March 16, 2012
This is the second entry in a six-part series focused on exploring five of the key areas of opportunity for better pricing in the chemicals industry.
The most profitable companies treat different customers differently; customer definition of value varies, and so does willingness-to-pay for that value. Some sales people intuitively understand these variations in willingness-to-pay. The challenge, however, is turning this intuition into a repeatable and measurable policy: knowing what to quote on each opportunity.
Virtually all chemicals companies provide sales with some form of price and/or margin guidance, communicating to the Sales Team the latest understanding of current market and competitive pricing. These pricing guidelines take the form of price targets, approval levels, and floors. Most of these simple guidelines are fairly general, as opposed to being based on rigorous statistical analysis.
Guidelines may vary with dimensions like customer size and industry/market. These simple guidelines are a good starting point. There is real value in automating the application and enforcement of even simple guidelines, but even more value in improving and evolving the sophistication of pricing guidelines. In rare cases, chemical companies may have attempted to compile value based guidelines such as value-in-use analyses, for example, but these guidelines are typically very expert-driven and neither scalable nor broadly implemented.
Many chemical producers buy in to the value of pricing guidance, but have yet to create a systematic process for setting, updating and enforcing these guidelines. Emailing excel worksheets into the field is not sufficient for driving improved negotiation outcomes. Vendavo’s point of view is that every chemical needs to employ 3 stages of pricing guidance, stages of increasing sophistication. Different guideline types will be appropriate for different products and markets. Which stage is most appropriate will depend upon organizational readiness for change, data quality and availability, and pricing strategy.
The first level of guidelines is Stage 1, or Matrix-Based Guidelines. Here, the organization operationalizes existing, matrix based guidelines by automating escalation, measurement and enforcement. What good is a target or approval policy if the calculation is done by various versions of an Excel worksheet floating around the organization – and which really follows the approval process only if there is sufficient knowledge of the process (and possibly fear of discipline for non-compliance)? So in Stage 1, the actual values of the target prices are still set somewhat non-scientifically, but are implemented in a consistent, enforceable, and measurable process.
With Stage 2 guidelines, organizations move beyond simple dimensions like Customer Industry and Customer Size, and begin to define pricing guidance through the use of Pricing Segments and more statistical measures like percentiles of distribution. Your best sales people intuitively know that different customers often value the same products differently – this is often referred to as variation in willingness-to-pay. With the use of software and some advanced statistical techniques, you can identify these groups of customers and develop pricing segments (often different than marketing segments). This enables you to be more specific and accurate than the matrix-based structures in Stage 1
In Stage 3, you being to actually optimize the guidance levels rather than rely on human judgment. At Vendavo, we believe that simple elasticity-based approaches to optimization are too naïve for B2B industries like chemicals. So we’ve developed an approach that’s specific to B2B called Power and Risk™ and we’ve deployed this with our chemicals customers with great success. Pricing Power is the unrealized ability to raise prices, while Pricing Risk is the risk of what’s at stake in the pricing decision.
When you define and quantify Pricing Power and Pricing Risk for each pricing segment, you can then utilize the computing power of software to calculate the optimal targets, approval levels, and floors. This kind of advanced pricing guidance can yield huge benefits, as evidenced by case studies where different chemicals manufacturers saw returns of 4% and 6% of sales (e.g. $40M and $60M for every $1B in revenue).
Even the best pricing guidance must be accessible and defensible during the negotiation. Emailing a memo or spreadsheet to your sales team is not going to be effective. Sales needs to see the guidance automatically as they quote or negotiate, and to enhance the adoption of these new and better guidelines, it’s a best practice to provide some level of contextual analytics or insights that will support the targets, approval levels & floors.
With smarter guidance delivered through a systematic process, you can drive significant value for your organization through higher price realization – just ask some of our customers.
– Colin Carroll