Do You Have a Pricing Playbook?

 

The Problems

After a prolonged period of higher than historical average inflation, including large increases in many “core” input costs, you might reasonably think that most companies would now have a better understanding of their cost structures, track and monitor changes more closely, and know what to do with regards to pricing (in order to protect revenue and profitability) when they experience new and additional cost changes.

But based on many recent experiences with small ($1M to $100M) to medium (>$100M to $1bM) sized businesses, which make up a sizable part of the US economy, if you thought this, you’d unfortunately be wrong.

Working with clients of this size over the last few years, we’ve seen some reoccurring issues:

• Insufficient data and subpar financial and business reporting, hampering correct and timely decision-making.
• Not increasing prices enough to sufficiently cover the impact of cost increases on their bottom lines.
• Raising prices in ways that hurt versus help long-term revenue and profitability.

Pricing is Simple, Right?

Rising costs? Raise prices.

Cut costs. Capture value.

Train and reward the sales team for adopting the right behaviors.

We know these tactics work in concept, but in reality, it is never that black and white, and making the right decisions takes time and a lot of effort.

Wouldn’t it be nice to have a “pricing playbook” that provides clear direction on how to adjust pricing quickly, and in ways that truly address underlying challenges and revenue and profitability goals while reducing some of the work?

This playbook would provide step-by-step guidelines to address key profitability challenges based on the scenario at hand so that you could navigate changes and complexity strategically, confidently, and backed by data.

Based on recent work we’ve done for some of our clients, developing such a playbook is possible, and not as hard as it sounds.

Developing Your Own Pricing Playbook

To get you started on your pricing playbook journey, we’ve compiled a handful of practices that will help your pricing decision making, based on changes to your costs, that support revenue and profit margin growth when rising expenses and volatile markets are at play.

Practice 1 | Understanding Price Increase Economics

Common mistakes when implementing a price increase include:

• Not understanding the economics of a cost increase
• Progress vs. perfection
• Failure to make a timely call
• Communication vs. negotiation
• Lack of preparation
• Not being resolute
• Not tracking price execution and realization

There is a lot of complexity that goes into executing any price change, from organizing and aligning your sales team through to managing customer expectations and ensuring that your actions will deliver the desired results, with minimal unintended consequences.

This all starts with understanding the economics of cost increases and how the results of proposed price increases will translate directly to the bottom line to ensure profit margins stay on track.

Consider the table below, which illustrates a scenario where costs go up 5%:

	Base Case	Scenario: Costs Go Up 5%	Pass Through: “Simple” $	Pass Through: Same %’age
Revenue	$500	$500	$513	$525
Cost	$250	$263	$263	$263
Gross Margin	$250	$238	$250	$263
Margin %	50.0%	47.5%	48.8%	50.0%
BPS Impact	.	(250 bps)	(122 bps)	0 bps

 

While many companies aim to “pass through” the dollar impact of a cost increase via pricing increases (in this scenario, $13) in order to maintain total gross margin dollars at $350, the net effect of the “simple” pass through is a decline in margin percentage of 122 basis points.

However, only when the pricing pass through is at the same percentage as the cost increase, is margin maintained at 50%.

This may sound simple, but a surprising number of businesses do not look at cost pass-throughs in this way, thereby damaging gross margins in the process.

Is this what you are currently doing?

Practice 2 | Optimizing Price Increase Strategies

Not all cost increase factors are made equal, and yet many organizations adopt a default strategy or typical approach no matter what the cost increase driver is, when alternative strategies and approaches might be better.

Consider the table below, which outlines different cost increase factors, and “typical” versus alternative approaches to resulting price increases:

	APPROACHES
COST FACTORS	TYPICAL	BETTER	BEST
Raw Materials	Historical Averages	Replacement Cost	Replacement + Indices View
Labor Rates	Historical Averages	Based on New Rates	Based on Projected Wages
Freight Expenses	Use Estimates	Use Actuals (Spot Rate)	Use Actuals and Pass- through Margin
Capacity Utilization	Not Considered	Price Adjusted based on Capacity	Capacity Factored into Pricing
Time Estimates	Estimated	Estimated, with Contingencies	Track Actual vs. Plan
Supplier Increases	Pass through $’s with 30-day notice	Pass through % and immediate (contract)	Immediate Pass through % + markup

Does your organization tend towards a typical approach, or do you consider alternative strategies?

Practice 3 | Addressing Backlog and Customer Portfolio “Role” and Profitability

If your company is experiencing a backlog of customer orders due to an increase in demand and / or a decrease in supply or resources, there are a few actions you can take now to help mitigate capacity constraints.

Likewise, when is the last time you assessed the “role” of each of your customers in your portfolio to understand (a) their profitability and (b) their impact on your resource utilization, cost structure, and operations?

Consider developing a customer “role” scorecard for the majority of your current portfolio (we recommend an “80 / 20” approach), similar to the example below:

CUSTOMER = ABC Inc.
	LOW	NEUTRAL	HIGH
Revenue	X
Potential Spend			X
Profit Margin			X
Relative Profitability			X
Share of Business	X
Tenure of Relationship		X
Ordering Behavior	X
Competitive Alternatives		X
Impact on Cost Structure		X

Undertaking this exercise may well deliver some very interesting and powerful insights on which customers to focus on for growth, what role each customer has within your business (i.e., their impacts on revenue and profitability), and where sales, marketing, and operational time and effort may best be invested.

Likewise, from a pricing perspective, this exercise will likely show that you do not necessarily need to increase pricing across the board and indicate how you could be strategic with prices increases, by product / service offering and customer, to drive better overall revenue, profitability, and customer “mix.”

Do you do this type of exercise on a regular basis?

Execution is Key

You can have the best strategy in the world, but execution is where the money lives.

Unfortunately, we’ve seen too many companies attempt to increase prices, yet suffer unintended consequences, including achieving zero net benefit to their top or bottom lines, and negatively impacting long-term relationships with key customers.

To counteract this, as well as helping them develop data driven rationales, backed up with supporting tools, we’ve worked with clients to empower their teams, communicate, engage, and establish buy-in and understanding (both internally, and with customers), and to measure activity to ensure the desired outcomes are achieved.

Conclusions

If you aren’t sure about the best route for managing pricing within your business, contact Core Catalysts to quickly assess where you might be losing money or missing opportunities, and then help you identify the best paths forward to manage and even increase your revenue and profit margins.

–Mark Jacobs, Client Service and Delivery