allowances

– Unearned Discounts

– Cash/ Credit/ Debit

– Return Policy – Return Abuse– Return Validation– Return Credits – Restock Fees – Sample Policy – Sample

Management – Free Trials

– Warranty/ Guarantee

– Pre-order Support – After Sales

Support – Product

Inspections – Rush Order– Vendor Managed

Inventory– Value-added

offers

22

Case Study – Program Delivered $3.3M on $50M Business

– Implementation Considerations• Rolled out in stages to new customers followed

two months later to existing customers• Sales team provided cost calculator of standard

vs. non-standard offering• Performance tracking weighted in favor of

elements that drove the most $ impact on revenue and costs

• Set internal target of ave. $100k per Sales rep

“Our goal is to have our customers comply with our program. It not only helps us to reduce cost and eliminate waste, but also add additional revenue.”

Annual Revenue Margin Impact Goal Change Profit Gain$50,000,000 7% New Fees $3.3M

Target Waterfall Items Cost % of Revenue Margin RevenueFee for Rush Orders 14.0% 3.4% $ 1.7M

Fee For Change Orders 2.0% 0.5% $ 250K

New Freight Program 11.0% 2.8% $ 1.4M

Price Schedule New FeesFee for Rush Orders $300/OrderFee For change Orders: Order minimum quant/order of 10K

Surcharge for less than minimum $300/order Special Batches $1000/Batch

Quallity Check on Special Batches $500/batchNew Freight Program

Fuel Surcharge $50/truckNon-Standard Shipping/packaging At Cost (materials/handling)

Off Hours Shipment $500/shipmentSame Day Shipment (all) $300/shipment

Special Handling $25/orderStorage Fee Based on space/handling costs

Price and Offer Program

Charge for even small exceptions to standard offer that can drive costs

Excludes lower costs from increased efficiency

23

Level 3 – Quick Wins

ROS: Return on Sales

1. Smart Price Increases

24

2. Price Points

3. Segmentation

1. Price Increases

25

Align Price with Value

You can reduce this risk by:1. Better aligning price with value2. Assessing and understanding your pricing power

+ Price Increases

Price Increase Sensitivity Metric Lower Average Higher

Revenue % High - Low

Growth Rate Low - High

Margin % High - Low

Level of Differentiation Low - High

Price Realization Low - High

Price

Prof

it

*

**

**

A

B

C

D

E

26

OVERPRICED

OPTIMIZED

UNDERPRICED

2. Price Points

– Customers read prices from left to right

– Customers tend to round prices to accepted price thresholds– Customers tend to exhibit “zones of indifference” to prices within those thresholds

• Also known as “left digit effect”

– Research has shown similar demand levels when a product’s dollar price is just under the next acceptable threshold (e.g., increase $56 to $59, or “under $60”)

27

Price Points Cont’d

– Decimal price thresholds are often observed at “standard” intervals

28

• $X.29, $X.49, $X.79, $X.99

– Customers tend to focus on decimal prices or pennies for highly sensitive products

BU Price List

There’s plenty of opportunity

Products

Item Description 01 Item Description 02 List Price

AP UNCTD BND 316SS 1/2X82X.030 Pub B9- S3 95.11

JR CLAMP,2-1/4X5/8 S.I.D G.C.S 402.52

VALUBAND, 1/2 X 100' SS Pub B9- S3 49.22

NIPPLE, M 5/8ID 3/4 NPT CS Pub B9- S3 58.92

MINI TIE-LOK II TOOL Pub B9- S3 336.31

TIE-LOK II TOOL Pub B9- S3 336.39

BAND, 5/8X100 GCS Pub B9- S3 39.34

CABLE TIE,3/8X24SS COATED Pub B9- S3, GLOBAL STYLE 272.33

BAND-IT TIE,1/4X9 SS COATED 148.22

JR CLAMP, SID 201SS, .5X2.75 Pub B9- S3 213.47

JR CLAMP, 3 X 3/4 S.I.D 201SS Pub B9- S3 150.43

EASY L OR EASY NO. 7 Pub B9- S3 32.27

JR CLAMP 5 1/4 X 3/4 SID G.C.S Pub B9- S3 50.08

29

3. Segmentation

Pricing Solutions employs micro-segmentation as the foundation for developing effective implementable pricing strategies, to ensure similar customers pay similar prices for similar products.

