Defending Profitability With Proactive Price Management

8/9/2019 Defending Profitability With Proactive Price Management

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Taking Advantage of Tumultuous Times is a series rom Monitor ofering insights into critical issues organizations ace during this unprecedented period o

economic uncertainty, and how business leaders can use this time to seize opportunities or lasting change and growth.

As the global economy transitions through a period of unprecedented

volatility, the urge to wait out the economic storm is natural. But in

tumultuous times such as these—in which the recession coincides

with structural changes in global demographics, the spread of ubiq-

uitous connective technologies, the emergence of sustainability as a

key business issue and the blurring boundaries between commercial,

government and civic sectors which elevate expectations for corpo-

rate social responsibility—inaction is not an option. It is critically

important that commercial leaders resist the urge to hunker down and

Deending Proftability with Proactive Price ManagementBY TOM NAGLE, JOSEPH ZALE AND JOHN HOGAN

M A R G I N M A N A G E M E N T



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instead adopt a proactive stance that enables

them to protect and grow prots.

In this difcult economic period, customers are

considering lower-cost alternatives and reevalu-

ating their essential needs, and these shifts in

buying patterns are creating new winners and

losers. For example, sales of traditional PCs are

down dramatically in the recession. At the same

time, sales of lower cost (and lower functional-

ity) netbooks have jumped more than 160 per-

cent over the prior year. Importantly, many of

those customers are nding that they don’t miss

the incremental functionality of traditional PCs;

it’s fair to wonder if they will return to buying

PCs after the recession.

Just as the recession has changed customer

behaviors, it is changing the behaviors of sellers

as well by intensifying competition. For example,

Wal-Mart leveraged its cost advantage in gro-

ceries to launch a price

war in late January that

already has seen Bruno’s,

a regional chain in the

Southern United States,

le for bankruptcy.

Similarly, McDonald’s

has stepped up price-

related advertising in the

premium coffee sector to

take share from Starbucks at a time when cus-

tomers are questioning whether a latte is really

worth four dollars. As these examples illustrate,

the recession has created opportunities and

threats that companies ignore at their peril.

It would be imprudent to suggest that all com-

panies should take aggressive pricing actions

as McDonald’s and Wal-Mart have done.

Successfully navigating this recession, however,

does require a proactive approach to protect and

grow margins. In such uncertain times, business

leaders need to identify moves that generate cash

ow in the short term while also positioning their organizations for long-term prot growth.

This article will identify smart moves you can

make both internally and in the marketplace that

will help you take advantage of opportunities to

improve your competitive position—now and in

the future, so you will be in a stronger position

when the economy improves.

GROWING MARGINS

FROM THE INSIDE OUT

Even in the best of times, it is a given that com-

panies must continuously improve execution

of key business processes such as price setting,

negotiation and contract compliance. But tak-

ing control of a corporation’s pricing system is

even more urgent in an economic downturn.

While companies never operate in a vacuum,

tough times often make players more aggressive with pricing in an attempt to achieve sales goals

despite declining market demand. Recessions

increase the risk of price wars in which all sides

lose, and those conicts are often initiated by

companies executing tactical pricing moves with

no intent to spark broader price competition.

By more tightly controlling and improving the

process by which prices are set and managed,

managers can reduce the risk of inadvertent price wars, while also generating substantial

incremental prot. Our experience suggests that

focused efforts to improve price execution can

generate an incremental two to three percentage

points of operating income, even in a downturn.

These improvements come from shoring up the

SUCCESSFULLY NAVIGATING

THIS RECESSION REQUIRES A

PROACTIVE APPROACH TO PROTECT AND GROW MARGINS. IN SUCH

UNCERTAIN TIMES, BUSINESS

LEADERS NEED TO IDENTIFY MOVES

WHICH GENERATE PROFIT MARGINS

IN THE SHORT TERM WHILE ALSO

POSITIONING THEIR ORGANIZATIONS

FOR LONG-TERM GROWTH.



leaks in your pricing system to capture revenues

that would otherwise be lost in excess discounts,

unenforced agreements and inconsistent applica-

tion of pricing policies.

