The Pricing Success Formula
Two customers can pay the same list price and contribute very different margins. Freight, rebates, payment terms and the cost of serving each account explain much of that difference. Start the pricing review with what the business earns on the deal.
Reconstruct the price the business actually receives
Take twelve months of transactions. For each concession, record its value, who authorised it and what the customer agreed to do in return. Comparing promised volumes with orders received can reveal a discount that continued after the original reason for it disappeared.
| Concession | What to check |
|---|---|
| Volume discount | Compare the volume the customer agreed to buy with the orders it actually placed. |
| Early payment discount | Check whether enforcing the existing payment terms would achieve the same result. |
| Free freight | Review the cost of frequent small deliveries. A freight charge may encourage customers to combine orders. |
The profit effect of a 1% improvement in each lever
For a company with average economics in the study cited below, a 1% price improvement increased profit by 11.1%. A 1% increase in sales volume increased profit by 3.3%.
- Pricing
- 11.1%
- Variable cost
- 7.8%
- Volume
- 3.3%
- Fixed cost
- 2.3%
Company with average economics. Source: Managing Price, Gaining Profit (Marn and Rosiello, Harvard Business Review). Reproduced from The Pricing Success Formula, page 3.
What the commission rate missed
A mobile network paid relatively low commissions to some online distributors. Their customers also bought lower-value contracts, left sooner and were more likely to leave unpaid bills. The apparent saving on acquisition cost concealed the difference in lifetime profitability.
The operator changed its channel investment after comparing customer economics. Apply the same test to sales incentives. A team rewarded for revenue alone can win a large order on terms that leave little profit.
What each deal contributes to margin
Revenue targets can reward a sale even when discounts have eroded its margin. The guide pairs sales activity with financial measures so managers can see which deals are worth pursuing.
Photograph and selected measures from The Pricing Success Formula, pages 16 and 17.- Sales activity
- Proposals sent and follow-up calls.
- Financial result
- Average deal margin and value of discounts offered.
Five ways to improve margin
Use the transaction review to choose the intervention. An account buying small quantities with frequent deliveries presents a different pricing decision from a customer willing to pay more for a specialist service.
- Review headline rates
- Test what customers in each segment are willing to pay. A price based on cost alone can miss differences in what customers value.
- Audit discounts and rebates
- Review the last twelve months of concessions, including in-kind benefits such as free freight. Identify who approved them and how much each one cost.
- Review unprofitable accounts
- Compare profit by customer segment, then examine individual accounts where the cost of serving them is high.
- Price ancillary services
- Identify services that customers value and would pay for separately. Consider where unbundling or cross-selling would improve the offer.
- Reward salespeople for margin
- Track the margin the team earns on each deal alongside revenue. Use both measures when setting sales incentives.