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36 | Fall 2012 | A Middle East Point of View

The price pricing eff

As companies seek ways to increase profit marginsand improve overall business performance, businessleaders are increasingly turning to pricing as adiscipline that can boost their bottom lines. Asearch of publicly available data reveals a significantnumber of blue-chip companies that acknowledgepricing improvement as a part of their earningssuccess.1, 2 Yet many seem to make little progress indriving the kind of consistent pricing disciplinethat yields the results they need.

is the view worth the

of fectiveness:

A Middle East Point of View | Fall 2012 | 37

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e climb?


This dichotomy in the corporate world suggests severalquestions:• What is the value of investing in pricing improvement?Is there a difference, attributable to pricingcapabilities, between companies that expendsignificant effort to address pricing and those that donot?

• What does it mean to be good at pricing? Can’t wejust raise our prices and see if our sales force canmake them stick?

• What are the risks of embracing and investing inpricing improvement and how can these be managed?

These are important questions in the face of manycompeting priorities and a challenging economicenvironment. However, a broad study of companyperformance and pricing reveals that, regardless ofindustry, geography or size, companies with effectivepricing capabilities significantly outperformed industrypeers across multiple financial metrics, including netmargin, market valuation, return on assets and return onequity. This suggests a correlation worth exploring.Intriguingly, even the diverse population of companiesstudied has identifiable commonalities in the capabilitiesthey have built. These commonalities, as well asidentifiable strategies and the risks the companies facedin building pricing capabilities, are worth a closer look.

Pricing and performanceGreat companies do pricing very well. Whether thesecompanies simply have more sophisticated pricingcapabilities, or pricing prowess has bolstered theirperformance, the link between pricing and profitabilityrecurs both anecdotally and in more detailed analysis.One study suggests that pricing has two to four timesthe potential to influence profitability relative to otherbusiness levers. Companies that actively pursue pricingas an important part of their strategy typicallyoutperform industry peers on several financial metrics.Even companies that may not have achieved fullmaturity in their pricing capabilities but have placed agreater degree of importance on pricing than their peersand are actively pursuing pricing improvement benefitsignificantly (see figure 1).

These are important questions in theface of many competing priorities and a challenging economic environment

Comparison of key financial metrics for an average company vs. companies that are pursuing pricing programs

Note: The metrics are indexed on base 100 for relative comparison

115

111

122 116

109 101

117

123

70 89 90 100 110 120 130

Average netprofit margin

Average marketcap/Net income

Average returnon equity

Average retturnon assets

Average company

Companies that actively pursue pricing programs

Companies with effective pricing programs

Source | Pricing Effectiveness Benchmark Study, Deloitte LLP, Deloitte

Analysis


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In general, then, it’s not a stretch to say that pricing isan area worthy of focus – and likely worthy ofdeveloping beyond the table-stakes level. When manyexecutives think of improving pricing, they envisionbeing able to set more market-relevant prices for theirproducts to drive greater volumes at higher prices,thereby increasing revenue. While price setting is anessential piece of the pricing puzzle, the overalldiscipline of effective price management concerns itselfwith managing transaction-level profitability, whichrequires capabilities in pricing strategy, execution,analytics and governance. The discipline also requirescoordination across many functions including sales,marketing, finance, product development and customerservice.

The complexity associated with this coordination isdaunting, but there are a number of commonalitiesassociated with enhanced performance in pricing. Acloser look at high-performing companies suggestssome useful points of consistency.

Clearly defined ownership and roles within thepricing processCompanies that exhibit effective pricing are 30 percentmore likely to exhibit clearly defined ownership andaccountability within the pricing process.3 They alsohave pricing job roles that are clearly documented,including an executive owner who is accountable forresults. Often, they have dedicated pricing organizationsthat help govern the process.4 Regardless of thestructure, though, leading companies included in ouranalysis have consistent accountability for pricingcontrol and transaction profitability embedded in theirorganizations.