30

Quad Chart

The Quad Chart is created by using revenue data:

3131

Source: Finding Hidden Profit Through Quad Analysis (Strategex, November 1, 2015)

Products80 SKUs 20 SKUs

Cust

omer

s 80 C

usto

mer

s Quad 1 64% of Total Revenue

Customers 138SKU’s 1150

Quad 2 16% of Total Revenue

Customers 132SKU’s 8600

20 C

usto

mer

s Quad 3 16% of Total Revenue

Customers 916SKU’s 780

Quad 4 4% of Total Revenue

Customers 1042SKU’s 6183

Customer and Product Counts by Quad

32

– Quad 1 to 2 # of SKUs grows by 750%

– Quad 3 to 4 # of SKUs grows by 800%

– Quad 1 to 3 # of customers grows by 690%

Source: Disguised from Client Project Work

Quad Profits Are Misaligned

33

– Business Unit not getting paid for their 20’s product complexity

– Quads 2 & 4 should have higher average margins than Quads 1 & 3

ProductsA SKUs B SKUs

Cust

omer

s A Cu

stom

ers Quad 1

64% of Total RevenueQuad 2

16% of Total Revenue

B Cu

stom

ers Quad 3

16% of Total RevenueQuad 4

4% of Total Revenue

Avg Margin 45% Avg Margin 42%

Avg Margin 39% Avg Margin 38%

ProductsA SKUs B SKUs

Cust

omer

s A Cu

stom

ers Quad 1

64% of Total Revenue

Avg Margin 45%Index 1.0

Quad 2 16% of Total Revenue

Avg Margin 42%

B Cu

stom

ers

Quad 3 16% of Total Revenue

Avg Margin 39%

Quad 4 4% of Total Revenue

Avg Margin 38%

Realigning the Quads Represents a Major Profit Opportunity!

34

– 3.7% EBITDA Improvement

Index 1.05+1.3% EBITDA

Index 1.03+1.4% EBITDA

Index 1.15

+1% EBITDA

– Price increases

– Quad 2 - 8%

– Quad 3 - 9%

– Quad 4 – 22%

– Implementation is key!

MOST SALESPEOPLE WOULD RATHER CATCH THE FLU THAN ANNOUNCE A PRICE INCREASE

35

Procurement is Getting Stronger…

Ongoing Struggle of: – Dealing with third party negotiators

– Blind RFP’s

– Reverse auctions

– Commodity pricing

– “Should” costs

– Hardball sales negotiating tactics

36

Relationship Selling is Dead

Source: Matthew Dixon and Brent Adamson (https://hbr.org/2011/09/selling-is-not-about-relatio)

37

Relationship Builders

–Develop strong personal & professional relationships

–Advocates across the customer organization

–Generous with their time

–Strive to meet every customers need

–Work hard to resolve tensions

Hard Workers

–Show up early; stay late

–Always go the extra mile

–Make more calls in an hour than anyone else

–Conduct more visits in a week than anyone else

Lone Wolves

–Deeply self confident–Rule-breaking

cowboys of the sales force

–Do things their way or not at all

Reactive Problem Solver

–Highly reliable and detail-oriented

–Focus on post-sales follow-up

–Ensure that service issues related to implementation and execution are addressed quickly and thoroughly

Challengers

–Use their deep understanding of customers’ business to push their thinking and take control of the sales conversation

–They’re not afraid to share even potentially controversial views and are assertive –with both their customers & bosses

7%4% 40%

64%

3 Types of Objections

– Fairness

– Value

– Negotiation

38

It’s Hard to Be Confident Asking for a 6% Price IncreaseWhen You Have Data Like This!

39

116

117

118

119

120

121

122

123

124

125

Nov ’15 Jan ‘16 Mar ‘16 May ‘16 July ‘16 Sept ‘16 Dec ‘16

CompanyPrices

Steel Index

The Sales Force Challenged the Customer with this Data!

40

80

85

90

95

100

105

110

115

120

125

2010 2011 2012 2013 2014 2015 2016

Steel Index

CompanyPrices

Summary

– Challenge the Customer!

41

The Journey is Worthwhile!

42

Summary

1. Get Quick Wins

43

2. Sell & price based on value

3. Challenge customers

44

80/20 Companies Are Missing a Big Opportunity in Pricing

The 80 /20 business model is not just about squeezing out the complex customers/product lines that only makeup 20% of your revenue. It is also about extracting more value out of those who make up the critical 80% with value-based pricing strategies.

A Layered and Streamlined Approach to Pricing Is there such a thing as selling too many products or having too many customers? The resounding answer is ‘yes’! Many successful industrial manufacturing companies have proven it by using the 80/20 process developed and refined at Illinois Tool Works.

80/20 is a proven methodology for reducing complexity, which decreases costs and dramatically improves profits, but there is one area that 80/20 does not do a great job of addressing and that is pricing. For this reason, pricing is a major opportunity for companies using the 80/20 process to increase revenue and price effectiveness.

First, let’s briefly review what the 80/20 process is and how it works. 80/20 is a process of sorting products and customers into two categories: those in the “80” category comprise 80 percent of the company’s revenue. Those in the “20” category include the remaining 20 percent of the company’s revenue.

Companies use transaction data to segment customers and products into two groups based on their revenue contribution.

The following chart is a nice way to organize customers and products for the 80/20 model. “A” Customers/SKUs are those that account for 80 percent of the revenue. “B” Customers/SKUs account for 20 percent of the revenue (hence the name 80/20).

Companies can place their individual customers, SKUs, and services on this chart or use hierarchies and families as an alternative.

