The Hindu Business Line : Reward salesmen for deal-by-deal pricing

ONE OF the first formulae we learnt in school was SP minus CP equals profit. It seems we forgot the importance of price after solving problems, because a new book from Wiley Finance (www.wileyfinance.com) states that pricing remains one of the most misunderstood and under-managed functions at many companies that are otherwise high performers.

"Even thoughtful general managers feel helpless to make real progress on the pricing front," is a castigating line from the preface of The Price Advantage, by Michael V. Marn, Eric V. Roegner and Craig C. Zawada, all of McKinsey.

So, what's the problem with our managers? "They do not even know where to begin to get a handle on identifying — much less capturing — the exciting performance upside that pricing so often holds."

To illustrate the leverage of price, the book has a graph on `the power of 1 per cent' in a sample of 1,200 companies around the world: a 1 per cent rise in price moves operating profit by 11 per cent. So, `recalibrate your thinking' if you had your eyes on cost.

"A 1 per cent decline in variable costs results in a 7.3 per cent increase in operating profit," and this is the lever most companies have been pushing hard and harder. One could be more foolish chasing cuts in fixed costs because a 1 per cent improvement in that department caused only a 2.7 per cent increase in operating profit. How about the volume lever? "A 1 per cent increase in unit sales volume, while prices and per-unit costs are held constant, results in a 3.7 per cent increase in operating profit."

There are three levels of price management, authors would state, and these are: industry strategy, product/market strategy, and transaction. The first two are self-explanatory; and transaction level is "deciding on the exact price to assign to each and every customer transaction. This is `the most granular level': "Transaction pricing is a game of inches where each day hundreds or even thousands of customer-specific (and even invoice line-specific) pricing decisions determine success or failure, where companies capture or lose percentage points of profit margin one transaction at a time."

Ask around in your company whether senior managers show "an interest to understand what is really going on at the transaction level", or are they happy with MIS reports that "shed no real light on pricing opportunities missed transaction by transaction." Another flaw you may commonly notice is the reward system for sales personnel — based on total sales volume, rather than "deal-by-deal pricing excellence".

Don't concentrate only on list price or invoice price but look at `pocket price' arrived at by subtracting transaction-specific, off-invoice items from invoice price; thus, pocket price refers to "the revenues that are actually left in a company's pocket from a transaction to cover costs and contribute to profit."

In a different chapter, the authors draw attention to `mapping value'. Value is one of the most overused and misapplied terms in marketing and pricing, they state.

Try this simple equation: value = perceived benefits minus perceived price. Then, with a paper and pencil, draw VEL, the value equivalence line. A key economics input you would need is `price elasticity', before you can calculate `the zone of indifference', within which your price can make little dent to volume. Beware of big numbers because they can make buyers sceptical: "A price can get so high or so low that it breaches the zone of credibility."

Separate chapters discuss new product pricing, post-merger pricing, price wars, technology-enabled pricing and legal issues.

Message of the book is straight: "Don't react to market and competitive prices but manage pricing actively." Because, it is worth the effort.

BooksOfAccount@TheHindu.co.in

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