By Alexander Lüring (pictured), partner of the competence centre "Private Equity" at Homburg & Partner, and Sebastian Elbel, Consultant at Homburg & Partner – Many medium-sized businesses are faced with constant cost pressure. The price of copper has increased an average of 8 percent annually over the past three years. Rapidly increasing oil prices have skyrocketed by up to 58 percent over the past three years.
According to regular surveys on recent trends and challenges in classical B2B branches conducted by Germany-based management consultancy, Homburg & Partner, (“Building material monitor”, “Chemicals monitor”, “Logistics explorer” or “Mechanical engineering monitor”), the increasing prices of raw materials have been a central issue in recent years. Activities on the revenue side aimed at strengthening margin situation frequently appear high on the agenda of companies surveyed. Yet it’s no secret, that the price itself is the most important determining factor for overall turnover. If price increases of for example 8 per cent annually are to be established in the market, a systematic approach is necessary. Unfortunately, all too often companies tend to commit the fatal error of revising their existing price structures only incidentally or selectively, creating complex price systems in the process.
Creation of Price Complexity
We talk about complex price structures when there is a variety of different prices and even perhaps different lists of prices for the same product. Price complexity can also arise when deductibles, discounts or bonuses and/or products that are free of charge are combined.
Complex price structures often evolve historically and are therefore avoidable. Over time, price systems are frequently adjusted to new market conditions, but never revised fundamentally. Many companies have also accidentally “exaggerated” their price systems by creating different prices and discounts for major clients, new clients, for winning back customers or for price promotions. Focusing too strongly on price differentiation in order to skim off payment reserves of individual customers is another reason for complex price systems.
Risks of Price Complexity
Unfortunately, a lot of risks arise through intransparent and complicated price structures, since sales volume, the price itself, costs and motivation of sales employees are all affected.
Smaller Volumes
In recent years we have noticed, that selling prices for customers have become more and more transparent. Many companies, for example from the buildings material sector, publish their prices in the internet. There are also many Asian providers using the internet to open up to the European market. Moreover, the international debt crisis has led to an increased price consciousness of customers and purchasers have been replaced by so-called “Margin Managers” (for example Akzo Nobel). Nowadays, customers want to and can actively compare prices. However diffuse and non-transparent price systems complicate this significantly, inevitably leading to customer dissatisfaction and ultimately to a decreasing sales volume.
Low Price Implementation
Loss of revenues due to insufficient price implementation should not be underestimated. Sales employees orientate themselves to list prices when negotiating. However, if the list prices are intransparent and the allocation of discounts is not explicitly regulated, employees have a poor basis for negotiation and can only enforce suboptimal prices.
Complexity Costs
Unnecessary costs also arise due to intransparent prices. A high number of prices and various discount possibilities lead to a high level of effort, when price systems are being updated. In addition, the time-consuming queries from sales has a detrimental effect on efficiency. As a result, intensive training courses are necessary in order to familiarize employees with the complicated price lists.
Demotivation of Sales Sector
One of the biggest problems caused by complex price systems is that sales employees lose centralized control of prices. Time-consuming and complex price systems make it impossible to quickly familiarize oneself with the pricing system of new products and demotivate the employees in general. As a result, “longstanding” products are being sold, whose prices are well-known. Profitable but unknown products remain unconsidered.
Conception of a lean and market-orientated Price System
The decisive question now is: How can companies avoid the aforementioned dangers and risks? We often use the following five steps in our consulting mandates.
Image 2: Five steps for a lean and market-oriented price system
Firstly, a customer segmentation based on suitable characteristicssuch as company size, quantity of sales, payment reserves and strategic importance should be carried out. Afterwards, a subdivision of products into segment-specific core and marginal products follows.
Core products represent those products that are important to the customer. Moreover, the customer knows the exact prices of these products and prefers negotiating them. Marginal products are products that are being bought casually and that the customer does not give too much attention to. To conclude, the products are being divided by means of price sensitivity.
The core products are often times the intersection of the most popular and best-selling products. In the next step, a product-specific bottom price (“Limit”) and a maximum price limit (“Target”) should be defined. By doing so, an additional price corridor for the core product and a tight price corridor for the marginal product will be determined. This has the advantage that sales employees possess enough flexibility and negotiating range with the core products and are encouraged simultaneously to achieve a high margin for marginal products. It is important to communicate clear guidelines when granting discounts and implementing price actions.
In addition, employees should be provided with an orientation guide in the form of empirical average prices, as well as with price arguments developed on the basis of promised benefits. Moreover, the realization of above-average prices should be promoted by individual and monetary incentives. It also makes Furthermore, in order to prevent jeopardizing the lean and market-oriented price system, regular price controlling should take place. This could include quarterly review of the share of total turnover, being generated by orders with prices below the price corridor, and the development of margins.
