In the first part of our two-part series on improved pricing models for manufacturers, we introduced the notion that pricing is an area where shrinking margins can be countered. Insofar as traditional qualitative methods for pricing are unable (or unwilling) to control for supply-chain and customer variables, as well as automation, most approaches end up being manual and/or ad hoc. Simply put: These approaches have minimal chances of producing maximum margins.
To achieve a more precise pricing scheme, manufacturers must employ quantitative pricing methods that overcome the challenges found in modern production. Doing so means making pricing decisions based on business intelligence—not business guesswork. The process of quantitative pricing begins by first recognizing what is working and not working with regards to methodologies, then deciding to take the pricing task to a more formal level that is informed by a variety of data.
First, it is vital to realize that ad hoc pricing facilitates price differentiation; that is, diversified manufacturers typically have extensive product portfolios and very sizable customer bases, and therefore many, many unique prices. After taking into account all price-related variables (e.g. costs, contracts, discounts, volume agreements, customizations, shipping, etc.), the total number of unique prices of a single manufacturer in the market at any one time can easily be in the tens of thousands. With so many products, exceptions, and changes over time, it’s no wonder that manufacturers’ price points and margins vary widely across their business. In fact, some manufacturers struggle with simply calculating prices that are correct (i.e., are in accordance with their numerous price lists, policies, and contracts, while also maximizing margins and overall profits).
Fortunately, this business complexity can be both managed and exploited. Information systems designed to allow companies to calculate correct prices are widely available, often as functional modules within the sales order management modules of ERP and CRM software vendors. With pricing estimation capabilities that function consistently through any number of processes, parts, and people, price optimization is achieved automatically and most efficiently. In turn, profits are maximized through correct prices in every sales order—not just some.
By definition, price differentiation is the tactic of segmenting customers by the price sensitivity and using each price segment’s unique sensitivity to set prices on future deals. Using this approach, manufacturers often can significantly increase the number of actionable segmentation variables they use to set differentiated prices. In other words, the manufacturer can have many different prices but with a consistent and rational profit margin through all products and orders.
As well, CRM data collection and integration has been improved to the extent that companies are now much better able to aggregate and analyze the data needed to define price segments and their relative profitability. Real-time ERP software that accounts for both a wide variety of transactional histories, material costs, direct and indirect labor, and overhead is going to be much more capable of maximizing profit through the increased margins found in accurate quoting.
Added to this is the notion that informed negotiations between informed sales personnel and their clients, as well as between company purchasers and their vendors, can play major roles in increasing the profitability of work and work orders. Conversely, uninformed decisions that are related to discounts and other costly concepts have the potential for being major sources of revenue loss.
It is a well-known adage in business that the most powerful negotiating tool available is information. Giving sales people reasonable price recommendations based on quantitative information about what similar customers paid under similar circumstances immediately improves bottom-line results. In addition to better market information and price recommendations, incentives also have a powerful effect on sales representatives’ discipline and confidence. And, when management deems that an order deserves an exception to standard discounting policy, the ability to evaluate different scenarios based on their relative profitability ensures “must win” deals help limit the overall financial impact. In the end, these pricing notions aid in maximizing profits and they suggest that pricing must be a closely watched concept in modern manufacturing.