Pricing Leader on Day One: Define your Hypothesis of Better

Congrats.?You have just been appointed to newly created role in pricing leadership.?Day One, what is your agenda?

The days where you could leisurely undertake a “listening” exercise to find your place are long gone.?You were hired to fix a problem and the CEO believes there is an opportunity to improve pricing.?The CEO also wants results in year one.?Ok.?but what does that action and results oriented agenda look like in practice.

The common goal for a newly appointed price leader is to improve profits by either increasing prices or improving the mix of products sold.?The uncommon goal is to lower price in the hopes of selling greater volumes to generate profits.?It is uncommon to be hired as a pricing leader to strategically lower prices precisely because management can made this mistake on their own without the help of a pricing professional.?So, let us assume you are there to improve profits by plugging a profit leak.

Sounds great but … woops!?What is a profit leak??Consultants and pricing software vendors love to talk about how great they are at fixing profit leaks, but they rarely define what they mean by the term “profit leak”.?Frustration cannot be part of your Day One agenda, so let’s take a stab at the definition.

Define Profit Leaks

The term “profit leak” is so wonderfully ambiguous while simultaneously emotive and action oriented, it is no surprise that it is bantered about so often.

Conceptually, a profit leak is a missed opportunity to capture better profits from customers by either charging higher prices or improving the mix of offerings sold.?

Now that we have a conceptual definition of the term “profit leak”, we need an action agenda to take to address these profit leaks.?

Which leads to another challenge: how do you definitively identify and address profit leaks in practice??And, how do you know if you plugged that leak?

Hypothesis Development

Well, the sad answer is you will rarely definitively identify a profit leak.?Generally, you must develop an informed hypothesis regarding the location of that profit leaks, and the appropriate plug.

Only a freshman would start with the hypothesis that prices could be raised across the board without damaging the company performance. True, it happens sometimes. But if it was that simple, again, you wouldn’t be nominated to a newly created pricing leader role.?

Instead, you need a more nuanced hypothesis.?Fortunately, we have many hypotheses to work with.?Here are eight.

1. Our commercial policy is leaving money on the table.?Either we are paying too much in planned discounts and rebates, collectively known as strategic price variances, or giving too much away in negotiations, known as tactical price variances.?In either case, the hypothesis is that if the company reduces a price variance, profits will rise.
2. Some customers are not paying enough.?While most transactions charge an appropriate price, some went awry.?In this case, you simply want to stop chasing bad transactions and start chasing more good ones.?To detect that, create a price histogram, define a reasonable price floor, and figure out why some customers pay so much because you want more of them.
3. Some small volume customers are getting prices intended only for large customers.?You have created a price-to-volume plot and you have seen transactions that would make you blush at their low-price for low-volumes.?Here, you define a price range, meaning floor, target, and ceiling, that varies by volume.
4. Some salespeople or customer segments are getting very low prices.?You have made a box-and-whiskers plot by salesperson or customer segment and found some inexplicable variances.?As a result, you either invest in sales training and escalation rules or you start to change your customer segment focus and negotiation strategy.?
5. Some offerings are priced low given their margin.?Here, you have measured or estimated elasticity by offering and plotted it against gross margin.?Simple rules: (1) raise prices on inelastic offerings, (2) raise prices on low elasticity and low margin offerings cautiously, and (3) leave the others alone.?
6. Some rarely purchased offerings can have price increases and customers won’t notice.?Here, you are using the consumer-packaged-goods concept of “price image” and “price signal” or the industrial distributor concept of “raising the tails”.?You have plotted your offerings by some measure of velocity (transaction, sales volume revenue, customer count, etc.) and identified the high-velocity offerings where customers are expected to be price sensitive separate from the low velocity offerings where customers are expected to be relatively non-price sensitive.?Raise prices on the low velocity offerings.
7. Some accounts can be realigned.?You examined the price performance of individual customers according to gross margin and price change compared to last year.?You found that some accounts have low margins and suspect it is due to a poor mix of offerings sold and you admonish the sales team to fix it.?Or you identify some accounts whose price performance lags that of others and you admonish the sales team to selectively raise prices on those accounts, as the other accounts accepted it.?
8. Some salespeople are selling a good mix at good prices while others are not.?Here, you believe that a change in incentives to focus on profit, driven by better negotiations and better mix, will deliver.

Hypothesis Measurement

After taking some price performance measurements, select a hypothesis and act.?After a period, be it week, month, or quarter, measure again.?Did you hypothesis and action drive change??Did the changes drive profits??What else happened that either exogenously or endogenously impacted performance.

If your hypothesis was determined to be correct, expand and repeat.?If not, try another one.?Either way, start day one with measurements, hypothesis development, and taking action to plug a profit leak.?Then take more actions and plug more profit leaks.?

Your company is depending on you and time is short.