February 8, 2016
Optimal efficiency is the name of the game to maximize profits in chemical manufacturing. The traditional model to load the plants and drop prices until they run at 100% is a tried method, but is it true and reliable?
Maybe, but the results are short-lived, at best, and it destroys prices across the market.
Modern companies are under increased pressure to maintain profitability and appease knowledgeable customers. Funny things happen when executives are scared of market dips or customer defections. The natural reaction is to simplify the process: volume equals revenue. Yet, once the plants are running at maximum capacity, revenue plateaus and more temporary fixes, like lay-offs, are implemented. It’s a rudimentary financial view that is outdated and no longer needs to be the default reaction.
The new path for setting prices in the chemical market is down and out.
Traditional pricing strategies relieve the manufacturer of control by relying on the raw materials supplier to set the cost. From there, it’s a vertical—or downward—analysis to set prices solely based on recovering cost. This tactic results in the one crucial mistake made by many chemical manufacturers: neglecting external factors throughout the process.
In the vertical model, reliance on cost leads to poor information throughout the value chain. With cost as the sole determiner, at each step of the refining process your company misses out on potential margin and profit improvements.
Rather than focus exclusively on the vertical, organizations must look horizontally at each step to ensure their prices are still in line with the market. Any fluctuations or changes can then be accounted for to establish a flexible pricing strategy that incorporates all factors—not just standard cost adjustments.
Extended market knowledge at each level also provides chemical manufacturers with options—sell now to save money or continue down the vertical route to the next steps. Weighing these options at each step allows for a system of validations that can be communicated internally to justify further production or cutting the process short.
In a world of improving niche specialties, looking down and then out at each step becomes instrumental in assessing the value added to your product. The challenging part is articulating the value add to employees and customers.
The combination of cost analyses with market updates sets a bar for the initial price. To take the evaluation one step further, your organization must question how the product is being used and what your customization adds.
How does the customer use the product? Is their business positively altered in any way by your customization? These types of questions help cement your product as more valuable. By knowing your customer’s needs, you ascertain their willingness to pay, thus identifying added value.
A cost-focused pricing system ignores these steps. In my experience, chemical companies that rely on cost-based pricing have simplified pricing systems that cannot handle complex approaches like the one I propose above.
When assessing customer willingness, market fluctuations, competitor pricing, and historical internal data, a stronger system becomes a profit lifeline. An organized system takes the countless influential factors and makes them manageable. More importantly, the data becomes flexible and customizable to your business.
A multifaceted system has the capability to segment your data by product, customer, or region, thus increasing the possibility of identifying the value you add. Some customers are willing to pay more because your product is so useful to them, price does not matter. Meanwhile, other customers will look for lower prices elsewhere to save money.
With this information you can assure your frontline sales teams, executive team, and shareholders that the prices being set are optimized for success on an account-by-account basis. Each price is specifically tailored to making an account profitable, regardless of volume.
When speaking with customers, you will have the pricing history at every step of the way.
Looking down and out, down and out, and so on gives a history of that product’s price level…and why. That “why” is key because customers are also looking outward and exploring the marketplace. If you can explain to them why a price went up or down and customize that message to their specific contract with your business, it establishes trust and transparency.
Finding a Better Way to Profit
At this point, I must assert that cost should not be ignored. It’s still a game-changer if market conditions fluctuate drastically. However, a complex pricing system that looks down and out gives you the data-based insights to articulate these price changes with confidence, knowing that you have the visibility into why.
Basing price on cost and volume is a never-ending chase for success. Basing price on value and all of the information at your fingertips puts you in control for long-term profits. Simply put, it’s a better way to reach your goals.