Pricing for Profit and Market Position: An Industrial Products Perspective
For those of us who have worked in—or who are currently working in—manufacturing and industrial products companies, the following statements are undoubtedly familiar:
Market share is critical; being number one is what matters most.
The higher our volume goes, the lower our costs, so we can cut prices to get the volume.
If our competitors cut prices, we must cut prices.
Profit lost by cutting price can be made up in volume.
For most of the companies we work for, these statements don’t hold true. The pursuit of market share, high volumes, price competition, and other reactive “strategies” may be what we are have become familiar with, but they are not what drive profitability and long-term sustainability. These assumptions and practices are symptoms of deficiencies in understanding:
competition within market segments;
costs and economies of the business;
market share and volume trade-offs;
material economics (inflation, deflation, currency impacts);
market, customer, and product level strategy formulation; and
pricing strategy formulation.
With Understanding Comes Profitability
For profitability and growth to occur, an industrial company must be able to define and articulate an explicit set of profit and growth objectives. These objectives are translated into targets and performance metrics for sales, profits, returns on capital, and profit growth. These statements must be formulated to focus specifically on measurable profits and profit growth to overcome the traditional tendency to focus on volumes and market share. These objectives also need to be segmented and matched by market, region, country, and economic conditions.
Profitability and growth objectives also require an analysis of each product, customer, and market segment in the context of the countries where they are being sold. All the information that the company has on its business, cost structures, operating efficiencies, and competition also flow into the process of setting the targets.
From Targets Come Strategies
You have your targets. Now it is time to set your strategies for achieving those targets: Marketing, customer, product, and pricing—strategies have to be formulated to fit the information you have—what you know about your business, its competitors, and how to do business. So, where does the business start with strategy formulation? Pricing is a good place.
Segmented Markets, Segmented Prices
The tendency is to think that there must be one price for every customer. The reality is that within the scope of regulatory requirements, businesses can differentiate prices to their customers. Prices based on a cost-plus-profit percentage formula are a practice best left to retailing or the last century. Setting prices are based on investment decisions: how many resources are being committed and what return is needed. The pricing strategy is usually a broad statement that can be clearly interpreted:
“Our prices are set to achieve market objectives and value to customers.”
“Our prices are set X% over competitors’ prices.”
Establishing pricing strategy—setting prices based upon knowledge of market segments, value-based customer needs, competitive analysis, costs structure analysis, and from the market, product, and customer strategies that come from that critical information—enables an industrial business to have strong follow-through in the administration and implementation. This translates into an ability to monitor how the strategy is working and when someone deviates from policy. The entire organization is accountable to maintain the consistency of the strategy and its application to each product, customer, market segment, business unit, and to ensure that IF deviations occur, they are motivated by sound, reasoned decision-making and not a sidestep of the policy. It requires of the business a strong resolution to enforce the policy and consequences for deviations that are unsanctioned and/or which reflect poor decision-making.
Factors to Consider in Setting Prices
When it comes to anything in business, it begins with the customer. So it goes with setting prices, we begin with an understanding of the customer and the market segment value. Here are questions you should ask of your business:
What are the tangible and intangible benefits of the product(s) to the customer?
What are the customer’s service needs? What is the life cycle of the product to the customer?
What is the customer’s life cycle?
Are there any proprietary product advantages?
What degree of credit risk do we have with each customer and the market as a whole?
What is the cost to serve each customer and the market segment? What is the profitability of each customer?
We’ve asked a few questions about the value of the market segment in the first section as it relates to products and services and how we serve the customer. We also touched on the risk related to extending credit terms. Now we need to look at the market segment in terms of competitive structures. Understanding how our competition is interacting with each market segment impacts what we choose to do (or not) with our pricing strategy, so:
What products are we competing against, directly or indirectly? Identify any potential substitutes.
How many competitors do we have and how big are they?
Are our competitors well funded and stable? How long have they been around?
How much capacity do our competitors have locally, regionally, and globally? Currently and planned?
How good are our competitors at delivering products on-time? What are their lead times?
What are our competitors’ cost structures?
How profitable are they? What are the profit goals?
Are our competitors; market shares focused?
How do our competitors compare to us and each other?
What do we know about our customers, market segments, products, and competitors? We have to know more, about them and about us, to have an effective pricing strategy and policy. Pricing is about not leaving profits on the table. Hidden profits—money left on the table—occurs every day in almost every business because of pricing issues. The value customers place on products and service varies significantly, so pricing can too. Finding the way to match pricing to customers effectively and efficiently (and legally) requires an understanding of all the elements of pricing and market segmentation and how they come together. We’ve discussed the external factors; now it’s time to look inside our organization and analyze our own information.
What is our capacity? How are we using it? What does it cost for additional capacity? Where are those volume/capacity investment points?
What is the relationship between our fixed and variable costs?
What are the unit costs at different volume levels? What happens at the different investment points?
How do our cost structures compare to our competitors?
What do our forecasted cost structures look like?
Do we have cost structure advantages in any business units or regions that can be leveraged?
Where are our break-even points?
What are our infrastructure reinvestment costs?
What is our return on investment requirements?
What are our profit goals?
What is the sales volume? What is our goal?
What is the annual growth rate? What is our goal?
What is our market share?
The Ability to Compete: Make a Change One Segment at a Time
The hardest thing for any business to do is to change. The toughest time to change is when competition is having its biggest effect on your profitability. When it comes to pricing, “what we’ve always done” may not be working, but it is what most companies are comfortable with and it seems intuitive: Follow the competition and price for volume. The reality is, if it was working, then businesses wouldn’t be looking for answers to profitability questions. So what’s a business to do? If a business isn’t comfortable changing pricing policy and strategy for the entire organization and all products all at once, then a company can choose a product line or business unit that is underperforming and start there. Commit that part of the organization to a comprehensive change in pricing, then implement and enforce it. Make this one part of the organization a “mini-company” and set the profit goals and growth objectives, segment the markets, calculate customer profitability: go through all the steps. Implement. Measure. Report. Analyze. See the results.
Don’t Sabotage Your Test Case
If you decide to sample the process, be sure that you enable the process. Don’t hold back your experimental group with the “activity” from the rest of the organization. For a test case to give you a true look at what a change in pricing strategy and methods can do for you and your profitability, you have to keep the subtle and not so subtle sabotage (intentional and unintentional) from occurring. Change is not a comfortable activity for an organization and it is normal for it to be resisted. Things happen to keep the status quo in place. If you are committed to finding more profits and growth, then commit to monitoring the level of support your test case is getting.