Without clearly defined roles, a company’saccountability for pricing is limited to functionalreporting lines. This root issue can manifest itself in anumber of ways.

For one large publishing company, the pricing processwas so fragmented that accountability was quite simplyabsent. While sales was responsible for the customerinterface and primary negotiations, an accountmanagement team was responsible for packagingadvertising opportunities, and finance set the rate cardand pricing guidance. These roles may appear welldefined but, upon closer review, no stakeholder wasultimately responsible for pricing and profitability at thetransaction level. Even if the initial package proposalmet all required pricing hurdles, sales was the solearbiter of final pricing – and sales was measured onpure revenue, not profitability. The details of why salesassigned a price – perhaps due to value of inventory,customer segment or cost-to-serve for the proposal –were not transparent, so the set price often disappearedin the course of negotiation. Essentially, each functionwas attempting to optimize its own performanceaccording to its local measures, which did not align withcorporate needs.

Great companies do pricing very well.Whether these companies simply havemore sophisticated pricing capabilities,or pricing prowess has bolstered theirperformance, the link between pricingand profitability recurs bothanecdotally and in more detailedanalysis


Understanding customer cost-to-serve and usingthese costs to manage profitabilityCompanies that are pricing leaders are 26 percent betterat managing true profitability.5 They have an advancedunderstanding of customer and product portfolios, andefforts are directed toward growing profitable productand customer combinations. They have a fullunderstanding of channel costs based on promotionaland distribution activities. Sales personnel can use cost-to-serve in negotiations and use forward-lookinganalyses to drive decision-making. A large consumergoods organization serves as an example. Historically,the company measured its sales force on production ofgross margin dollars. Leaders felt this provided a goodbalance of measuring revenue and pricing, which shouldcorrelate to profits. However, the company managed itstrade spending at a local level with little governance.This essentially gave the sales force carte blanche toinvest at will to ensure that it maintained and grew salesvolume – a situation that resulted in wildly varyingreturns on the trade spend dollars. As a result of agrowing disparity between gross margin growth and netprofit growth, the company invested in reporting andtools that created a new level of visibility formanagement and for the sales force. This reporting

provided visibility into the effect of trade spending onthe profitability of each salesperson’s book of business.With this new system and by simply redefiningprofitability targets instead of implementing draconiancontrol measures, the company saw an 88 percentimprovement in quarter-over-quarter profitability withina year.

Companies that underutilize pricing as a driver ofprofitability tend to have a limited understanding ofproduct profitability beyond gross margin. Similarly,they have limited visibility into the costs associated witheach distribution channel and no real understanding ofcustomer service costs beyond gross selling andadministrative costs. This lack of information handicapsdecision-making on deal management and approval. Italso hinders development of quality revenue metrics forthe sales force.

Segmenting customers based on needs andbuying behaviorCompanies with leading pricing practices are more likelyto use segmentation techniques to fine-tune pricing.They have a full understanding of what customers valueand why and include customer needs and requirementsin product development decisions. They differentiatetheir marketing to appeal to particular dimensions ofcompetition in each segment and they use clearlydefined channel strategies that are largely driven bydifferences in cost-to-serve. Customer lifetime value isused effectively when making customer portfolio andrelationship decisions and is input for decisionsregarding segments to target or drop.

For example, a leading medical device company recentlyused conjoint analysis to differentiate customers by theirwillingness to pay for its service plan offerings. Thefindings from the study helped the company define

Companies that underutilize pricingas a driver of profitability tend to havea limited understanding of productprofitability beyond gross margin


which services to include in silver, gold and platinumservice plans. As a result, the company now specificallytargets its service value proposition to customersegments based on their relative preference for featuressuch as parts cost coverage, labor cost coverage,response time and uptime guarantee.

Companies with less sophisticated pricing capabilitiestend to rely on different internal assumptions: they trackcustomer needs for product development but followonly sales volume for segmentation. They oftenexperience significant leakage of customers betweenchannels and have no real understanding or use of cost-to-serve information to drive channel separation. Theydon’t understand customer value well, and they basemetrics largely on unit or dollar volume, not profitability.These segmentation “shortcuts” hinder effective pricediscrimination and, thus, profit realization.

