Five quick hits in business-to-business pricing
Pricing is the practice of setting and getting the prices that reflect the value of your products and services. In this article, we will zoom in on pricing’s direct effect on profit and present you with five quick hits in pricing that are certain to impact the bottom line.
Pricing has both an indirect and direct effect on profitability. The indirect effect is through the price’s inverse relationship with turnover, known to economists and pricing professionals as the demand curve. This is the willingness to buy more units when the prices are low. Conceptually easy to understand, but notoriously difficult to estimate precisely.
The realised price also has a direct effect on profit. Any increase in price impacts the profitability undiluted, i.e. a price increase of 2% will yield a profitability increase by 2% or more.
The power of pricing is undeniable and perhaps even “the single most important decision in evaluating a business”. Pricing improvement projects are often focused on delivering sustained value over a long period of time, considering multiple dimensions, attempting to optimise for both the direct and the indirect effects – which, in most cases, takes a substantial amount of time to materialise.
In this article, we will zoom in on pricing’s direct effect on profit, presenting five quick hits in pricing that are certain to impact the bottom line. We are not arguing that the indirect effect should be disregarded. Demand curves and marginal profit optimisation are important to master for any pricing excellence professional. Instead, we want to highlight that pricing can be a fast (and very effective) route to improved profitability, and if implemented carefully these five quick hits in pricing will not affect the demand curve.
With ten years’ experience in price excellence consulting, we are yet to come across a business-to-business company that could not implement at least one of these quick hits to achieve fast impact.
For your customers, the goods and services create zero value when sitting in your warehouse. Therefore, freight is an integral and value-creating part of your business, and hence you should charge for it.
It is not uncommon for companies to grant large hidden discounts by giving away freight for free, even on very small orders. We typically see this, because it is easy for salespeople to give away something that is not the core product – and that they are not measured on. Although easy to follow, the reasoning is wrong: A core product that is not delivered is no product at all. Value is created only together with the freight, and thus it is just as important as the product itself.
If you are operating in an industry where the de facto standard is to give away the freight for a “full truck load”, then see if you can change the standard (perhaps you have a large share of the total market and can shift the perception of what is normal). “It has always been done this way” is a poor excuse.
How to get started: It is easiest to introduce the new freight policy at the same time as you do an update to your price list or other commercial terms. You could also introduce it mid-term saying that you need to charge for it to keep up the service level. Just remember that your customers probably have a feeling for what the cost of the shipping is on the open market, so do not exceed that without a very clear rationale.
Make sure to set a rule in your ERP system so that the freight cannot be given away. Also remember to follow up on the prices after the introduction of freight charge to make sure that it is not given away as a discount on the products.
For anything sold “by the metre”, changing the unit used when invoicing can have a substantial and immediate impact on profit. On anything from professional services such as dentistry or journalism to selling electrical wires, reviewing the unit of measurement used to calculate the invoiced price can reveal price increase opportunities.
Suppose your company performs a service where the standard operation takes 45 minutes. It could be anything from fixing a tooth to writing a draft of an article. Instead of invoicing three-quarters of an hour at your hourly rate, change your terms to “commenced hours”. Getting paid for the commenced hours is equivalent to a 33% price increase.
This method can also easily be applied to physical products such as electrical wires or floor tiles. Setting the unit of measurement to metre, as opposed to centimetres, will get you 11% extra for all orders of 90 centimetres.
How to get started: As with all new pricing initiatives, it is easiest to introduce updated terms to new clients. Depending on your customer acquisition speed, this implementation tactic could take many weeks or months to materialise.
One trick that could ease the introduction of the new terms to existing clients is to get the sales team to refer to a new setting in the ERP system that only allows them to sell full metres.
Few things erode profit margins like handling small orders manually. Especially if you are operating at a normal manufacturing gross margin of 30-40%. Adding to the extra cost, a manual process often results in errors which must be corrected and/or credited. To ensure that those orders become at least margin neutral, you should introduce a “small order fee”.
The size of the fee and the threshold of what constitutes a “small order” varies, but we have seen many business-to-business settings where an order handling fee of €40 to €60 has been accepted.
How to get started: Since the fee is avoidable for most customers, it can be introduced by an informative letter. In the cases we have seen, customers generally accept the fees, because they can avoid them by changing their purchasing behaviour. However, you should expect some noise when you introduce it and arm your sales force with one or two strong counterarguments: There is a clear cost argument which most customers cannot deny.
To lock it down and create the impact on the bottom line, make sure to set the fee as a default in your ERP system when you are processing orders below the threshold. Also make sure to monitor the development in realised prices on the products and services to avoid the fee translating into increased discount levels of the products.
We know it is simple – yet all too often, it is forgotten: updating prices in your system. Many companies grant customer-specific discounts that depend on last year’s volume, or a volume that was agreed when the initial supplier contract was signed. However, few of these companies have installed a formal process that updates prices and commercial terms each year, leading to the fact that it is forgotten or poorly executed.
How to get started: Identify all your customers who have a contract where the discount is dependent on last year’s volume and check how much they have purchased in the current year.
If it is obvious that the customer will not be buying the committed volume in the current year, adjust their discount (and prices) accordingly. Conversely, if the customer is eligible for a better discount, you should change that and make sure that they become aware of it. Pricing is not about having the highest price but about having the “rightest” price.
If you do not have a “list price minus discount” system but individually agreed prices for each customer and product, review those contracts and update the prices in the system where applicable. Remember to put an index clause into any new price agreement so that you can increase the prices year over year.
This price change should be communicated straight to each customer with a reference to the agreement and associated volume requirements. Since the new prices are according to a contract, the customers should not be overly disturbed.
In the business-to-consumer arena, a lot of focus is spent on the actual price point. We are all familiar with the psychological effects of €9.99 being perceived lower than €10. Strangely enough, not many business-to-business companies seem to care about those important details for the actual price points. We argue that business-to-business companies should pay at least some attention to the actual price points. Not to make them “more appealing to the eye” but to increase the price and profit. One example of this applies to organisations that have many stock keeping units (SKUs). Rounding up from €98.00 to €100.00 can make quite a difference on the bottom line without many customers even noticing.
How to get started: Start by identifying what different price points you have in your price list. Then define your new rounding rules. They should be different depending on the size of the price, for example, rounding up the cents on a €100 price tag will not make much of a difference, whereas going from €2.45 to €2.50 increases the profit by 2%.
Once you have defined your new rounding rules, calculate the new prices and update your price lists. Since these price changes are small, and the total effect varies greatly with the product mix, the best way to introduce it is gradually when a customer buys a new product. This will ensure an effect in the long term while decreasing the risk of upsetting customers who are used to buying at a certain price.
Do you think this quick hit would work in your business? Or have you already tried it? Please share your experience in the commentary field on the original LinkedIn post.
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If you think that any of these quick hits would give a positive effect on your profitability, go ahead and try them! If you want to discuss them further, feel free to contact any of us in the Pricing and Profit Optimisation team for a chat.
Implement Consulting Group