Blog, Pricing

Back-To-Basics: Understanding the Relative Math of Price Improvement

By David Anderson
August 18, 2020

I was meeting with a customer recently and found myself revisiting one of the original arguments for investing in pricing. It’s something most pricers are well familiar with, but as I realized in some recent discussions, I have taken for granted that newcomers to commercial improvement often don’t fully understand. As such, I wanted to really get back to basics with an illustration on the math regarding the relative benefit of 1% improvement in cost versus volume versus price in a business.

Most practitioners of commercial excellence will be familiar with some version of the below graphic. PWC, McKinsey, Deloitte, Bain, BCG, all have some version of this message.

Relative benefit for B2B EBIT for 1% price improvement (photo credit: Bain Consulting)

In my opinion, the best way to fully understand the dynamics behind these numbers is to explore some examples that break out the numbers in a few examples that illustrate how exactly improving price outperforms other efforts in driving benefits in a business. 

 

What do these examples illustrate?  Here are 5 takeaways:

  1. Cutting costs can be beneficial if it can be done without negative effects but understand from a practical standpoint that cost focus can have terminal value and bad effects if not managed properly.
  2. Growing volume has less upside than one might imagine because incremental volume brings variable cost along for the ride, so there is less margin flow-through than with cost or price improvement.
  3. Volume will not grow the margin % of your business (margin dollars/revenue dollars) even as it will grow net margin dollars.
  4. Revenue from incremental price falls directly to the bottom line and is the biggest financial lever on a % basis, improving both margin % and margin dollars to the greatest degree.
  5. Given the 2 examples, relative % improvements obviously generate more relative benefit in thin-margin businesses.

Given that price is so special as a lever, why not focus there? It is true that there is not limitless opportunity to drive price, but the reality is that there is often substantial price opportunity in almost any business. Also, businesses are often heavily invested in operational and procurement systems to keep costs low and are almost always substantially invested in sales and marketing, but not in pricing. 

The argument I make take is that it is important to understand the dynamics outlined here, and to appreciate the opportunity that price offers. Consider creating balance in your efforts to maximize revenue and margins in your own business.

If you would like help in tapping the opportunity that price offers to improve your financials, download our whitepaper that includes a pricing maturity assessment, Map Your Path for Fast Improvement and/or give the experts at Vendavo a call.

 

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    David Anderson

    David Anderson is a Boston-based Business Consultant with Vendavo. Since 2001 he has led and consulted on pricing & commercial process transformation at some of the world’s largest companies. After joining Vendavo in 2016, he has specialized on driving value & outcomes with Vendavo’s high tech, medical device, and process industry customers. Dave is a manufacturing process engineer by training (BS, MSE from Kettering, Purdue), and received his MBA from Harvard Business School.