October 8, 2012
In a TED Talk entitled Fractals and the art of Roughness (one of his last talks before his death in 2010), Benoit Mandelbrot discusses “dealing with acts of God.” (minute 12:00 if you are in a hurry)
“These two curves are averages: Standard & Poor, the blue one; and the red one is Standard & Poor’s from which the five biggest discontinuities are taken out. Now discontinuities are a nuisance, so in many studies of prices, one puts them aside. “Well, acts of God. And you have the little nonsense which is left. Acts of God.” In this picture, five acts of God are as important as everything else. In other words, it is not acts of God that we should put aside. That is the meat, the problem. If you master these, you master price, and if you don’t master these, you can master the little noise as well”
In pricing, it is often the noise which is the critical signal. Suppose you are analyzing a segment on the traditional scatter plot, and you see a few dots way off the line. It is tempting to dismiss these as “noise,” probably due to bad data. So you sigh, and develop a routine to omit the bad data as part of a “data cleansing” algorithm.
But as noted by Mandelbrot, these outliers may be the meat, not the problem. In this example, further research may be in order to understand the fundamental cause of this “noise.” Here are some possibilities:
One customer does really pay significantly higher than the going rate for your product in certain situations. This may be because your sales team has uncovered extra value in this situation and was able to charge a premium for it. You need to research what this was, perhaps by studying the deal, or running a Value Analysis study.
The customer only appeared to pay a high price because the chart is only looking at Invoice Price, not Pocket price. In this case you should encourage analysis of Pocket Price, which might account for the difference. For example, if the customer had been participating in a distributor “ship-and-debit” program (also known as “price support”), the Invoice Price would be artificially high.
You are looking at Pocket Price, but there is some other Rebate or Credit which does not appear on the waterfall. Perhaps check with Account Receivable to see if a Credit memo has been issued: sometimes certain “special rebate” programs are under the radar.
So, rather than arbitrarily assuming that outliers are part of the problem, it is worth recognizing that they could be the true heralds of something new.