Strategic Flaws of Statistical Price Targets

These days, everyone in the analytics space has a pricing product to talk about. Toss enough transaction data points at the problem, you’re going to get a few insights that may help you earn higher margins. Even better, moving the pricing process to a modern software tool often improves your control over pricing errors and sales rep concessions.

Can this work? Absolutely. For an organization with weak pricing practices, the first wave of pricing optimization often yields brilliant results.  For a typical manufacturer or wholesale distributor, this can raise your net profit margin by one to three percentage points. Given the low margins in many of these industries, this is a meaningful improvement in the overall profitability (and thus, valuation) of the business.

But you need to have a careful plan for Act II. There are limits to how far you want to ride this horse.

The Downside of Relying on Statistical Optimization

Step back for a moment. Assume we deploy the system and systematically execute this program “by the book” for the next year or two. Moving in technology enabled lock-step, our sales team makes a habit of marching into the customer pitching every industry increase at full price, tacking a surcharge onto the invoice for every additional service, and aggressively quoting every off-contract purchase.

Will the average net price rise? Certainly. Especially at your best accounts, since they trust you to treat them fairly. Your price-sensitive buyers will push back on every increase, eventually putting you out to bid. Overtime, your business will earn more money from a smaller base of key accounts. You’re not going to regret many of the defections either, since many price-sensitive customers are often prolific drama creators.

Over time, many of your most profitable accounts will become riddled with potential flash points: products and transactions priced above market, where an alert buyer or savvy competitor can swoop in to challenge your value. Most of these aren’t important. Nobody really cares THAT much that you gouged them an extra couple of bucks for orange pens over your usual price for blue ones. But the perception builds over time.

It’s a bit like stepping onto a used car lot. If you’re high every time I check your prices, I’m going to start checking your prices more often. Since I know your sales organization is going to speed if given the opportunity, your pricing will get increased scrutiny and competitors will learn how to poke and prod at the product categories where you tend to aim high. Congratulations, you’ve sensitized the customer to price.

Raising Price without Raising Value

As I mentioned above, the first couple of waves of improvement efforts will create significant value. There are usually a few accounts which have suffered from “rogue pricing experts” (aka sales reps gone wild) and price increase participation may be spotty. This is a great opportunity to clean this up, with little risk. Guiding the organization towards reliably taking action on pricing recommendations is generally a good thing.

The strategic risk here is that you are raising your average price without adjusting your value to the customer.

In fact, it is not uncommon to see your sales team invest less time building value at your strategic accounts while the change is being implemented. Most sales teams can effectively execute a very limited number of business priorities. Time invested in improving transaction pricing is time which cannot be spent cultivating advocates at the customer, pushing new ideas, and addressing customer satisfaction issues.

Over time, this reduces your growth rate and increases the risk you will be challenged on your pricing by customers and competitors.

Avoid Working At Cross Purposes

Retailers, wholesale distributors, and commodity manufacturers have an even greater threat: to what degree is an assurance of “fair market pricing” built into your customer value proposition?

As much as the pricing community likes to talk about selling value, there’s nothing inherently wrong with selling based on price. You just need to organize the rest of your business model around this strategy. Walmart works because the supply chain is super efficient and service is minimal. Attempting to run a high-touch retailer with the same pricing strategy is a recipe for disaster.

The wholesale distribution equivalent comes down to your value to the customer: logistics efficiency vs. solution expertise. In theory, you have both but which did they REALLY value when they selected your services? There’s a good market out there for serving as an outsourced procurement arm for a larger organization. Especially if you’re operating in a specialized domain servicing an unsophisticated buyer. If that’s why you’re getting hired, be cautious about pricing games. The fastest way to get fired as a supplier is to fail to live up to the reasons the buyer hired you in the first place.

If Amazon Business is a key competitor, be aware they are positioning their platform as the antidote to pricing optimization: an efficient way for business buyers to manage “tail spend”. Amazon Business offers a low-effort option to ensure B2B buyers get a fair price on the bottom 20% of their indirect purchases, which are missed by traditional sourcing programs due to the effort involved. Your pricing analytics algorithm probably tagged these for higher pricing since a typical buyer is less sensitive. To quote Jeff Bezos: your  margin is his opportunity….

The key here is not work at cross-purposes. If you’re going to lead with price, own it and organize the team appropriately to take out the cost. If you’re going to invest in creating customer value, make sure you get paid.

Should you pursue statistical price optimization? Probably.

But approach it as the first step in a broader strategy.

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