03_Managing Price, Gaining Profit

8/3/2019 03_Managing Price, Gaining Profit

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Transaction prices represent one of the m ost attractive - andoverlooked-opportunities to boost profits.

M anaging Price,Gaining Profit

by Michael V. Marn and Robert L. Rosiello

The fastest and most effective way for a companyto realize its maximum profit is to get its pricingright. The right price can boost profit faster tha n in-creasing volume will; the w rong price can shrink it

just as quickly. Yet many otherwise tough-mindedmanagers shy away from ini t iat ives to improveprice for fear that they will alienate or lose cus-tomers. The result of not managing price perfor-ma nce, however, is far more damaging. Getting theprice right is one of the mo st fundam ental and im-portan t m anag em ent functions; it should be one ofa manager's first responsihilities, a nuts and boltskind of joh that de term ines the dollar and cen ts per-formance of the company.

The leverage and payoff of improved pricing arehigh. Com pare, for exam ple, the profit imp licationsof a 1 % increase in volume and a 1 % increase in

price. For a company with average economics, im-proving unit volume by 1% yields a 3.3% increasein operating profit , assuming no decrease in price.But , as Exhibi t 1 show s, a 1% imp rove me nt in

price, assum ing no loss of volum e, increases op erat-ing profit by 11.1 %. Improvements in price typically have three to four times the effect on profitabili-ty as proportionate increases in volume.

With such extreme profit leverage, pricing is onefunction that a company can always improve. Oneconsumer durable products company increased op-erating profit dollars hy nearly 30% with a mere2.5% improvement in average prices. An industrial

Michael V . Main is pricing consultant in the Cleveland,Ohio office of McKinsey &) Com pany, Inc. Robert LRosiello is principal in McK insey Com pany's New YorkCity office.



1 %

Improvementi n . . .

Price

VariableCost

Volume

Fixed Cost

equipment manufacturer boostedoperating profits by 35% by care-fully managing price levels up amodest 3%. According to our re-search, a wide variety of husiness-e s , including those in consumer

packaged goods, energy, and bank-ing and financial services, haveachieved comparable results.

Even if a company's managersmake the right pricing decisions9 0 % of the time, it's worthwhileto try for 9 2 % - the payoff is thath igh . But the price lever is adouble-edged sword. Themes-sages of Exhibit 1 also apply in re-verse: a mere 1 % price decrease foran average company, for instance,

would destroy 1 1 . 1 % of the com-pany's operating profit dollars.

Pricing issues are seldom simple and isolated;usually they are diverse, intricate, and linked tomany aspects of a husiness. But while most man-agers have a handle on the bulk of pricing issues,many overlook a key aspect of this m ost basic man-agement discipline: transaction price managem ent.Without realizing it, many managers are leavingsignificant amounts of money-potential profit-onthe table at the transaction level, the point wherethe product meets the consumer. Most companies

use invoice price as a reporting measure, hut thedifferences between invoice and actual transactionprice can mean significant reductions to bottom-line profit.

Some companies that have identified this prob-lem are hand ling it by applying two basic concepts:the pocket price waterfall and the pocket priceband. Reduced to their essentials, these conceptsshow companies where their products' prices erodebetween invoice price and aetual transaction price,and they help companies capture untapped oppor-tunities at that level.

T h e T h re e L e v e ls o f P r ic e M a n a g e m e n t

The pricing puzzle is more manageable whentaken in pieces. Price management issues, opportu-nities, and threats fall into three distinct but close-ly related levels:

1 . Industry supply and demand. At this highestlevel of price management, the basic laws of eco-nomics come into play. Changes in supply (plantclosings, new competitors), demand (demographic

1 . C o m p a r i s o n o f P r o f i f L e v e r s *

...Creates Operating Profit improvement ot

n . 1 %

7.8

3.3

2.3

*Bassd on overage economics ot 2 ,463 compan ies InCompustat aggregate

shifts, emerging substitute products), and costs(new technologies) have very real effects on indus-try price levels.