The key to improving price execution is to

diagnose the sources of prot leaks in your com-

mercial system and build the business case for

change. Managers often underestimate the com-

plexity of their pricing processes and as a result

don’t fully understand the drivers of undesirable

pricing behaviors and the barriers to better ones.

For example, a life sciences company had been

experiencing relatively at margin growth of one

to two percent for nearly 18 months despite the

fact the sales had been increasing at a healthy

ve percent clip during the same period.

A simple discount analysis discovered that

on and off-invoice discounts for key products

ranged from two to 75 percent with almost no

correlation with volume. Moreover, the dis-

count spread had increased substantially over the very same period that margin growth had

stalled. Subsequent investigation revealed two

root causes for the problem. First, key market-

ing managers were heavily focused on growing

market share and had essentially been buying

that share with aggressive price discounts. The

discounts were not highly visible because of the

loose, poorly controlled process for discounting,

rebating and waiving charges.

The second root cause of the disappointing pric-

ing performance was found in the sales organiza-

The management team at Tech Co., a Fortune 200 technology

manufacturer, recognized a coming recession and made aggressive

moves to use it to their company’s advantage. Historically, the man-

agement team responded to downturns with aggressive cost cutting.In this instance, however, cost cutting was il l-advised because the

company needed to aggressively support a pipeline of promising

new products when the business cycle turned. The question the

team addressed: How could the company generate incremental

operating profts to avoid critical headcount reductions that would

endanger future growth?

Tech Co. attacked the problem by focusing on price execution

improvements to identify opportunities to deliver bottom line results

by the end of its scal year. The project leaders focused on three

critical areas:

THEY PERFORMED A FAST-CYCLE DIAGNOSTIC to identify

the best opportunities to realize short term improvements. The

diagnostic mined the transaction data base and mapped key

pricing processes to identify “prot leaks” where prices were not

implemented according to policy. By analyzing transaction prices,

for example, Tech Co. was able to identify many customers that

were purchasing key products at very low prices—often resulting in

negative prot margins. This was just one of 25 potential opportuni-

ties the company uncovered in the global diagnostic.

THEY FOCUSED ON EXECUTING those opportunities with the

biggest impact and fewest barriers to implementation. Tech Co.

acted quickly to enforce pricing oors for low-margin accounts and

reducing the variability of its pricing of key products. The companyoffered a price discount for online orders, restructured contracts to

minimize special price breaks, and established rates for premium

service delivery and the charge for a minimum product order. Tech

Co. gave customers three months to transition to the new pricing

model, to minimize the loss of customers to rivals.

THEY IDENTIFIED CRITICAL ENABLERS to ensure the changes

created lasting impact. The management team wanted to ensure

that any changes in their pricing processes would be long lasting

and form a solid foundation to support the company’s upcoming

product launches. They ensured that every improvement was

embedded in the organization by ensuring that the necessary data,systems, incentives and processes were in place so that pricing

decisions would be made consistently throughout the organization.

Through these efforts, Tech. Co. identied millions of dollars in addi-

tional operating income by focusing on internal improvements to their

pricing process. Moreover, the effort created awareness of pricing as

a strategic growth lever.

TECH CO. MOVES FAST TO IMPROVE PROFITABILITY



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tion. The long-time sales strategy was to build

deep relationships with customers to become

a trusted provider of solutions to their most

pressing technical challenges. The goal was to

make price less important in the selling process

to enable higher prices and volume. The reality

was that over time, sales people developed close

personal relationships with their customers and

often felt obligated to provide their closest cus-

tomers with the best prices. Thus, as marketing

gave deeper discounts to win new customers, the

sales organization responded by ensuring that

their relationship accounts got even better dis-

counts to protect their preferred status.

This example is but one of the opportunities that

the life sciences rm discovered as it began to

identify and seal the leaks in its pricing execution

process. A detailed analysis of the company’s

pricing discount practices, combined with an

analysis of its sales organization to identify root

causes for its poor pricing performance, enabled

the company’s leaders to build a robust business

case for the size of the opportunity. In the end, the rm was able to reverse the margin declines

while maintaining its sales volume growth.

