5 Essential Rules for a Successful Pricing Reset
Distributors often sacrifice margins to gain market share and drive sales. Such tactics, however, negate a strategic pricing process, rendering it virtually nonexistent. Without a proper method, your team must make pricing decisions in a vacuum.
While they may compensate for inefficiencies and achieve short-term success, sustaining healthy margins over the long term becomes difficult without a solid strategy.A well-structured pricing process should help you achieve healthy margins where appropriate and ensure the cost to serve doesn’t spiral out of control.
The key is to focus on a critical set of customers and use the right tools and data to offer customer-specific prices instead of one-size-fits-all solutions. A well-informed sales force can then capture higher margins by focusing on three classic blind spots:
- Over-discounting based on sales volume alone (an imperfect topline approach).
- Over-discounting out of fear of customer churn (some customers aren’t worth it).
- Undercharging for or over-delivering services (capture the value you create!).
Pricing is complex, but by optimizing the actions of all stakeholders through a strategic process supported by accurate data, you can achieve clarity, understanding, and superior profitability.
To help guide your margin recovery, here are five essential rules:
1. Rule of Visibility: Maximize Profits Through Clearer Pricing Insights
Your team cannot optimize what they cannot see. However, it’s impractical to provide them with every cost element before they finalize prices and offer customer quotes. The solution is to break down the price equation.Traditionally, the focus has been on gross margin percentages and dollars, but there’s much more to consider. Ignoring key pricing drivers can lead to failure. Consider these perspectives:
- What your salespeople see: Price = Cost of Goods Sold + Gross Margin
- What your CFO or pricing analyst sees: Overall Profit = Cost of Goods Sold + Gross Margin – Cost to Serve + Vendor Rebates – Customer Rebates/Discounts
Start by applying the rule of visibility through customer segmentation. This is the first step toward a stable pricing process. Segment customers based on more than just sales dollars; consider adding factors like sales growth, gross margins and cost to serve to classify customers into discrete segments (e.g., core, opportunistic, marginal, and service drain). Consistently using these customer segments to inform pricing can streamline your pricing process and improve decision-making.
For example, a distributor segmented their customers into high volume (21% markup), high growth potential (23% markup), low volume (30% markup), and low growth potential (27% markup).
This same distributor developed a pricing strategy they called the 4i Plan:
- Insulate: Protect low-growth potential and some high-volume customers from competitors by offering the best prices with only minimal, periodic price increases (1%-3%).
- Increase: Target high-growth potential customers as a whole with controlled price reductions in exchange for increased volume and market share.
- Identify: Identify five specific high-growth customers that merit exploring a more coordinated, strategic pricing plan.
- Investigate: Investigate profit leakage from low-volume and low-growth potential customers; assign the highest prices and shift them to inside sales if necessary.
For a more detailed and tailored approach to pricing, consider leveraging Sales FOCUS+, a powerful analytics tool that helps you segment customers effectively and set optimal pricing strategies.
2. Rule of Control: Lock in Costs to Preserve Profitability
Establishing a cost-lock is essential for pricing discipline. Cost-plus pricing remains a staple approach for distributors, but how it’s applied can significantly impact your bottom line. Distributors often provide multiple price points in the market, leading to inconsistencies. The root of this problem is not just price fluctuation but also cost fluctuation.Consider these common scenarios:
- If an item costs $80 and the sales team applies a 25% markup, the price becomes $106.67.
- If the purchasing team secures a better deal, reducing the cost to $70, the new price with the same markup becomes $93.33.
In this situation, a cost-plus pricing process nullified the purchasing team’s effort to improve gross profit. The savings were passed on to the customer along with additional margin, which actually hurt profitability rather than helped. This issue is often exacerbated by flawed, automated pricing processes. To avoid this pitfall, lock in your costs for a specific period.
Consider using Price PERFECT to maintain pricing discipline. This tool lets you lock in costs and automate pricing updates without losing control, ensuring your savings translate into healthier margins.
3. Rule of Ownership: Build Accountability in Your Pricing Strategy
It is crucial to create accountability and transparency in your pricing process. Currently, only 1 in 15 distributors have someone solely responsible for pricing. However, responsibility must go beyond having “pricing” in a job title. This person should be dedicated to designing a coordinated pricing strategy, communicating effectively with sales and operations, and influencing field-level decisions.Often, pricing analysts alone cannot fulfill this role, leading companies to implement new pricing software to fill the gap. However, these tools can become “black boxes” without proper training, understanding or access, hindering adoption and effectiveness. Establishing roles such as Chief Profit Officer or Chief Pricing Officer can help create accountability and ensure pricing tools and processes are used effectively.
4. Rule of Focus: Prioritize Core Business to Prevent Margin Erosion
In your core business avoiding margin erosion is an ongoing challenge. Value creation for distributors hinges on three key elements: customers, inventory, and suppliers. Addressing all three simultaneously is essential to prevent conflicts and ensure a balanced approach to pricing.For instance, reducing inventory might satisfy purchasing teams but could upset sales teams concerned about customer satisfaction. Similarly, supplier management teams might resist inventory reductions due to potential impacts on volume discounts. These interdependencies can lead to intense negotiations, dissatisfied customers, and compromised pricing strategies.
To stabilize pricing in your core business, separate value from noise and cohesively address the interdependencies between customers, inventory, and suppliers. Companies that manage complexity well are better positioned to maintain healthy business practices and achieve profitable growth.
FUSION Analytics offers transparency and actionable insights across all levels of your organization. It empowers your team with the data and understanding they need to make profitable pricing decisions while supporting the needs of each functional group (inventory, sales, and supplier management).
5. Rule of Balance: Align Autonomy and Management for Optimal Pricing
Two independent drivers of profitability are sales management and pricing autonomy.Pricing autonomy can exist at different levels:
- Low-level autonomy: Salespeople have limited power to change prices.
- High-level autonomy: Salespeople have more control over pricing.
Sales management also varies:
- Low-level management: Minimal access to tools and guidance.
- High-level management: Extensive access to tools and clear guidance.
- Consistency (High-High): Process guidelines drive sustainable pricing decisions with a pricing band that controls cost-to-serve.
- Compensation (Low-Low): Basic customer segmentation and limited sales force involvement (sales only sees the effects of pricing efforts in their compensation).
- Competition (High pricing autonomy and Low sales management): Competitors drive pricing decisions, often resulting in inconsistent practices.
- Control (Low pricing autonomy and High sales management): Pricing decisions are disciplined, focusing on market share growth.
Most distributors fall into the “Competition” zone, where pricing practices are inconsistent, and customer conversations often revolve around price rather than value.
At ACTvantage, we’re committed to helping you navigate challenges and achieve growth through targeted education and actionable insights. To help you make the most of our tools, like our mission critical plug-in scorecards, we provide personalized coaching and training. If you’re interested in customized training or certification programs, feel free to reach out—we're here to help.
Reset for Long-term Sustainability
These five rules are the pillars of a robust pricing strategy. As you strive for topline growth, ensure your margins are not sacrificed due to poor pricing tactics. By adhering to these principles and utilizing advanced analytics tools, you can build a sustainable pricing process that drives profitability in the long run.*This article was originally written by Pradip Krishnadevarajan and published by MDM under the title, 5 Rules for Conducting a Pricing Reset