At a global chemicals manufacturer, the marketingdepartment employed a customer segmentation schemecomprising four segments: small, medium, large andnational accounts. The customers were categorizedbased on their annual purchase volume alone and theyreceived discounts commensurate with their segment.The large and national accounts received virtually all ofthe sales force’s attention because they were thecompany’s “best” customers. When overall companyperformance started to stagnate, it decided to take acloser look at customer profitability. It discovered that itsbiggest customers were actually its least profitable onesonce cost-to-serve was included in the margincalculations. One of the biggest culprits was theshipping and handling costs incurred by themanufacturer – not because of the large volume ofproduct they had to ship, but because of its customers’purchasing behavior. They would place relatively smallorders nearly every day, and the products would beshipped as soon as the orders were received because itsbest customers deserved its best service.

The manufacturer incurred significant expense in less-than-truckload (LTL) fees and its customers virtuallyeliminated its inventory carrying costs. Armed with thisnew view of profitability, the manufacturer traded its oldvolume-based segmentation scheme for a new onebased on customer value and purchasing behavior andthen put its best sales people on the newly-defined“best” customers.

Risky businessWhile it seems intuitive that effective price managementcan lead to improved financial performance, manycompanies remain unable to improve their pricingcapabilities. Establishing or broadening these capabilitiescan be a very complex, risky and sometimes costlyinvestment that requires specific skills and a goodreserve of commitment on the part of leadership.

Changing pricing management is complex in partbecause pricing manifests itself in just about everyfunction within a company. Product management, sales,marketing, finance and even operations either affect orare affected by any price change. Aligning diverseconstituencies to drive a change in this system is nosmall feat. Organizational and process inertia cancomplicate things further. Specific pricing-relatedprocesses may have been in place for a long time andundoing or adjusting them would force people across all

While it seems intuitive thateffective price management can leadto improved financial performance,many companies remain unable toimprove their pricing capabilities

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these functions to learn a new way to do specific thingsor reduce the autonomy of certain stakeholders. Inparticular, the sales organization may view broad-basedchanges to pricing practices as a reduction in itsinfluence.

Amid this complexity and inertia, the risk of making amistake is high. It’s easy to find case studies that spellout the unintended consequences of misguided pricingtactics and strategies. No one wants to tinker withsomething that may damage the company’s bottom line.

Finally, a company’s own characteristics may presentmany obstacles. Other priorities and initiatives may havemomentum and take precedence, especially becausepricing is rarely perceived as an urgent problem oropportunity. Employees may lack the capabilities neededfor making the required changes. Poor data may limitvisibility into transaction profitability. And of course, thecompany’s performance or an economic downturn maylimit investment resources to the point where paying fora project is impossible.

Even when these companies overcome the reluctanceand inertia and embark on a program, there are theusual risks associated with any project: many stall, getoverwhelmed, or lose their focus.

What we have observed is thatproficiency in pricing is not a bolt-oncapability, but one that requires a seriesof changes in data collection anddesign, as well as analytically baseddecision processes

Quantifying the value of investing in pricingIn June 2011, Deloitte Consulting LLP and Deloitte’sGlobal Benchmarking Center (GBC) hosted an onlinesurvey to benchmark pricing competencies,performance and investment of respondents acrossindustries, geographies and competitive markets.This study was also designed to shed light on therelationship between company performance andeffective pricing capabilities. More than 40respondents completed the online survey and self-reported their performance.

The responses were analyzed along two dimensions.The first approach was based on developingcomparison groups within the respondent set drivenby the responses related to the financialperformance and the effectiveness of pricingprocesses. The second approach was based oncomparing survey respondents who representedpublic companies with a broader set of peers withintheir industry sectors.