GROWING MARGINS IN

UNFRIENDLY MARKETS

The economic downturn has led buyers, both

end consumers and business customers, to

change their purchasing behaviors in notable

ways. Customers are more price-sensitive and willing to shop in new channels for the goods

and services they need. They are willing to do

more to secure better deals while taking a hard

look at their needs and wants. These shifts in

customer behavior, combined with an analysis of

what your competitors are doing (or not doing),

present opportunities to gain share and margin.

Here are three strategies that will help you nd

market openings in a recession:

1. Increase Category Spend through

Precision Discounting

Recently, select Hyatt hotels implemented a new

discount program targeted at local residents,

offering substantial discounts for dinners in their

underused restaurants. While hotel guests con-

tinued to pay regular rates, the hotel was able to

bring in more customers to dine, thus covering

xed operating costs and building brand recog-

nition in the local community.

The power in Hyatt’s approach is that it

accounted for the fact that, even in a downturn,

not all customers are highly price sensitive. The

management team could simply have dropped

prices in their restaurants, but that would have

cut prots for the business travelers staying in

the hotel who are less concerned about prices.

Instead, Hyatt used a laser-like focus to identify

a growing segment of price sensitive custom-

ers and then designed a discount program to

ensure only those customers got lower prices.

By analyzing price change and sales volume

data, a pricing organization can determine which

customers deserve discounts and which should

be paying the same or more. The key mistake

to avoid is to assume that all customers will

respond to price cuts in similar ways. Instead,

take a segmented approach that accounts for

changes in price sensitivity as well as changes in

desired value.

2. Leverage Competitive Advantagesto Take Share

McDonalds entered the premium coffee cat-

egory in late 2006 with the belief that it could

take share from coffee powerhouses such as

Starbucks and Dunkin’ Donuts. McDonald’s fol-



lowed a seemingly infallible approach of improv-

ing its product quality at signicantly lower

prices than Starbucks. Surprisingly, McDonald’s

coffee sales were disappointing through 2007

and into 2008 despite heavy investments in

advertising to support the effort. That changed

in the fourth quarter of 2008 when sales surged

as increasingly price sensitive customers recon-

sidered the price-value ratio of their morning

brew. As Starbucks is slated to close 600 stores

in the United States in 2009, McDonald’s is

accelerating the global launch of lattes to lever-

age the emerging opportunity.

It would be easy to dismiss McDonald’s aggres-

sive price moves as simply being in the right

place at the right time. But that perspective

would overlook McDonald’s inherent advan-

tages that ensured it would succeed in its share

grab. First, McDonalds was able to leverage

its position as a small market-share competitor.

When it cut prices on a high margin product like

coffee, McDonald’s knew that it only needed

to capture a few percentage points of share in

order to increase prots. In contrast, Starbucks

position as a market leader placed it at a dis-

advantage because it would have to cut prices

across nearly 50 percent of the market in order

to respond to McDonald’s moves.

A second advantage that McDonalds lever-

aged was related to brand equity. Starbucks has

invested heavily to build its brand around deliv-

ering high quality coffee in a relaxing environ-

ment. Much of that investment would be lost if

Starbucks chose to compete on price instead of

value. Combined, these advantages are enabling

McDonalds to take share from Starbucks with-

out signicant risk of retaliation. Although not

all aggressive price moves are winners, the struc-

tural changes caused by recession can uncover

opportunities to improve your market position

if you are able to spot them and leverage your

advantages to press the attack.

3. Strategically Unbundle to DefendAgainst Aggressive Pricing

In the 2001 recession, Distributor Co., a lead-

ing technology distributor in the U.S., found

itself losing share to a small competitor that was

competing largely on price. As the economy

worsened, the share losses mounted and spurred

an internal debate within the company about the

best response. Many senior managers advocated

for a broad and aggressive response that would

leverage Distributor Co.’s signicant economies

of scale to compete aggressively on price. Others

argued for a more measured response that could

deect the attacks without broadly undercutting

margins across the board.

To resolve the debate, Distributor Co. conducted

a careful analysis of customer business models

and value to better understand what custom-

ers valued and were willing to pay for if asked.

The results of the study were compelling. The

management team learned that most of the sales

losses came from a growing price-sensitive

segment whose business model relied primar-

ily on efcient logistics and breadth of supply.