Managers examining pricing in this contextshould understand the pricing "tone" of their niar-k et s- th at is, the overall direction of price pressure(up or down) and the critical marketplace variahlesfueling that pressure. This knowledge allows man-agers not only to predict and exploit broad pricetrends but also to foresee the likely impact of theiraetions on industry price levels.

2 . Product market strategy. The eentral issuehere is how custom ers perceive the benefits of prod-ucts and related services across available suppliers.If a product delivers more benefit to customers,then th e company can usually charge a higher priceversus its competition. The trick is to understandjust what factors of the product and service packagecustomers perceive as important, how a companyand itscompetitors stack up against those factors,and how much customers are willing to pay for su-periority in those factors.

Market research tools, like conjoint analysis andfocus groups, can help managers understand cus-tomer perception of benefits. And understanding atthis second level of price management helps guideboth theproduct's price positioning and the fine-tuning of product and service offerings.

3 . Transactions. At this last level of price man-agement, the critical issue is how to manage the ex-act price charged for each transaction - that is,what base price to use, and what terms, discounts,allowances, rebates, incentives, and bonuses to ap-ply. Where concern at other price m anagement lev-els is directed more toward the hroad, strategic po-sitioning of products in the marketplace, focus at



TRANSACTION PRICING

2 . In the P o c k e t P r ic e W a t e r f a l l , e a c h E l e m e n t R e p r e s e n t s a R e v e n u e L e a k

[dollars pe r square yarO}

$6.00

DealerListPflco

0.10Order SizeDiscount

0.12Competive

Discount

S5.78

Invoice

Price

0.30PaymentTermsDiscount

22.7%

ofl invoice

0.37

Annual\toiumeBonus

0.35Off-Invoice 0.20

Promotions Co-opAdvertising

0.9Freight

$4 .47

Pocket

Price

the transaction level of price management is micro-scopic-customer by customer, transaction hytransac tion, deal hy deal.

The three discrete levels of price managementare clearly related. If, for example, a company fore-sees an industrywide supply shortage of its product,repositioning the product hy lowering the pricewould he a mistake . In the same way, the product'smarket strategy should set the context for transac-tion-level pricing decisions: a move hy Toyota todiscount its Lexus luxury sedan at the transactionlevel would conflict with the market positioning of

that model as a high-benefit, fair-priced alterna tiveto com petitors like Mercedes Benz, BMW, or Jaguar.

Unfortunately, many top managers perceivetransaction pricing decisions as unimportant andoften relegate them to low-ranking managers oreven entry-level clerks, with some flexihility at thesales force level. By doing so, companies may beforegoing one of the most substantial profit oppor-tunities available.

The Transaction Pricing Opportunity

The ohjective of transac tion price management isto achieve the best net realized price for each orderor transaction. Transaction pricing is a game ofinches where tens, hundreds, or even thousands ofcustomer- and order-specific p ricing decisions dailycomprise success or failure-w here companies cap-ture or lose percentage points of margin one trans-action at a time. But top m anagement neglect, hightransaction volume and complexity, and manage-ment reporting shortfalls all contribute to missedtransaction pricing oppo rtunities.

The com plexity and volume of transactions tendto create a smoke screen that makes it nearly im-possible for even the rare senior managers whoshow an interest to understand what is actuallyhappening at the transaction level. Management information systems most often do not report ontransaction price performance, or report only average prices and th us shed no real light on pricing opportunities lost transaction by transaction.

The pocket price waterfall and the pocket pricehand have proven valuable in lifting this smokescreen and providing a foundation to capture opportunity at the transaction level.

The Pocket Piice Waterfall. Many companies fto manage the full range of components that contribute to the final transaction price. Exhibit 2shows the price components for a typical sale bya manufacturer of linoleum flooring to a retailerThe starting point is the dealer list price fromwhich an order-size discount (hased on the dollavolume of tha t order) and a "competitive discount(a discretionary discount negotiated before the order is taken) are subtracted to get to invoice price

For companies tha t mon itor price performance, invoice price is the measure most com monly used.

