The current crop of pricing companies is missing the boat. The industry is focused on selling software to squeeze a few extra points of yield out of your accounts, often at a risk to volume. We should focus on a broader view of how we create value for customers.
Current State – Pricing Software Platforms
Most strategic pricing software packages are built around one of a few big ideas:
- Customer Segmentation – Who can pay more?
- Product Segmentation – What isn’t being watched?
- Process Control – Ensure policy execution
- Price Elasticity – Juggle price vs. volume
- Customer Profitability – Fix unprofitable business
Can these add value? Certainly. There is a solid basis in accounting, economics, and management science to support these concepts. While you can certainly overdo them (example from customer profitability), these ideas can work in many industries.
But are you lunging at risky pennies when you should be hunting for safe dollars?
The 80 / 20 Of Customer Profitability
I’ll spare you a lecture on 80 / 20. Short version, widely validating in economics, is most of your profits (80%) generally comes from a handful (less than 20%) of your customer base. Entire consulting firms have been built on this idea. Got it? Good. Let’s move on.
You learn a funny thing when you look at your most profitable customers.
Your most profitable relationships rarely come from squeezing people on price…
Intuitively this makes sense. You’re not usually not alone in a market. Nor are most of your competitors inept. The typical B2B buyer receives multiple vendor solicitations per month. High priced accounts are easy targets. Worse, they train competitors to hunt you.
But if you look at most pricing software applications, that is the end game. Your business will systematically increase the average price they charge their customers. Competitors will start to figure this out. Customers start to figure this out. And then you’re in big trouble…
By increasing profit margin goals without affecting value, you make yourself a target.
But what if we raise margins without raising prices? We present nine case studies on how to improve profit margin – without sacrificing your future.
Case Study #1 – Replace middlemen
Consider the following example, three different ways to buy a corporate website:
- $1,500 for a ‘friends & family’ developer
- $5,000 for a dedicated freelance consultant
- $15,000 for a digital agency
These are real prices, by the way, for an actual project. Note the 10 X spread in costs.
The difference is the service – each level of service injects additional middlemen to help
“smooth the ride”, ranging from the digital agency’s account executive to a designer and technical architects. These serve to make the experience seamless to a business client.
A good digital agency can get a completely clueless client across the finish line with a decent product, despite a total lack of engineering expertise and marketing moxie. Hiring a freelancer? You need to know how to judge talent and supervise the development process. Pursuing a “friends and family” route with part-time developers involves even more drama.
Now – what if the client doesn’t need all of this? Or you can take out a few middlemen by consolidating all of these services under one roof? Fewer hand-offs, less expense, and better processes. Your cost to deliver a project goes down and you will likely see gains in speed and quality. Since the client’s best alternative is to pay market price for the same service elsewhere, some of these cost savings should drop to your operating profit.
Lean out the process. Pocket part of the savings. Repeat. A formula for greatness.
If you can identify a customer or set of customers where you can restructure the way that you serve them to reduce costs, this is often a wonderful source of high net margin profit customers. You’re basically matching industry pricing and pocketing the savings from your process.
Case Study #2 – Build Solution Value
Our next example comes from the packaging industry. When you look at the value that a new packaging distributor can bring to an account, there are a number of components:
- The cost of the box (what they buy)
- Tape, labels, padding (secondary items)
- The labor to pack the box (cost of use)
- Packaging Inventory (carrying cost)
- Reorder frequency and lead time (supply chain)
- Freight cost of the packaging (outbound logistics)
- Shipping damages (cost of poor quality)
- Retail reaction (benefit of good design)
The conversation with the account started with an RFQ to buy boxes for $1 each.
But things escalated quickly from there. Our corrugated buyer optimized the specs for the box and squeezed the manufacturer (sheet plant), reducing our costs. We consolidated orders for similar boxes into the same massive single run at the manufacturer, reducing costs even further. Our packaging engineer looked at the customer’s line, finding way to streamline the operation and selling them an automated case packer that uses less labor. Shipping damages are down too, from a better box design. Cost savings everywhere….