Distributor Co.’s unsurpassed customer service

and technical support were not valued by this

segment and, not surprisingly, they were not

willing to pay a premium for it.



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The solution was straightforward once the

problem was clearly dened. Distributor Co.

unbundled its high value solution to create a

lower price, lower value offer for the price-

sensitive segment (see table above). This

approach enabled them to compete aggressively

on price against the smaller competitor and do

so protably because of the lower cost of the

unbundled offering. The power in the approach,

however, stemmed from the fact that the aggres-

sive pricing was not attractive to Distributor

Co.’s other customers whose business models

relied on quality technical support. For these

customers the added value of the technical sup-

port far outweighed the incremental price they

had to pay.

A STRATEGIC APPROACH

TO PRICING PAYS OFF

From our experience, it’s clear that a stra-

tegic approach to pricing can generate sig-

nicant returns, even in a recession. Those

returns may take many forms including higher

prices, lower discounts and increased volume.

Success requires organizational commitment

and thoughtful leadership to see an enterprise

through tumultuous times. And those that make

it through the downturn will have strengthened

their position when the recession ends.

SUCCESS FOR DISTRIBUTOR CO.: A REDESIGNED OFFER AND POLICIES THAT ENFORCE VALUE-PRICE ALIGNMENT

Discount Option Standard Option FullService Option

Pricing > Lowest Price Competitive Price Premium Price

Ordering > Must order onli ne Can use any method o ordering Ca n use any method o ordering

Fulfllment > Within two business days Within one business day Same day

Handling Fee > For orders le ss than $1000 For orders less than $500 For orders les s than $100

Freight > All reight expenses chargedFree reight or ordersmore than $2000

Free reight or ordersmore than $1500

Presales

Tech Support> Not included

Requires minimum purchaseo $50K per quarter


Postsales

Tech Support> Not included Not included


Financing > At order 30-day net terms 30-day net terms

Sales Support >Available or complexorders only

Available or placement pricing,availability, and order verifcation

Available or placement pricing, availabil-ity, and order verifcation



Copyright © 2009 Monitor Company Group Limited Partnership.

All rights reserved. Reproduction in whole or part is prohibited

without permission.

www.monitor.com

About Monitor works with the world’s leading corporations, governments and social sec-

tor organizations to drive growth in ways that are most important to them. The

frm oers a range o services—advisory, capability-building and capital services—

designed to unlock the challenges o achieving sustained growth.

About TOM NAGLE

About JOSEPH ZALE

About JOHN HOGAN

Tom Nagle is a partner at Monitor and founder of the Strategic Pricing Group, Monitor’s com-

pany focused on pricing and value capture strategies. Dr. Nagle is a frequent keynote speaker

and former professor of marketing and strategy at the University of Chicago and Boston

University. He is the author of the bestselling book The Strategy and Tactics of Pricing, and

has published in MIT Sloan Management Review and Harvard Business Review . E-mail him

at [email protected].

Joseph Zale is a Partner and Global Account Manager in Monitor Group, where he leads

the pricing strategy practice. Prior to joining Monitor Group, Joe was a Vice President and

Managing Director at Strategic Pricing Group (SPG), which was acquired by Monitor Group

in 2005. Joe has worked across multiple projects in a diverse set of industries including

medical products, data services, basic materials, capital equipment, publishing and print-

ing, and semiconductors. E-mail him at [email protected].

John Hogan, co-author of The Strategy and Tactics of Pricing 4th ed., is a recognized

thought leader on the topic of strategic pricing and building pricing capabilities within the

firm. As a partner at Monitor Group and leader in the strategic pricing practice, John has

worked with clients to develop more effective pricing strategies in technology, software,

distribution, manufacturing, financial and professional services, and pharmaceutical sectors.

Taking Advantage of Tumultuous Times is a series o articles rom Monitor oering

insights into critical issues organizations ace during this unprecedented period.

Today’s economic uncertainties, combined with multiple, signifcant and disruptive

orces, change the nature o industries and competition across the globe. The articles

explain how business leaders can seize opportunities during these times or lasting

change and growth. Read more at www.monitor.com/tumultuoustimes.

Defending Profitability With Proactive Price Management

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