But in most businesses, particularly those sellinthrough trade intermediaries, invoice price doenot reflect tbe true transaction amount. A host opricing factors come into play between the set invoice price and the final transaction cost. Amonthem: prompt payment discounts, volume buyinincentives, and cooperative advertising allowancesW hen you subtract the income lost through thestransaction-specific elements from invoice pricewhat is left is called the pocket pric e-t he revenuethat are truly left in a company's pocket as a resul





TRANSACTION PRICING

action pricing opportunities. If a manager ean iden-tify a wide pocket price band and com prehend theunderlying causes of the band's width, then he orshe can manipulate that band to the company'sbenefit. Recall from Exhibit 1 the huge operatingprofit payoff from a 1 % increase in average price.

When, as in the case of the linoleum flooring manu-facturer, poeket prices vary over a 33% range, it'snot hard to imagine how more deliberate manage-ment of such wide price variations might yield sev-eral percentage points of price improvement - andthe rich profit rewards that would accompany th atimprovement.

The width and shape of a pocket price band tell afruitful story. Managers are invariably surprised notonly by the width of their pocket price bands bu t al-so by the identity of customers at the extremes of

If a compa ny doesn'tnnanage its pricing policieson all levels, custonners maywork those policies to theirown advan tage.

th e band. Custom ers perceived by managers as veryprofitable often end up at the low end of the band,and those perceived as unprofitable at the high end.

The shape of the pocket price band provides the as-tute manager with a graphic profile of a business -depicting, among other things, what percentage ofvolum e sells at deep discounts, whether there existgroups of customers who are willing to pay higherprices, and how appropriately field discounting au-thority is being exercised.

The Castle Battery Company Case. The follow-ing, somewhat disguised, case shows how one com-pany used the pocket price waterfall and band toidentify profit leaks and regain contro l of its pricingsystem. It illustrates one way in which the water-fall and band concepts can be applied, and shows

how, if a company doesn't manage its pricing poli-cies on all levels, experienced customers may beworking those policies to their ow n advantage.

The Castle Battery Company is a manufacturerof replacement lead-acid batteries for automobiles.Castle's direct customers are auto parts distribu-tors, auto parts retailers, and some general massmerchandisers. With return on sales averaging inthe 7% range. Cas tle's profitability is very sensitiveto even small improvem ents in price: a 1 % increasein price with no volume loss, for instance, wouldincrease operating profit dollars by 14% .

Extreme overcapacity in the battery industry andgradual commoditization made it increasingly dif-ficult for Castle to distinguish its products fromcompetitors. So Castle senior management wasskeptical that there was much, if any, poten tial forprice imp rovement. But Castle managers had en-tirely overlooked lucrative pricing op portunities atthe transaction level.

Exhihit 4 shows the typical pocket price waterfallfor one of Castle's common battery models, thePower-Lite, sold to an auto parts retailer. From abase price of $28.40, Castle deducted standard deal-

er/distributor and order-size discou nts. The compa-ny also subtracted an on-invoice exception dis-count, nego tiated on a eustomer-by-customer basisto "meet competition." With these discounts, theinvoice price to the retailer totaled $21.16. Whatlittle transaction price monitoring that Castle didfocused exclusively on invoice.

4 . Of f - Invo ice Di sco un ts : a Big Part of the Pr ic ing P ic ture

$28.40

BasePrice

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$21.16

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5 . A S ing le Pr oduct Can Have a Wide Pocket Pr i ce Band ,

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That focus ignored a big part of the pricing pic-ture-off-invoice discounting. Castle allowed cashdiscounts of 1.2% for t imely payments hy ac-cou nts. Additionally, the compatiy granted extend-ed terms (payment not required u ntil 60 or 90 daysafter receipt of a shipment) as part of promotionalprograms or on an exception hasis. For this transac-tion, the extra cost of carrying these extended re-ceivahles totaled 22 cents. Coo perative advertising,where Castle contributed to its accounts' local ad-vertising of Castle p rodu cts, co st 85 cents . A ,specialmerchandising program in effect at the time of this

transaction discoun ted ano ther 60 cents. An annu alvolutne rebate, based on total volume and paid atyear end, decreased revenues by yet another 74cents; and freight paid hy Castle for shipping thebattery to the retailer cost 32 cents.

