Case Study – Distributor Pricing Strategy
Executive Summary:
- Corporate distribution company $0.6B in annual revenues
- Selling 25,000 SKUs to 10,000+ customers
- Under significant margin pressure – gross margin of 25% and EBIT margin of 5%
- Engaged Pricing Insight to develop a pricing strategy to improve gross margin
- $1.4M in gross profit generated in 12 months on addressable project revenues of $20M
- Achieved using Project Blackbird – Pricing Insight’s algorithmic price optimisation program that generates risk free incremental gross margin profit
How to generate an extra $1.4M in gross profit on addressable revenues of $22M in one year.
A company with a large portfolio of products generates margin gains using value based algorithmic pricing.
Initial situation
The distribution company we worked with was facing a number of challenges to profitability. Specifically, their pricing system was lacking relevance to the market, the way they’d set prices was with incredibly high list prices, and then incredibly large discounts.
This caused all sorts of headaches as far as trying to set prices to go to market. There was a lot of confusion and inconsistencies with overall discounts to customers, and tactical discounts for individual products. With a standard discount of 65%, an additional 5% discount could erode up to 30% of gross margin profitability and 100% of EBIT margin contribution.
With many hundreds of unique pricing deals and combinations in place, pricing, management and maintenance took a very long time to complete, and an inordinate amount of effort and resources to manage.
Changing market
At the same time, customers were becoming better informed about what pricing they should be paying by checking the internet, as well as talking to each other. So inconsistent pricing was starting to become a problem for the business, creating credibility gaps in the ability to negotiate prices to customers. This situation left the frontline sales force overwhelmed and frustrated.
When price increases were attempted, they were often easily detected and picked off by procurement, resulting in further margin erosion as price concessions had to be made to these procurement demands or threats to go to market. This was particularly the case with larger customers who had large procurement divisions and teams who were able to analyse every price.
Recent price increases to major accounts had triggered tender actions and go to market reviews. Customers were retained, but at lower margins. Fatigued and tired, sales and territory managers simply reverted back to cost plus mark-ups and walk away margin levels to try and set prices. Often this resulted in too heavy a discount being offered or a missed opportunity resulting in further margin erosion. Even the more experienced sales reps and people were unable to articulate what the prices for various products should be to win or retain business.
Outdated pricing structure
In the past, the current pricing structure was to set a list price, which was created by taking a mark-up multiple of 2-3x the cost loaded into the system then simply discount off that list price to derive a customer net price. Ideally, this would then generate a gross margin that was appropriate. However, that list price was developed from cost prices.
If product costs changed, or if the company’s cost position was better than the competitors, this would not be recognized, and the company would simply giveaway margin.
What Pricing Insight did
What Pricing Insight was able to do was to analyse pricing across customers and markets. This meant in depth analysis by SKU x customer x product x day to identify patterns or inconsistencies that predicted opportunities to improve pricing and margins. From there, it was a matter of developing a value-based pricing algorithm that was able to collect all these pricing opportunities. From there build a new list price and discount structure that would allow the business to manage a more effective go to market.
A series of pricing initiatives was undertaken including:
- Price reductions – adjustments to product pricing levels that were The prices of these products were just simply too high tainting the market positioning to give customer the impression that all prices were too high.
- There were also some price reductions various customers who were procurement focused to give them some quick wins so they’re able to show that they were doing their job.
- There was a more consistent and structured process architecture implemented so that would give the salesforce more credibility and confidence to hold the line in negotiations.
- There were also substantial margin expansion opportunities identified across thousands of products. Approximately 15,000 different products were optimized. Within that there was a substantial percentage of products that were able to be repriced delivering substantial EBIT gains for the business.
Program implementation
The actual program of price optimization was undertaken over a period of six months. Initially, there was a trial period where prices were tested in the marketplace on a small population of products. Once this trial proved successful, there was further optimization on a wider range of products and a greater magnitude of price optimization.
Quick wins and longer term gain
The initial optimizations were derived from conservative margin improvements. The second, third and fourth price optimizations gradually and progressively got more ambitious in terms of what they could generate, and also, what scope of products were actually optimized. All of these initiatives ultimately brought margin improvement to the business. Around $22 million of addressable revenue was ultimately optimized, generating about $1.4 million in annualized gross margin gains.
Wider rollout
In addition, the category management buying teams were educated on pricing strategy and pricing architecture to allow them to continue on with the process of setting new product prices, particularly as they began to range new products into the marketplace.
To support the pricing operations process, a pricing manager and analyst were hired. Their job was to analyse the data sets to identify further pricing improvements, continue to work to manage tender to pricing, and assist the sales teams to come up with more effective pricing strategies to win or retain business.
The pricing management function worked with the category buying teams and the sales teams and communicating with finance the margin improvement story. In an ideal world, the pricing management function works cooperatively and collaboratively with merchandising / buying teams, marketing teams, sales teams and the finance team.
In Summary
In summary, there were a range of initiatives undertaken with great efficiency and without disruption to the business.
These initiatives included:
- The build out of a new List Price structure with product price relativities supported by a value-based pricing architecture
- Development of an effective customer discount matrix
- Development of tactical discount authority levels and delegations of authority
- Incentive programs for the sales team to sell on revenue aligned to profitability metrics,
- The setup of a dedicated pricing management team for ongoing price maintenance optimization.
About Pricing Insight
Pricing Insight are specialist B2B industrial pricing strategy advisors that help innovative and action-oriented CEOs to improve profitability.
We generate incremental profit growth for our clients in three distinct ways:
- Pricing Strategy Diagnostics – A numbers and insights [Quant & Qual] led program to identify the right pricing strategy and operating capability for your business.
- Price Optimisation – A value based algorithmic approach to price setting that generates 100-900 basis points of margin across 30-50% of a company’s addressable revenues.
- Price Training – Build a culture of value to empower your teams to make more profitable pricing decisions for contract negotiations, tenders and tactical discounts.
Our Philosophy
Pricing Insight are not another big consulting firm.
We are specialist pricing experts with over 21 years industry experience.
Our focus is to deliver practical pricing strategy advice and insights, generate cash margin earnings without risk to volumes and empower your staff to make more strategic and profitable pricing decisions.
Whether you’re contemplating an SAP or WMS implementation project and need a new pricing architecture to fit the SAP system, or in need of immediate cash margin expansion to drive earnings growth, or want to transform your company culture from a cost plus commodity mindset to a value based pricing centre of excellence, we will help you realise these outcomes.
We can work across industries and have extensive experience in B2B industrial markets for both products and services.
We have provided advice and undertaken price optimisation programs for Retail, FMCG and Service based companies.
Regardless of industry and business model, pricing excellence is technique driven.
We will help you implement the required disciplines and capabilities needed to improve margins using tested and proven methodologies.
Pricing Insight make complex pricing challenges easy, using a systematic and structured approach to pricing strategy to allow you to focus on leading the business through the next phase of growth.
