June 19, 2012
This is the final entry in a six-part series focused on exploring five of the key areas of opportunity for better pricing in the chemicals industry.
In B2B, especially in the chemical industry, deals (quotes, contracts, agreements) can be quite complex as the profitability of the deal (or lack thereof) is driven by many things, not just the price per unit of the material(s) being sold. Margin leakage and margin recovery are driven by things like costs-to-serve (e.g. freight/transportation, cost of payment terms, certificates of analysis), rebates, and even related capital investments.
To complicate things further, costs and costs-to-serve can vary depending on each combination of the plant (ship-from), the material, the customer location (ship-to), etc. All of these factors (and often others) can make understanding the profitability of a deal very difficult.
The best-practice tool for understanding these important aspects of price, costs, and margins, is the pocket-price waterfall, and it’s being used more and more by companies seeking to improve their margins.
When you’re considering what price and what charges are appropriate on a given line item, you want to know things like what rebates – if any – are going to be assessed, what are the estimated costs-to-serve like freight, and then what is the estimated profitability of this line item.
And often, you will want to consider what the waterfall looks like for the whole deal and/or customer, since you may make trade-offs of margin from one material to another. So building and using an accurate price waterfall is a crucial best-practice in modeling the profitability of customer pricing in the chemical industry.
Once you have the ability to visualize your margin capture/leakage through a waterfall, you’ll want to model different scenarios while negotiating or planning to negotiate with your customers. What would the profitability look like if I held firm on price, but gave a little ground on my freight rates (maybe I have advantageous freight costs for this lane)? What if I gave ground on this one line item/material, but held firm on this other line item? How does this deal’s waterfall compare to other deals’ waterfalls?
Being able to run scenarios with different prices, charges, rebates, costs, etc. will enable you to find the most profitable scenario you can while still winning/keeping your customers’ business.
Lastly, since the best practices mentioned above are all around an estimated waterfall… you’ll want to be able to take your actual waterfalls and compare them with the estimated. In Vendavo we call this Deal Lifecycle Analysis. As transactions/shipments occur and actual billing data, costs, etc. come in, this data is correlated back to your original deal (e.g. quote, contract, etc.) so that you can see how and why your actual margins differ: Was it because of different freight costs? Was it an order-time price override? Was the mix of materials bought different than what had been forecasted? Etc.
Finally, by linking the estimated waterfall data with the actual, you can monitor metrics like Freight Accuracy Ratio (which tracks how accurate your freight cost estimates are) and you can actually automate the tracking of win/loss status. When a certain threshold of volume is shipped off of a quote for instance, then Vendavo can automatically record that as a “win”.
So because customer quotes and contracts in the chemical industry can be complex, you need to equip your commercial teams with best-practice tools like line-item and deal-specific waterfalls, planned vs. actual metrics, etc. so they can be as informed as possible and make the best decisions then can.
What are some other best practices you’ve seen, or novel approaches to ensuring profitable contracts?
– Derrick Herbst