The invoice price minus this long list of off-in-voice i t em s resul ted in a poc ket pr ice of only$18.18, a full 14% less than invoice. The total rev-enue drop from base price down to pocket price isthe "pocket d i sc o u n t" - i n th i s ease , $10.22, ofwhich $2.98 was off-invoice.

Of course, not all transactions for this particular

tnodel of battery had the same pocket price. As Ex-hihit 5 shows, each element of the pocket price wa-terfall varied widely by customer and transaction,resulting in a very broad pocket price band. Whilethe average pocket price was $20, units sold for ashigh as $25 and as low as $ 14 - p lus or m inu s greaterthan 2 5% around the average. Ap rice band like thisshould trigger immediate questions: What are theunderlying drivers of the band's shape and width?Why are poeke t prices so vai(iable, and can th at vari-ability be positively managed?

Cas t le managers were qui te surpr i sed a t the

width of the price band for their Power-Lite model,

hut on reflection, concluded that it was due to dif-ferences in account sizes. The company had a clearstrategy of rewarding account volume with lowerprice, rationalizing that cost to serve would de-crease with account volume.

But when tnanagement examined the Power-Litepocket prices against total account sizes for a sam-ple of 50 accou nts, i t found tio co rre latio n-i t was avirtual shotgun blast. A num her of relatively smallaccounts were buying at very low pocket pr iceswhile som e very large accou nts were buying at veryhigh pocket price levels.

Cast le managers , perplexed hy the seat ter ofpocket prices by account size, launch ed an imm edi-ate investigation. In most cases, they found no le-gitimate reason why certain low-volume accounts

Castle's Power-Lite pocketprices showed no correlatiorito the acc ou nt sizes - it wasa virtuol shotgun blast.

were paying such discounted prices. Often, theydiscovered that these accounts were unusually ex-perienced and clever acc oun ts-cu stom ers w ho hadbeen dealing with Castle for 20 years or more andwho k new just whom to call at Castle he adqua rtersto get that extra exception discount, that percent-age point of additional co-op advertising, that extra30 or 60 days to pay. These favorite old accountswere granted extra discounts based on familiarityand relationships rather than on economic justifi-cation. These experienced clients understood Cas-tle's pocket price waterfall and were working it

against the company.



TRANSACTION PRICING

Castle senior ma nag em ent realized that its trans-action pricing process was out of control, that deci-sion mak ing up and down the waterfall laeked dis-c ipl ine , and that no one was focus ing on thecom prehensive total of those decisions. The end re-sult was a pricing reality that didn't square with

Castle's strategy of rewarding account size withlower prices, and that was costing Castle millions.

To correct its transaction pricing situation, Cas-tle mo un ted a three-part p rogram. First, it took veryaggressive corrective actions to bring the overdis-coun ted, "old favorite" accou nts back in line. Man-agement identified the prohlem accounts and ex-plained the si tuat ion and i ts impact on overal lcompany profits to the sales force. Then the compa-ny gave the sales force nine months to fix or dropthose outliers. Fixing meant decreasing the exces-sive discounting across the waterfall so that outh er

accounts ' pocket prices were more in l ine withthose of accounts of similar size. Salespeople whocouldn't negotiate their outlier pocket prices up toan appropriate level were to find other accounts intheir territory to replace them .

Within the time allotted, the sales force fixed90% of the troub le acco unts. Sales' newfound real-

WELCOME.

VOtUf^E

Companics can assimilate pricing policy information to

influence retailers.

ization that every element of the waterfall repre-sented a viable nego tiating lever contribu ted to thissuccess. And, in most cases, the salespeople easilyfound profitable replacements for the other 10%.