Companies that were identified as “highperformers” based on analysis of the surveyresponses showed a number of traits in common:• They are more likely to understand the importanceof key pricing competencies and effectivelysupport them.

• They have a more centralized pricing function,with solid support from the top layers ofmanagement.

• They spend about as much as others ontechnology, but they are seeing a much higherreturn on their investments.

• They look beyond gross profit to measure theprofitability of each transaction.

• They have a consistent focus on pricing across allphases of the economic life cycle.

• They are nearly twice as likely as low performers tohave a C-level executive involved in pricing.

• They give their sales forces slightly less discretionthan others when it comes to negotiating prices.

• They appear to be the leaders in adopting pricemanagement software.

• Nearly two-thirds of high performers are using avalue-based pricing strategy.


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Overcoming the hurdlesOf course, if it was easy, everyone would do it. What wehave observed is that proficiency in pricing is not a bolt-on capability, but one that requires a series of changesin data collection and design, as well as analyticallybased decision processes. Moreover, organizationalchanges are often required to support processes basedon a newly acquired arsenal of data – and moreimportantly, the insights derived from it.

Start by building a transaction-level fact baseGood decisions begin with a quantitative understandingof transaction profitability at the most granular level.This will be the source of truth as well as of ideas forimprovement. Once an organization has built its factbase, qualitative information gathered from all pricingstakeholders should provide the fodder for hypothesis-driven analysis and opportunity identification. With thisapproach, the business case is built into the process ofanalysis. Key actions and considerations include:• Identifying all components of a transaction that add orsubtract value from the business on a marginal basis.Each component represents a lever that can be usedto affect profitability. For example, costs to serve suchas expedited shipping, special packaging, the cost ofcapital included in payment terms and technicalservice costs are often overlooked in traditional margincalculations. Tying these costs to specific transactionsinstead of aggregating them across all transactionswill demonstrate the true profitability of eachtransaction. They can then be aggregated along anydimension – customer/product/region – to aiddecision-making.

• Gathering data at the most granular level possible.More detail equals better and more flexible analysis.The cost of gathering, storing and processing thesedata has plummeted, so the assumptions about whatwas knowable back when original pricing practiceswere put in place are probably no longer useful.

• Being judicious with allocations. Fixed costs that are not marginally affected by the transaction should

not be included in the analysis. This is an economicexercise, not a restatement of accountingperformance. Therefore, costs such as corporateoverhead and taxes do not need to be assigned toindividual transactions; an arbitrary allocation wouldbe misleading in pricing decisions.

Strengthen processes and information tools toenable rapid, fact-based decisions The best analyses and strategies are of limited usewithout an efficient and effective pricing process. Theability to manage information flow, make rapid pricingdecisions, escalate pricing exceptions and controlmarket execution of pricing is critical to any effectivepricing improvement. Companies can use data analyticsto identify process weaknesses. If data analyticshighlight a customer that is getting a discount that hedoesn’t qualify for, it indicates a weakness in the pricingprocess tied to discounting.

Characteristics of strong pricing processes include thefollowing:• Complete closed-loop flow of activity and informationto drive continuous improvement. Pricing is, at itscore, a series of judgment calls based on guidelines setaccording to market information and corporateobjectives. In an ongoing business, marketinformation is consistently flowing in. The processmust be able to incorporate and use it on acontinuous basis.

• Clearly defined, communicated and enforced roles andauthority.

• A concise framework and structure for exceptionescalation.

• Balanced measurement of activity and outcomes.

Be thorough but not overly complex inperformance management design.Partial measures invite loopholes.


Identify specific risk areas and the red flags thatwill trigger predefined response plans andactions. Pricing is a high-leverage game. Small changes in themarketplace can require significant changes to a pricingstrategy. Red flags (such as margins, volume droppingbelow certain thresholds, rising salesperson turnover ornew competitors entering the market) can alertexecutives to a new risk that requires corrective action.Organizations should plan in advance how they willreact to potential threats – and they will arise. Theescalation hierarchy for pricing exceptions should have atop strategic level within which significant structuralpricing issues can be addressed quickly and effectively.

