Are The Costs Of Poor Pricing
Weighing Down Your Financial Results?
[GUEST COLUMN] Barrett Thompson
Is there financial waste in your business as a result of poor pricing practices? By waste we mean revenue and profit leakage related to pricing. Most commercial leaders have a hunch that pricing leakage occurs, but how
do you discover where and how much it is draining from
your income statement?
If you have this concern, but have not attempted to
quantify the problem, a practical first step is to do a “
pricing diagnostic.” At my company, we’ve spent more than a
decade working with industrial distribution companies in
an innovative area called Pricing Optimization. Before we
consider whether such a quantitative approach is warranted, we first evaluate a company’s current pricing practices
using a series of diagnostic tests similar in purpose to those
that doctors perform on patients and mechanics perform
on cars. The goal is to understand where and to what
extent systemic pricing problems exist, and estimate the associated costs. In this article, we’ll discuss a few of the most
common areas of pricing waste and how their costs can
ripple through into overall business performance.
Laggard Loss: Slow Quoting Hurts
One of the most intuitive, yet pervasive costs of pricing
problems stems from being slow to quote. Why does such
an obvious problem exist so widely? Because most companies wait until a quote comes in or a negotiation is underway before they determine what price they are willing to
accept. Reacting to deals, by definition, takes longer than
having the answer predetermined. Take a typical branch-based distribution business such as automotive parts.
Mechanics have their top three distributors on speed dial
so that when they need a part, they can quickly call with
two questions in mind: availability and price. Often, the
counter rep is unable to immediately offer a discount
that’s aligned with the customer’s price expectation, and
thus has to go through an approval process for a lower
price. The supplier with the fastest price response time,
other factors being equal, wins. If, on average, suppliers
take an hour or two to call back, imagine the sales upside
for the company that could consistently quote a market-aligned price instantaneously.
To quantify the cumulative cost of this waste, let’s take
a fictional $500 million parts distributor. Its first call-to-close ratio is 60 percent, the distributor pursues half of
the other inquiries for price override approval, and of
those only one in four closes. In effect, the close rate
drops from 60 percent to 25 percent on override approval
deals, and those that are won require more selling time
and yield lower margins. With the winning answer immediately available at the counter, we’ve seen companies
dramatically reduce the occurrence of overrides. In our experience, achieving a 10-point improvement to 70 percent
first-call close is achievable. Based on typical broad-line
margin rates, eliminating approval waste can stop tens of
millions of annual price leakage and also have a material
effect on market share.
Mistakes & Misalignment: Errors that
Impact Customer Relationships
Mistakes happen, especially when you continually do
something complex. While pricing mistakes can happen
for a variety of reasons, one way to diagnose them is by
looking at rebills. Let’s take a look at the size of waste
associated with such pricing mistakes.
Companies tell us that rebills as a percent of sales are
increasing. This is likely a result of three factors. First,