Unlocking the price side of the business has taken on a sense of urgency given the mounting layers of overheads plus the rise in product costs. This has led to the emergence of the ‘pocket pricing’ strategy.
Effectively implementing a pricing strategy is more than simply viewing products on a cost-plus basis, according to Deloitte in a report on August 1. It is also more than tracking pricing performance at the aggregate level.
Instead the promise of pricing is in the details, notes the firm.
“An effective strategy should rely on understanding economic profitability at the customer, product, and segment level—the ‘so-called’ pocket margin—and using that information to inform overall decision-making,” said Richard Hayes, principal at Deloitte Consulting. “To get to that level of detail, though, may require overcoming cultural, data, and compensation barriers to determine pocket costs.”
In fact, research has shown that pricing has up to four times more impact on profitability than other improvements, notes Deloitte.
The firm has started to see increased interest in corporates tracking pocket margins. For example, three-quarters of chief financial officers (CFOs) reported that their finance organisations were at least moderately involved in tracking and reporting pricing performance and profitability.
“It is the customer-level economic profitability that can offer an untapped reservoir of information—and potential for improved margins,” said Hayes. “For example, which customer segments are being given unwarranted volume discounts; which are unaffected by slight price increases; and where are delivery promises being made that materially increase transaction cost, but are not charged for?”
To get at that level of information, however, may require moving past the aggregate view of pricing –gross margin, net margin – that finance typically demands to the “pocket” view that takes into account everything from payment terms to freight costs in order to identify the true profitability of a transaction.
Leveraging pocket information
While the analytic tools exist to identify costs at a pocket level, the data is often widespread and incomplete, and frequently siloed, notes Deloitte.
For example, sales executives typically worry about revenue and the commissions associated with it; supply-chain professionals care about containing fuel and other factors; manufacturing wants the lowest unit costs; marketing focuses on which discount campaign to offer next; and all are concerned with optimising their particular piece of a product’s life cycle.
But to fully assess pocket costs, the finance department should identify the components that add or subtract value from the business on a marginal basis.
“Those include factors that are not part of cost of goods sold (COGS), such as expedited shipping, fixed-asset or fixed-cost productivity, the cost of capital included in payment terms, and the various discounts and promotions offered,” said Hayes.
One effective tool to identify those factors is the price waterfall, highlights Deloitte.
“Working backwards from the list price, CFOs can use the tool to identify margin leakages and create visibility from a reference list price down to the pocket margin, including discounts, rebates, and other cost elements,” added Hayes. “Moreover, the visual representation makes comparison with competitors very easy—and offers convincing proof of where price erodes in the multiple steps between making and delivering a product.”
Such an exercise also allows finance to match revenue and costs for individual transactions.
While a product that earns 40% margin may look like the a winner in the product portfolio, if it turns out to be highly engineered and highly specialised, and requires extra sales support, it may not be, notes the firm.
Instead, it may be the product that earns 20% margin and only has to be packed and shipped, which is the item that the company should invest in.