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Pricing Strategies in the Downturn
February 26, 2009 | By COLIN CARROLL, V.P./BUSINESS CONSULTING AT&NBSP;VENDAVO
by Colin Carroll, v.p./business consulting at Vendavo
The impact of the downturn on the chemical sector is clear: volume and prices are down, backlogs are weak, operating rates continue to fall and virtually every customer has requested one or more price reductions. In response, commercial teams must ask themselves: “what can we do?”
Most teams have already begun by curtailing or slowing production, pulling up maintenance downtime and cutting costs wherever possible. But when volume and pricing both continue to fall, what can companies do next? Pricing best practices can help chemical companies preserve margins, make sure that margins don’t fall as far as competitors, and position the business to extract maximum margin benefit from the eventual upturn. Following are eight pricing best practices to help you take control of pricing in order to improve bottom-line results.
Manage Customer Profitability
The first step to using price as a revenue lever is managing customer profitability at a much more precise level. It’s important to view customer profitability as an average metric with multiple key components, including product profitability and customer ship-to profitability. For many of your customers, there will be one or two products that are clearly less profitable than they should be. Along the same lines, you may have one “ship to” that has significantly higher freight costs than others. Understanding customer profitability at more precise levels – the ship-to and product levels – helps identify price leakage so you can take corrective actions.
Define Your Outliers to Determine Root Causes
After conducting an in-depth analysis of customer profitability and identifying issues that need correcting, it’s important to define your outliers, meaning your worst-performing customers. For example, you can focus on the 25% of your volume that is least profitable, or on all transactions with contribution margins below 12%. After defining the criteria for “outlier” or “poor performer,” companies can make a list of customers that are negatively affecting business the most.
Next, for each customer deemed a poor performer, identify the root cause so you know which corrective actions to take. By comparing each poor performer to its peer group – for example other customers in the same region or industry – you can identify the cause and correct the margin differential. Specific causes may include: a low price, a high rebate, high freight or materials costs, or differences in invoice prices driven by volume discount.
Create a Downturn Playbook
With poor performers and root causes clearly defined, organizations can develop a “downturn playbook” to outline the courses of action needed. Additionally, naming a pricing team with employees that assume pricing responsibilities will help you carry out the strategies in the playbook. To provide a specific example, a playbook for poor-margin performers with a root cause of high rebate might look like this:
Reduce rebate, if possible, or
Increase invoice price, if possible, or
Change rebate mix and volume targets, or
Reduce service costs
You are unlikely to want to exit a customer like this in the market, but identifying a range of corrective actions can at least help you push back against downward pricing pressure, or at best to reduce price leakage. For poor performers like this, corrective actions include:
Reduce service costs or freight allowance
Change freight mode from truck to rail
Increase invoice price
Refrain from paying rebates on shipments with freight cost exceeding $x/ton
Only the internal organization can define the list of root causes and the appropriate corrective actions for each, but this playbook concept will help prevent ad-hoc responses and avoid fighting the same fires over and over again.
Use Policy to Enforce Improvement
It’s important to keep in mind that playbooks leverage organizational knowledge and best practices to create repeatable processes, but to make them stick you need to enforce policy. Escalation policy – for example, setting a margin floor of 12% – is an excellent technique. This would mean that approval is needed for all quotes, price reduction requests, or competitive situations that would deliver a contribution margin of less than 12%. Setting this escalation policy gives clear direction to the organization.
By automating the enforcement and escalation of policies like these, companies can consistently respond to discount requests in a systematic and disciplined fashion. Monitoring the effectiveness of policies and refining them will help also drive improved margin realization in any phase of the cycle.
Develop a Discount Concession Strategy
In this market, companies will receive frequent requests for deep discounts, or additional discounts on business already secured. A discount concession strategy mapped out in the form of a playbook can help your company respond to discount requests in a systematic manner to limit price erosion without putting too much volume at risk. The first step in this strategy is segmenting customers into groups such as strategic, key, preferred, or value and price seekers. Your segmentation model can be simple, a function of volume and margin, or multidimensional, driven by a number of key metrics and strategic attributes.