Second, Castle launched a program to stimulatevohime in larger accounts that had higher than av-

erage pocket prices compared w ith a ccou nts of sim-i lar s ize. Management singled out the at t ract ive"target" accounts for special treatment. Sales andma rketing personnel investigated them carefully todetermine the nonprice benefits to which each wasmost sensitive. The company increased volume inthese acco unts n ot by lowering price but by deliver-ing the specific benefits that were most importantto each; higher service levels for some, shortenedorder lead times for others, more frequent salescalls for still othe rs.

Finally, Castle embarked on a crash program to

get the transa ction pricing process back under con-trol. This program included, among other compo-nents , setting clear decision rules for each discre-t ionary i tem in the waterfal l . For example, thecompany capped exception discounts at 5% andgranted them only after a specific volume and mar-gin impact evaluat ion. Management also set upnew informat ion sys tems to guide and moni tortransact ion pricing decisions. And Cast le estab-l ished pocket price as the universal measure ofprice performance in all of these systems. It beganto track and assign, transaction-by-transaction, all

of the significant off-invoice waterfall elementsthat were previously collected and reported only ona compan ywide basis. Further, pock et price realiza-tion became a major component of the incentivecompensation of salespeople, sales managers, andproduct managers.

Castle reaped rich and sustained rewards fromthese three transaction pricing initiatives. In thefirst year, average pocket price levels increased 3%and, even though volume remained flat, operatingprofits swelled 42%. The company realized addi-tional pocket price gains in each of the two subse-

quent years.Castle also received some unexpected strategic

benefits from its newfound transaction pricing ca-pability. Account-specific pocket price reporting re-vealed a small but growing distr ibut ion channelwhere Castle pocket prices were consistently high-er than average. Increasing volum e and p enetra tionin this emerging channel became one of Castle'skey strategic initiatives this past year. The freshand more detailed business perspective that Castlesenior managers gained from their transac tion pric-ing invo lvem ent be came th e catalyst for an ongoing

stream of similar strategic insights.



6 . Tech-Craft Gave a Pocket Discount o f 3 9 . 1 % Af ter W ater fa l l E lem ents^Dealer List Pricej

1 0 0 %

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2.03 ,9 ' —

Nationol 2. 7Promotion

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PocketDiscount

39 .1%

5,6Annual

Volume

Bonus

1.9g

Allowance

2. 1

Freight

60,9

P D C MP r i c e

The Tech-Craft Company Case. Consider anoth-er case - one that takes an even finer cut than theCastle example. Here, top management used boththe pocket price waterfall and the pocket price bandas broader tools. The company not only assimilatedvaluable information about its pricing policies butalso used that knowledge to m anipulate its pricingsystem and influence its retailers. The Tech-CraftCompany took the w aterfall and band and extendedthe concept, successfully applying the lessons of afinancial tool to benefit its marketing strategy.

Tech-Craft is a manufacturer of home appliances,with microwave ovens as its primary line. Tecb-Craft sells its microwave ovens directly to appli-ance retailers and a variety of m ass merchandisersand department stores. With dozens of major andminor brands available, the microwave market ishighly competitive and most retail outlets carrymultiple brands.

Very complex price structures had evolved overthe years in this competitive market. Exhibit 6shows tbe average pocket price waterfall (on a per-centage of dealer list price basis) for a Tech-Craft

transaction to an appliance retailer. The companygave a total pocket discount of 39.1 % over 11 differ-ent waterfall elements.

Research into competitors' pricing practices re-vealed that m ost com petitors' price structures werejust as complex as Tech-Craft's hut varied in fo rm -particularly off the invoice. For example, tbey var-ied by cash discount terms, co-op advertising rates,volume bonus discounts, volume break points, andfreight payment policies. Tbe variety and complex-ity of price structures made it somewhat difficultfor appliance retailers to compare microwave prices

among competitors. Further research showed thatmost retailers used just invoice price minus cash

discount as their yardstick for comparing prices,taking for granted m ost of the off-invoice item s. Soa dollar discount on the invoice had m uch m ore im-pact on the retailer's buying decision than a dollaroff the invoice.