The box doesn’t cost $1 anymore. Although any new distributor who tries to break into the account will probably quote that price. Don’t worry – the current distributor is making a good profit on the business as a result of the changes. And the customer is pretty happy too – in addition to a large savings on the materials, their labor cost is down and they appreciated the level of service they received. Their retailer is happy as well – less damages and claims. More projects are coming.
This is literally a case of engineering your way to success: our technical team repeatedly found opportunities to take cost out of different pieces of the total cost of ownership. The customer was delighted with the outcome and the buyer’s career received a big boost. We generally got to pocket some incremental net income along the way. Doing this on a regular basis will generate very loyal long term accounts with a higher profit margin.
Case Study #3 – Bridge Customer Gaps
Speaking of making the customer look good, this goes beyond saving them money…
This next story comes from a merger integration project I worked on. We had just merged with another company and were comparing our printing costs. This vendor was very high, charging double the typical price (get that gross profit!). Our ask was simple: a 50% reduction, a $1.5 million cut.
We asked. They (politely) told us to go pound sand. We moved the business.
Their net profit went to zero.
At which point, all hell broke loose. It became abruptly apparent that the business person they were supporting didn’t have a clue about how to manage the process. The supplier had been covering for them for years, loading up the bill with additional services, taking every price increase, and pocketing any savings. They had correctly figured out that their recipe for survival was making him look good. We ultimately had to replace him.
In retrospect, the vendor’s biggest mistake was aiming too high. Had they padded their gross margin by 10% – 15%, it wouldn’t have been worth the time and effort to go after them.
While this is an extreme example, this idea can be applied a little more ethically. How can you expand your service offering to reduce the expertise a customer needs on staff? If you execute this well, you can often get away with charging a little more. These accounts will likely be extremely loyal, since they cannot easily switch suppliers. Play the long game: set up the relationship and slowly milk them for a little extra over many years.
A good profit margin for a long period beats a great profit margin interrupted by a loss of trust.
Just don’t mark it up a 100% please. I don’t want to go through this again.
Case Study #4 – Ride The Freight Train
Got a fast growing customer, someone who is transforming their industry, with steadily increasing sales?
Lean in close and climb on on the freight train. The most profitable relationships that I’ve worked on were often forged when the customer was a small or middle market account. These accounts are great for multiple reasons:
- Passive revenue growth as you ride the customer’s coattails
- Your cost to serve usually declines as they scale up
- Growing pains prompt demand for other services
The latter is a key opportunity. I can think of one consumer products company that rapidly exploded from being a regional player to a national powerhouse. Their supply chain went from a few people in a warehouse to a multi-site network and a customer service group. Rather than hire a VP and build the operation themselves, they placed all of the business with their existing logistics partner. The operating profit margin for the account rose steadily as the unit operating expenses were reduced with scale. This quickly grew into a massive relationship.
The key to this strategy is accurately identifying customers who are growing quickly and investing appropriately. Most businesses do this by accident, stumbling into a few opportunities via blind luck. What if we trained reps to seek out these opportunities?
Three key qualifiers if you’re going to head down this path:
- The Customer must value your capabilities beyond price
- Growth in account sales and your share of the business
- Clear path for the customer to grow faster than market
Every frog is not a prince. Every small business has barriers to growth: limited opportunity, limited capital, limited talent / expertise. Pick the ones that show they can overcome these. Insist on objective proof (higher sales) the account is growing and your share is expanding. Along the same lines, a customer who is all about price will only get worse as they expand.
Case Study #5 – Put Them In Business
Nothing builds a great relationship like helping a small business owner at the right moment. This is something you need to keep in mind when you’re approving credit and handling escalated customer service requests from small accounts. These moments can shape relationships.
This is particularly true if you’re serving one of the following three industries:
- “Revolving Door” industries where small firms enter and exit (construction companies!)