Basic Pricing Principles of 80/20 There are a few simple pricing moves prescribed by 80/20. The most basic of them is to dramatically increase the price in quadrants three and four, which results in significant price increases for 20’s customers.

Many businesses that are using the 80/20 model are deathly afraid of raising prices for their 80’s customers. In fact, the focus is on overserving 80’s customers because that is where the least complexity and biggest growth opportunities are.

However, price increases aren’t the only pricing strategy for companies using the 80/20 process. Our team has developed a layered approach to the 80/20 model that drives

significant profit improvement. The price effectiveness improvement results seen are typically an average of two percent of earnings before interest, taxes, and amortization (EBITA) in addition to the more traditional cost savings that come from the 80/20 process.

The Layering Process and Segmentation for 80/20 Pricing Businesses using the 80/20 model have already organized clients into an 80 or 20 category based on internal data and analyses. However, further refinement by layering pricing segmentation overtop of the 80/20 model is critical to optimize outcomes and reduce pricing leaks.

By having a margin driven cross-section of customers and products, clearer picture forms of which products or customers need specific pricing actions.

From a cost and complexity perspective, the abovementioned four-quadrant chart is still an effective way to organize customers for the 80/20 model. To create a different view for pricing, we use margin and discount data, placing customers, SKUs, and services into the quads to create a new layer or view of the four-quadrant chart.

After organizing customers and products into each of the four quadrants, the next step is to focus on the first quadrant and further segment to make better, more targeted pricing strategies. To do this, a company can apply a scoring system to reveal how the current customer base or product portfolio scores within each quadrant.

Scoring refers to the product’s pricing power. Not every 80’s product in a company’s portfolio will have the same pricing power, but when you segment the products by pricing power within a quadrant you can uncover increased margin opportunities.

A useful tactic to consider at this stage is to run the 80/20 pricing analysis separating those products sold directly to customers or to OEMs from those sold through distributors. Often it also helps to separate parts from original equipment.

When a company has thousands of products and customers the potential to save money in terms of cost, and explore untapped opportunities to make more money by pricing for value is very powerful.

To identify pricing inconsistencies within each quadrant, a business must:

• Interview customers and internal stakeholders • Conduct an analysis of pricing data • Work with the company’s 80/20 stakeholders.

To better understand pricing opportunities, ask these questions:

1. What prices are quoted to customers for these products? 2. Are these customers offered an incentive program? 3. What is the value and pricing power by product and customer? 4. What is the net margin or discount alignment?

Note: Criteria that you use for scoring should ideally be in your data. For example, some of the criteria we have used for Products include revenue, growth and total price. But there can be several more depending upon your data.

Once a layered and segmented pricing approach has been successfully implemented in the first quadrant, the business can then move onto the second quadrant and refine strategies through segmentation. Then to the third and fourth quadrants.

Identify and Correct Inconsistencies Through our analysis of 80/20 businesses, we have found that customers in quadrant one often receive essentially the same discount as those in quadrant three. For one of our clients, that the difference between customers in the 80 and 20 categories was one percent. We would expect the difference to be more like 30 to 40 percent. This inconsistency meant that the company was leaving 29 to 39 percent margin on the table across all four quadrants.

Other common inconsistencies are often found around net margins and list price. A layered approach to pricing in the 80/20 model also helps businesses identify areas where their current pricing practices are faulty.

When it comes to shifting a company’s core pricing strategies, our four most common suggestions include:

1. Stop applying discounts or price increases across the board. Instead, focus on the margin each quadrant can generate. This strategy will yield the best margin on each individual product.

2. Let go of past decisions. Offering legacy products, or discounts based on volume or relationship will not increase margins. Only offer discounts where it makes sense to, based on the quadrant analysis.

3. Examine freight, shipping and distribution practices for leakages and reconsider taking pricing actions around these services.

4. Reconsider the pricing of innovative products. If you price the new product based on legacy pricing then the new product will often fail to yield a significantly better return on sales (ROS). Instead, use the 80/20 score and segmentation analysis to set pricing and capture target margins.

Correcting these pricing inconsistencies will increase margins significantly. Overall, our clients find an average of two to four percent increased profitability by overlaying a segmented pricing strategy to their traditional 80/20 strategy. An annual review of the 80/20 strategy and continuous refinement further reduces internal costs and supports strategic price increases. Importantly, investors see these price actions as sustainable and equal to creating long-term value through price effectiveness.

Train Your Team on Pricing

Pricing Solutions offers valuable support to companies looking to successfully implement this 80/20 process. Many companies have complex pricing environments and find it difficult to properly categorize products and customers into the 80/20 model, conduct accurate segmentation, or make refinements. Our experts train pricing and sales teams to not only change company culture, but also to independently conduct these analyses on an annual basis, or with our team’s support where needed.

Refining the 80/20 pricing model year after year with a layered approach provides a better return on investment and moves a firm away from legacy pricing practices or basic cost reductions to improve performance.

Looking to refine your 80/20 process? Contact our team for specialist pricing advice to maximize profits and pricing efficiency within your organization.