By Gene Russell, Manex President and CEO
Pricing a line of products in a complex and competitive market is not simple. It represents one of the most difficult jobs in manufacturing. If set too low, the business will not remain solvent. (See my previous blog, Gross Margin Drives Your Business Model). If set too high, the product may be priced out of its markets, producing sales volume below the breakeven point.
Many owners and general managers are unhappy with their pricing efforts. They feel they may be leaving money on the table and in some cases missing larger volume orders in others. James Naut in a Conference Board Report said, “Pricing is a subtle art. Too often it has consisted of one-third facts, one-third myths and delusions, and one-third academic economic theories that are out of touch with reality.”
Rather than dwell on the complexities and the theories, let’s go to a great resource, the out-of-print book, Dartnell’s The Sales Manager’s Handbook. The book is full of excellent facts, advice, formulas, and so forth. In this case, a pricing checklist of 10 questions.
- Are prices falling in real terms, yet the share is constant or declining?
- Do you have the feeling that you are leaving money on the table but cannot substantiate it with hard data?
- Are your salespeople, or estimators always claiming your prices are 3 to 8 percent high, yet your share is holding steady or rising?
- Are pricing approval levels acting more as a volume discount mechanism than a control mechanism?
- Do pricing approvals reflect real profit levels?
- Do your prices reflect customer-specific costs (e.g., transportation, set-up, or design costs)?
- Do margins (after customer-specific costs) vary widely by the customer?
- Can you define/describe your competitor’s pricing strategies/rules?
- Can you predict how and when competitors will react to your price moves?
- Do you have a planned method of communicating moves to 1.) Customers 2.) Competitors (legally of course) 3.) to your sales team?
Answering these questions requires a detailed understanding of your company’s pricing system. By this, I mean how pricing starts, how they are administered, price and cost relationships by customers, and more.
In my experience, strategic pricing is much easier than tactical day-to-day pricing. Strategic pricing means your stated goal and supporting business acumen. You might tell yourself, “We are the best and we will charge for the best!” Tactical pricing is the day-to-day management of pricing in a warfare style of protecting your business or growing your business against a host of competitors. It may or may not support your strategic pricing plan if that plan is simply a set of goals rather than a well-thought-out and realistic strategy.
When I managed a team of 15 national account managers calling on every retail chain in the Americas, I experienced one form of very bad pricing intelligence. That being the “last buyer talked to”. You need more than the intelligence gathered from the last customer/buyer your team or even you spoke to. That’s often just a negotiation tactic or a low-ball version of a market shift.
Your criteria for pricing includes:
- Gross margin objectives
- ROI goals
- Buyer/market reaction to proposed price or prices
- Expected volumes at price levels
- Possible and probable competitive reaction
- Newness, innovation, and degree of competition on the product or products
Reasons for changing pricing include:
- Changes in costs
- Competitive review
- Periodic review
- Pressure from customers
- Increased competition as the product loses its innovation advantage
Reasons for pricing variations in your company:
- Quantity ordered for delivery at one time
- Channel of distribution
- Quantity ordered over a period of time (longer horizon)
- Type of customer (direct, wholesale, chain store)
- Location of customer
- Services required
- New tooling
- New or existing production line
- Investment required
- Level of difficulty
Inflation/changes in the general price index. Establish a pattern flexible enough to meet any condition, and yet rigid enough to meet an adequate profit at varying levels of sales productions.
Alertness and flexibility should be the keynote of your pricing activity. Things are moving fast, and predictions of the economic future may not pan out. Therefore, policies must be continually reviewed and revised. A normal lifetime setting of price-setting decisions is being concentrated in a few months. A philosophy of pricing is not indispensable today. A patchwork of price decisions cannot successfully meet a continuously changing situation. You should formulate a pricing strategy to the sales/marketing effort required to move a given volume with a certain / specific time into the market. -Dr. Joel Dean, Former Business professor at Columbia University
- Conduct price research
- Adjust your costs to current and prospective price levels
- Adjust your P&L to reflect economic realities.
- Align your prices with the competition in order to achieve buyer reaction and market share
- Put your pricing house in order. Many companies have let their geographical, quantity, functional, key account, and product line differentials get out of control.
All the factors bearing on pricing decisions are seemingly endless: costs, product, product life cycle, services, distribution channels, industry segments served, credit, demand, market share, competition, local, regional, national, and global economic environment, government support within industries, public policies, and the law. Mathematical models, or simply running “what if’s” on an Excel version of your budget / P&L are very helpful.
However, in the end, price is the result of your discretionary value judgment after considering and evaluating all factors. Just remember, it’s easy to give and very difficult to take away a discount or a lower price. How much will you need to sell in order to earn the same gross profit if your gross margin is 40% and you cut your price or prices by 10%? 33.3% more.
Model your pricing changes carefully and communicate to your key team members the financial literacy around pricing, gross margin, net margin and staying in business or not. Pricing is not a tool to get an order at all costs. It can be, and I’ve certainly witnessed too many cases where the implications are not modeled or ignored to the company’s detriment.
About the Author
As Manex President and CEO, Gene Russell is a driving force behind the firm’s successful track record in helping California manufacturing companies grow and thrive. He has held three successful CEO positions over a 20-year period for businesses that included early-stage, private equity, and non-profit. He has served as senior leadership for global Fortune 100 and iconic consumer-branded companies. Prior to Manex, Russell led a turnaround at a California midsized manufacturer. His experience in global sourcing and manufacturing over several decades led him to Manex where he brings real-world experiences, and as a result, a personal passion to restore and invigorate domestic USA-based manufacturing. He can be reached at email@example.com.