With this knowledge, Tech-Craft managers m adea simple price structure change to one product line.They took their largest off-invoice discount - theannual volume b on us- an d shifted it to on-in voice.To do this, they estimated each account's annualpurchases at the beginning of the year, paid the vol-

ume bonus on the invoice hased on tbat estimate,and tben made an end-of-tbe-year adjustment ifnecessary. Tbe resu lt was an 11 % increase in same-store volume, not by deeper discounting but rath erby tailoring the pocket price waterfall so tbat Tech-Craft's price reflected the criterion that retailersused in comparing prices.

The result so intrigued Tech-Craft managers thatthey researched their pocket price waterfall evenfurther, discovering evidence that retailers werenot equally sens itive to price changes across all ele-ments of the waterfall. For example, they found

that retailers were much more sensitive to a $1change in the national promotion discount tban toa $1 change in the order-size discount, despite tbefact tbat they affected Tcch-Craft's pocket priceequally. Tech-Craft managers used such insightsregarding dealers' unequal sensitivity to differentpieces of the waterfall to alter their pricing ap-proach in several areas.

First, when tbey wanted to lower price to stimu-late volume, Tech-Craft managers adjusted the wa-terfall elements to which their retailers were mostsensitive-thus engendering the maximum volume

growth. Conversely, when tbey wanted to raiseprice to increase margins, they adjusted tbe ele-



TRANSACTION PRICING

7. A Quar te r l y Repor t Mon i to rsthe Water ta l l fo r Ma jo r Product

[Doliars p e r unit}

B a s e p r i c e

S ta n d a r d d e a l e r -d i s t ri bu t a r d i s c o u n t

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198904

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0.68

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0.71

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merits to which their retailers were least se nsi tive -thus m inimizin g loss of volume.

Second, over time they decreased the amount ofdiscounting in the waterfal l e lements that justdidn't matter to retailers, shifting part of that dis-counting to those elements that really influencedretailer huying decisions. By doing so, Tech-Craft

made sure it was getting the most retailer buyingpreference for its discoun t do llars.

Tech-Craft management became quite skillful inthe fine art of "waterfall engineering"-that is, fine-tuning the components of its pocket price waterfallto optimize the effect on buyer behavior. Not un-like Castle, Tech-Craft reaped rich rewards from itsnewfound skills and initiatives in transaction pric-ing. W ithin a year, the comp any had no t only grow nits unit volume by over 1 1 % but also had increasedaverage pocket price levels by 3.5% , resu lting in a6 0 % operating profit impro vem ent.

Captur ing Untapped Transac t ionPricing Opportuni ty

while the specific moves required to capture un-tapped transaction pricing opportunity can varywidely from company to company, the most usefulimprovement actions fall into three general areas:

1. Manage the pocket price band. An understand-ing of pocket price and its variability across cus-tomers and transactions provides the bedrock of

successful transaction price management. The en-t ire pricing process should be managed toward

poeke t pr ice rea l iza t ion ra thethan invoice price or l ist pricePocket price should be the soly a r d s t i c k f o r d e t e r m i n i n g t hpricing attractiveness of productcustomers, and individual deal

All price measurement and peformance gauges should he recawith p ocket price used as the basfor calculating revenues. As thC a s t l e B a t t e r y C o m p a n y c a sdemonst ra tes , consider ing busness from this pocket price viewpo in t c a n d ra s t i c a l ly c ha nge company's perspective on the reative attractiveness of segmentcustomers, and transactions.

Crea t ing informat ion systemtbat correctly measure and repopocke t pr ice i s problemat ic fomany companies. Elements of thwaterfall often reside on differe

systems or do not exist in data systems at all. Thedif f icu l t ies notwi thstanding , companies shoumake the inves tme nt to produce a correct and comprehensive pocke t pr iee ca lcu la t ion . Managemu st resist the temp tation to leave elemen ts out the waterfall because they are difficult to calculaor inconvenient to include from an informatiosystems standpoint . Effective transaction pricmanagement often requires tough customer initit ives, but incorrect or incomplete pocket price rporting gives managers an excuse not to initianecessary pricing policies.

