Want profits to endure? Think differently about pricing
November 15, 2022
What’s the most powerful action CEOs can take to improve profitability? Increase sales? Reduce fixed or variable costs? Cut down on expenses?
While changes in these areas can improve margins, pricing has the biggest impact on EBIT for B2C and B2B companies. Despite whatever you may believe about competition and demand pressures, I tell CEOs that with the right data-driven approach to pricing, they can protect and grow customer share of wallet, optimize product portfolios and drive sales across channels. These outcomes are especially critical today.
The ongoing effects of the pandemic, the war in Ukraine and supply chain disruptions have all contributed to high inflation, with record-breaking rates in some regions. The Producer Price Index in the United States rose 8.5% from September 2021 to September 2022—a dramatic jump in the cost of producing goods. Amid such uncertainty, consumer sentiment and purchasing behaviors are not only shifting, in some cases people and companies are spending more. Which can be paradoxical, as people make trade-offs to reconcile their own values with practical realities.
In response to tight margins and unclear demand signals, 73% of executives are already implementing or planning cost transformation initiatives. But cost initiatives alone won’t solve for consumer spending shifts from non-essentials or premium brands to mid-tier or budget brands.1 You must assess pricing related to product value within the overall commercial offer context, which is key to minimizing erosion while expanding margins.
Even without the cumulative effects of disruption, most companies are long overdue to rethink their commercial strategies—and pricing is a critical part of that. Name the industry, and we’ve seen tremendous unexplained pricing variability, margin erosion and revenue leakage.
While previous cost pass-throughs to customers or channel partners were relatively effective, today’s market disruptions and unique consumer sentiment require more targeted pricing changes. To make informed decisions about pricing – regardless of cost increases – companies need to systematically address their pricing strategy with a data-driven approach.
But here’s the catch.
The business environment is so volatile that there’s no time to wait for a holistic multi-year pricing transformation. But you can’t address pricing in isolation. Companies should take a precision approach to pricing within the broader context of the existing commercial strategy. To rapidly realize pricing strategy benefits, we recommend five fundamentals for quick wins and sustained impact.
1. Know your costs. Cost visibility gives you the opportunity to make deliberate decisions on pricing so you can manage margins. Analyzing internal, market and benchmarking data allows you to pinpoint how direct material and production costs flow to specific products and compare to market levels. It can reveal which products are most affected by higher costs or are putting strong pressure on margins. At the same time, pricing strategies should incorporate future cost shifts. Imagine if a company knew the cost of a specific raw material was expected to go up by 5% over the next six months. Decisionmakers can identify which products are impacted—and what actions to take to protect margins.
2. Truly understand customers. Companies that develop pricing strategies based on assumptions about how customers once behaved will be caught flat-footed. The whole commercial offer must be grounded in how customers behave now, their buyer values, and willingness and ability to pay. And companies should continually reassess pricing and everything layered around it as needed. It’s a portfolio approach to address customer needs by calibrating the value exchange.
3. Optimize the commercial offer. Strengthening the commercial offer involves addressing pricing variability to capture value by correcting mispricing independent of inflation impacts. Low-risk, natural price corrections can go a long way in alleviating cost pressures. Our client experience reveals that it can lead to a 10–20% bottom-line impact, if not more. Also, a surgical approach to curating the whole commercial offer is key. This means evaluating everything from promotions and product-service bundles to discount decisions.
4. Execute with precision. Companies struggle to execute pricing guidance at the point of sale. Sometimes, it’s a technology issue. The right pricing must flow properly through systems. Other times, it’s a disconnect with sales and marketing teams. It can also be a human issue, as sellers look for workarounds to soften the impact of higher prices. While governance structures and price thresholds are important protections, seller enablement programs to ensure compliance address the “human” risk here.
5. Shore up revenue leakage. Protecting margins is a matter of “good housekeeping.” For example, payment terms are big margin eroders for B2B companies when customers don’t comply, especially with the cost of capital rising. By buckling down on contract compliance, companies can maintain current margins, even with locked-in contracts. For B2C companies, it’s key to avoid giving away things that customers value a lot. This comes back to understanding customers’ willingness to pay.
Companies that address these fundamentals are seeing results. Consider the specialty chemicals company with a complex operating model and a heavy reliance on raw materials. Every business unit approached spend and pricing solutions differently. By working through these five pricing fundamentals, the company uncovered the potential to generate more than $200 million in EBITDA in nine months to a year through improved procurement and pricing.
When leaders ask how to get results like this, the first thing I tell them is the CEO must take an active leadership role in pricing strategy—and the initiative must be multi-disciplinary. I also remind them that pricing isn’t monolithic. Success in pricing is informed by customer behavior and targeted offers that align with it. Knowing this, CEOs can take full advantage of the most powerful action to improve profitability.
1 Accenture Global Consumer Pulse Research, Q2 2022