- Cyclical industries which go through a nasty down cycle on a regular basis
- Frequent bankruptcy / financial distress in the business (but people return)
Should you approve everyone? Absolutely not. But if you are serving a group of customers in an industry where there is a regular cycle of corporate renewal, this should be part of your relationship development strategy. Are there business models and payment terms which help you serve small accounts without putting your entire business at risk?
And then, of course, make sure you get rewarded with higher prices and turn them into a loyal customer.
Case Study #6 – Sell The Full Bundle
Do you know that the drinks, dessert, and appetizers are some of the highest profit items in a restaurant? Or that the best janitorial supplies accounts purchase both bulk commodities (build large orders) and high margin chemicals and proprietary dispenser systems?
Sadly, many salespeople get the “top product” installed in a customer and stop selling the rest of the bundle, reasoning that they have most of the volume. Well, you might – but you may not have most of the margin. There’s often additional revenue stream opportunities in your “add-on” and “upsell” items.
One of the easiest ways to increase the average profit margin of a customer is to put more stuff on a truck that is already going there. In fact, you can be super-competitive on pricing. You already paid for the truck ride! I wrote about this: Getting run over by a paid for truck.
This also improves your competitive position within an account. First, as your spend rises your access to key decision makers usually improves. This has many benefits. From an economics perspective, shipping more products in the same order reduces your average cost to serve as a percentage of sales. This can either be pocketed (increasing profits) or shared with the customer (creating a higher barrier for new entrants). Plus your are often pushing out a direct competitor and reducing their incentives to fight for the business.
Finally, this is some of the easiest business to develop. You’re already in the account. You have perspective on the customer’s current spend and pain points. They may like you. Identify and resolve any remaining barriers to sale and ask them for the order.
Case Study #7 – Huge Scale in a Few Items
What would happen if all of your volume was in a single product? Or small set of items?
Your costs would drop. Massively.
This is particularly true for manufacturers. Layer after layer of cost can come out of the system as you scale up production of a single product. Setup costs, downtime, and overhead expenses can be leveraged across progressively longer runs. Larger runs mean you can buy raw materials in larger batches from your suppliers, for lower direct costs. More volume running through fewer items decreases your average inventory and makes it turn faster, reducing carrying costs as a percentage of sales revenue. Production lines can be optimized for a single product. Sellers can be focused on building sales volume in a handful of items.
The money literally rains out of your manufacturing plants.
This happened to me when I was squaring off against a local upstart, a tiny company that had decided to dominate the dollar store market for particular product. They were selling into a large distributor for almost 30% less than us.
The secret? We produced that item in small batches for what we thought was a specialty market. They threw everything at it – and owned that market, which was 10 X larger than we previously thought. Nobody even bothers to share guidance with someone 30% high. We reverse engineered their cost structure and learned their average profit per ton was above ours. Their secret was driving massive amounts of demand into a single product.
As before, these savings can either be shared with the customer to lock out competitors. Or pocketed to increase your average profitability. Or potentially both.
Case Study #8 – Maximize Scrap Value
There’s gold in your garbage.
Most of us are familiar with the concept of manufacturing scrap – that portion of the raw materials which doesn’t make it into finished goods. Most of this is recovered and sold to various recycling operations. But what about the following other sources of scrap?
- Finished goods that don’t meet quality standards?
- Dead and Excess Inventory in the warehouse?
- Generating leads from unqualified prospects?
- Idle Employees (due to lack of work)?
- Trucks with empty space?
- Markdowns (dumping product)
In each of these cases, we paid the full price for something that we can’t use. And while we would probably prefer to avoid spending the money again, there’s often a way to recover at least some value. This requires working to find buyers and build a market for your scrap.