Once a company establishes a pocket price mesure, it should drive explicit sales and marketinsteps off th e " tai ls" of the poeket price band. Excelent transaction pricers look to the pocket priband and target specific actions for the best anworst 1 0% to 20 % of transactions and customerMarketing and sales should target customers wi

transactions at the high end of the price band fincreased volume. These departments should alidentify clients at the low price end, marking thefor actions that will either result in improved prilevels or their termi natio n as custom ers.

Management should not exclude any low-pricustomers, regardless of their history or relatioship with the company, from such corrective at ions. The hard pocket price numbers must detemine wh ic h c us tome rs r e qu i re r e me d ia l p r iaction. Price band management initiatives quicklose credibility and momentum if exceptions a

made that allow favored customers to languish the low end of a pocket price band.



2. Engineer the pocket pricewaterfall. The best transactionpricers understand the leverage ofwaterfall engineering. Despite thefact that a dollar anywhere alongthe waterfall affects a company's

pocket p rice and profit equally, theTech-Craft case demonstrates thatnot all waterfall elements equallyinf luence custom er buying. Aknowledge of which pieces of thewaterfall matter to custom,ers canguide not only how a companychanges overall price and pricestructure but also how it negoti-ates with individual customers.Managers shouldn't be at all sur-prised if different sets of waterfall

elements are important to differ-ent customer segments or differ-ent channels of distribution . Salesrepresentative input can furtherenrich understanding of specific Salespeople carry the company's benefit and value

customer se nsitivity to waterfall eleme nts.Each component of a company's pocket price

waterfall deserves careful and explicit manage-ment. Top managers should set a quantifiable ob-jective for each element of the pocket price water-fall, and if that goal is not achieved, they mustchange or even discontinue that element. Too

tnany companies put in place a waterfall elementlike annual volume bonuses and leave it there un-changed, regardless of its effectiveness in influenc-ing customer behavior. The sales and marketingorganization should set hard objectives for each wa-terfall element. For example, the objective for anannual volume bonus might be to cause sales vol-ume to grow at an average of 8% annually in exist-ing accounts.

A company should take an annual snapshot ofthe results of its efforts. If it fails to m eet it s objec-tive for a waterfall element, it should either adjust

or eliminate that element. Excellent transactionpricing companies, like Tech-Craft, routinelyreengineer their pocket price waterfalls and makeeach piece of the waterfall work for the m .

3. Get organizational involvement and incen-tives right. With percentage points of return onsales in the balance, transaction pricing meritsbroad organizational involvetnent; it is too impor-tant for even the president and CEO of a business toignore. Com panies that are best at transaction pricemanagement have general managers who under-stand its importance, set specific goals for transac-

tion price improvement, and monitor those goals

through regular and concise transaction price per-formance reports.

Exhibit 7 shows a quarterly "Pocket Price Sourceof Change" report that the president of Castle nowuses to monitor the waterfall for major productlines. From it he can quick ly see changes in averagepocket price and understand the key sources of

those changes along the price waterfall. He can rec-ognize and reward pocket price improvement, ques-tion price performance shortfalls, and communi-cate to his organization that transaction pricing isimportant to him.

Deeper in the organization, superior transactionprice performance seldom occurs unless top man-agement offers appropriate incentives to key pric-ing influencers and decision makers like pricingmanagers, salespeople, sales managers, and m arket-ing managers. Individuals incur an unavoidable riskwhen they strive for higher prices from cu sto m ers -

the risk of alienating the customer or losing thebusiness altogether. It's always easier and less riskyto price low. To offset the risk of pushing for higherprice, tie incentives like compensation to pocketprice realization.

Sales force incentives based on total sales rev-enue are not enough of an inducement for salespeo-ple to push for higher prices. The pricing leveragefor sales revenue-based compensation is always outof balanc e-a 5% decrease in price, for instance, w illcause only a 5% decrease in a salesperson's com-pensation. But assuming average company eco-

nom ics, it will engendera

60% operating profit de-

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Documents

03_Managing Price, Gaining Profit