Early-warning triggers and the responses to definedscenarios will be specific to each business and itsstrategy. The key lesson is that pricing should be aprimary consideration and weapon of response, not areactionary afterthought.

Design compensation and incentives to promotecompliance.Very few disciplines draw as direct a line between actionand incentives as pricing, especially for a sales force.Pricing is often the primary lever that closes a sale.Process and governance may be able to largely controlpricing compliance. But incentives that align with pricing

objectives provide the structure that allows the salesforce to operate with autonomy, as the touch point withthe customer, without running afoul of corporatefinancial needs.

• Compensation and performance measurement shouldmotivate proper use and protection of key levers inthe transaction, as identified in the pricing analytics.

• Revenue and even gross-margin-based compensationplans are often insufficient to align sales behaviorwith corporate objectives.

• Stakeholders (in this case, the sales force in particular)should have direct influence and control overelements of performance measures.

Be thorough but not overly complex in performancemanagement design. Partial measures invite loopholes.Complex measures invite lack of focus, which leads tothe use of proxies for practical decision-making. Somecompanies, for example, have turned to discount rate(or “price realization”) as a proxy for profitability, mainlybecause it is simple to understand, already captured inexisting systems, and easy to measure at the transactionlevel. However, this metric ignores all of the costs toserve that the sales reps often use during a negotiationthat ultimately affect profitability.

Keep the focus on the customer. Organizations can create value only by addressing theneeds and goals of buyers. They should design pricingprocesses that reflect the client’s perspective and makethe most of the entire value chain, regardless oforganizational boundaries. For example, a consumerbusiness company sells to a retailer that finally sells tothe end consumer. Thinking of profit improvementstrategies for the first transaction in the value chainwithout understanding the ramifications on thedownstream demand may suboptimize overall valuecreated. In another setting, for large business-to-business companies, one customer may purchase

Very few disciplines draw as direct aline between action and incentives aspricing, especially for a sales force.Pricing is often the primary leverthat closes a sale


products from multiple business units, which are oftenmanaged as separate organizations with differentleaders, different objectives, and different pricingmetrics and strategies. As these companies begin to usedata for advanced analytics that suggest increasinglysophisticated and targeted pricing changes specific totheir business unit, it can be easy to lose sight of thecumulative, customer-level impact of these multiplepricing actions across BUs.

Executives contemplating an investment in pricingeffectiveness often ask whether the view is worth theclimb. There’s no shortage of risks to mitigate andchallenges to overcome, even beyond those listed here.However, with the right approach – one that focuses ondeveloping the organizational and process aspects ofpricing, improving analytics and understanding thecustomer – a company can direct its investment towardthose efforts with the highest return.

Reprinted from Deloitte Review, issue #12 : 2012

by Julie Meehan, principal in the Strategy & Operationspractice of Deloitte Consulting LLP., Chuck Davenport,senior manager in the Strategy & Operations practice ofDeloitte Consulting LLP., and Shruti R. Kahlon, seniormanager in the Strategy & Operations practice of DeloitteConsulting LLP.

The authors would like to acknowledge the contributionsof Michael Hart of Deloitte Consulting LLP andMatthew Herbein, formerly of Deloitte Consulting LLP.practice of Deloitte Consulting LLP.

Endnotes1 Global Benchmarking Center, “Pricing Effectiveness Global

Benchmark Study,” Deloitte Consulting LLP, August 2011.2 Based on t he 2011 Shift Index (Deloitte Development LLP) of

Compustat data; Impact estimated based on the averageFortune 1000 company.<http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/us_tmt_2011shiftindex_111011.pdf>

3 Global Benchmarking Center, “Pricing Effectiveness GlobalBenchmark Study,” Deloitte Consulting LLP, August 2011.

4 Ibid.5 Ibid.

The key lesson is that pricing shouldbe a primary consideration and weaponof response, not a reactionaryafterthought

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