- “Scratch and Dent” packaging? Look at dollar stores, close-outs, and exporters…
- Dead & Excess Inventory – many options to sell this at a higher price
- Those unqualified leads? Sell them to someone who can use them
- Idle employees? Figure out how to move work between centers
- Freight brokers are happy to book back-hauls for empty trucks
- Excess food? Write off your food costs with charitable donations
Applying pricing and commercial expertise to optimize the value of your scrap, excess inventory, and surplus capacity can add several points to your bottom line. When you consider that many wholesale industries have single digit margins, this can be a big lift.
Case Study #9 – Improve Customer Retention
How do you avoid making price concessions? By never going out to bid.
While said as a joke, there’s a huge grain of truth in that statement. Customers think about your prices far less than you would believe. Your typical corporate buyer has two settings: “I’m Busy Doing Other Things” and “Issue RFQ”.
The second of those settings will have a pronounced downward impact on your margins.
So what if we keep the customer sufficiently happy they never go out to bid?
It’s not a bad goal. While you need to be aggressive during the RFQ, you can usually creep your margins up a little bit during the off-season between passing market price increases, some cost savings efforts, and opportunistically selling off-contract items at higher prices. Delaying the RFQ cycle enables you to maintain a higher average margin in the account.
You can play defense a number of ways. The first is staying on top of service, mitigating any serious service problems before the customer is affected. Service failures are a key source of customer defections from established suppliers. RFQ’s can also be triggered through larger change initiatives within the customer. This is an area where an effective “top-to-top” meeting cycle between your two organizations can provide opportunities to interject yourself deeper into the customer so you can deflect and exploit these events.
The other problem with going out to RFQ is you’re going to lose a few bids. This, in turn, means you’re going to have to go out into the market to win a few deals to replace what you lost, generally at lower pricing. Many B2B industries win new business at pricing significantly below their current book of business.
A final challenge with high churn rates is you wind up acquiring new customers who aren’t as inherently loyal as the ones you lost. “Good” customers rarely put their suppliers out to bid without good cause. “Aggressive” accounts put suppliers out to bid on a regular basis. When you need to quickly replace lost business, you often wind up bringing in aggressive, price-focused accounts with a very high risk of defecting to a competitor in the near future. Setting a cycle in motion where you must constantly replace accounts at declining margins.
Getting a good handle on risk of attrition can yield a nice boost in average margins.
Strategic Pricing – Rethinking The Mission
I can already hear the whining: “These have nothing to do with pricing!”
Indeed. They have everything to do with value creation. They look for ways where we work together with customers and suppliers to expand the pie. As the owner and architect of the process, we have any number of ways to quietly divert part of the benefits into our own pockets while leaving the other stakeholders better than they started.
So let me get this straight: we want to spend millions of dollars on software, agitate our sales team, and risk business owner relationships in pursuit of 100 bps – 300 bps of incremental gross profit margin….
When we can create an even greater amount of value by focusing our sales team on the right accounts, offering the right product bundle, and learning to delight the customer? Without causing controversy or putting customer relationships at risk?
I can spend operating cost savings and cash flow as easily as incremental gross revenue. In the long run, quality of sales matters immensely: if you can help your existing customers grow their total revenue and overall profit margin, you will have very loyal customers down the line. That translates into lower churn, less effort to acquire new accounts, and greater scale…
A winning formula for increasing a company’s profit margin.
The future of pricing is value creation strategies, not pricing software.
Why optimize when you can change the game?
Want to take a deeper dive into pricing? Check out some of our other work…
- Strategic Pricing – 9 Real World Ways To Earn Higher Margins
- Using Customer Profitability For Good and Not Evil
- Target Pricing – Setting The Correct Focus With Your Sales Team
- Using Yield Management To Improve Overall Performance
- Aligning Pricing Tactics With Your Process
- Measuring Pricing Performance
- How To Balance Cost vs. Value in B2B Pricing Strategy Consulting
- How to Ensure Your Distribution Pricing Consultant is Successful
There’s also our guide to pricing terminology. If you’re looking for help trying to improve pricing for your business, we’re available as a pricing consultant.