For example, your A customers are your “retain and protect” customers. These are the customers that you want to keep throughout the cycle, and the customers your competitors will seek to pick off. Upon receiving a discount request from an A/retain customer, the following steps will help you approach discounts appropriately:
Offer an increased service bundle
Position value, reminding the customer of the benefits of your product/service bundle/supply relationship
If these steps don’t work, make a price concession, but offer less than requested
Lastly, concede to floor price. Remember that these are customers to keep, even if you have to concede margin on some products for some phases of the cycle
Considering the strategic value of this product volume
Treating D’s as price buyers, with the price buyer discount and service offering
Reducing service costs wherever possible, for example enforcing lowest shipment mode
Withholding allocation rights
Setting and enforcing a walk-away price
Your most aggressive price seekers will be in this D customer category. You should be careful not to play price poker with price buyers unless you can afford to lose the volume. Also, be sure not spend a penny more on service costs than absolutely necessary.
As long as your model helps you treat different customer types differently, especially when fielding discount requests, you will be well positioned to respond to discount requests in an orderly, systematic and disciplined fashion. If you’re not responding to discount requests in this way, you could be creating self-inflicted downward pricing pressure.
Respond to Changing Customer Needs
It is also important to consider how your customers are affected by the down economy in order to respond intelligently and proactively. For example, a customer seeking to outsource functions in a downturn may ask for extended payment terms, or for vendor-managed inventory. With a solid discount policy and strategy, you’ll be better prepared to determine whether to accept the new service requirements. You can also monitor factors such as changes in payment behavior to identify changing customer needs. With a strategy in place for monitoring these needs, you’ll be better prepared to price each customer segment appropriately.
Keep in mind the way your business is changing in response to the economy as well. A pricing and discount playbook will help you establish the systems and insights to understand when and where your service costs are fluctuating so you can evaluate them alongside the needs of your customers.
Examine Your Product Portfolio
Starting your downturn analysis with a deep customer inspection is essential to examine your product portfolio. Using the same detailed margin analysis that you use for customers, compile a list of your worst performing products. For each of these identified product issues identify the root cause in order to respond to deep discount requests more intelligently. On which of your products will you fight hard to resist this downward pricing pressure? Where will you bend, and where will you suggest a substitute product? An established product strategy will help you make the right decisions.
You may also consider offering tailored products for some customers. In the downturn, customers only want to pay for what they value. If you have the right offer and the right price for your important segments you’ll see greater success with these customers.
A segmented approach to both customers and products will minimize your service costs where they are not valued, help you extract value where they are, and keep you from losing volume because you don’t have the right product service bundle for that customer during this downturn.
Don’t Forget the Sales Force
Playbooks are a best practice for narrowing the gap between pricing strategy and execution. They are a tool for the pricing team to execute repeatable, systematic processes, even during the disorder and stress of a downturn. But the best intentions of a well-intentioned pricing team are not sufficient unless they align with the sales force.
A discouraged sales force can be less likely to defend price in this market, considering it a fruitless pursuit. Even in the downturn, it is critical to position the value of your product, service, company and relationship. For this reason, it’s important to give the sales team price targets and floors so that when making a price concession they understand the full effect. Even if these targets go down monthly, they will enforce discipline. Other best practices for helping the sales team include: measure, manage, and leverage internal competition to drive price improvement where you can, or freight minimization where you can’t; track policy enforcement at the sales person level and display results at sales meetings; and let everyone know which key metrics you are tracking.
Prices follow operating rates downward, and always have in the chemicals sector, but that doesn’t mean chemical suppliers are without tools to mitigate downward pricing pressure. This year will keep you busy responding to requests for price concessions. Handling these requests in a systematic, disciplined fashion will let the best-run chemical companies minimize price, margin and cash-flow erosion. Clawing back to better prices at the rate of a penny per pound can have an unexpectedly-large impact on margins and resultant cash flow. It’s up to you: ad-hoc fire-fighting, or disciplined, systematic discount management?
Pricing best practices and playbooks can help every organization increase the strategic impact of the pricing lever, even the most challenging pricing environment.