Chief Pricing Officer

Sounds pretty lofty and never an easy undertaking – transforming an organization.  But, even in this difficult economy and especially because of it, leading manufacturers are doing just that – transforming their pricing organizations to achieve better control over margins and profitability.

A 2008 AMR Research study “Building a Bullet-Proof Business Case for Pricing Improvement Initiatives” conducted by researchers Noha Tohamy and Heather Keltz asserts, “Companies that succeed in improving their pricing practices have typically centralized many of their pricing practices and invested in training their sales organization on fact-based pricing.”  A centralized pricing organization focused on using improved forecasting and optimization for more fact-based selling characterizes the companies that, in my experience, have successfully implemented pricing initiatives, as measured by their profit gains (ranging from over $1 million up to $20 million). Moreover they have been able to reduce price volatility.

There are four key elements at play in the success or failure of every pricing transformation:

1. Re-designed and Centralized Pricing Processes

2. Enhanced, Cross Department Communication

3. Effective Training, Integrating Process with Technology

4. Active Executive Sponsorship

Centralized Pricing Processes

In his recent guest post, Dr. Michael Freimer highlights the impact of price volatility and the need for tools and processes to control volatility.  Organizations that centralize the pricing function along with implementing better processes and tools gain better insight into customer buying patterns and improve fact-based pricing decisions.   For example, a growing commodity processor created a price management function focused on finding margin opportunities through changes in operations, product mix, and timing.  The price management function reports directly to the CEO and helps the organization execute their strategy to shift from spot to more forward sales of their commodity-based products.  Price managers have the responsibility for conducting detailed analysis of improvement opportunities using sophisticated forecasting and optimization software and communicating the results of their analysis to the sales team.  This provides sales with more fact-based and dynamic information that can be used in sales transactions.  In the fast-paced, transaction-oriented world of the sale representative, the time to conduct this type of analysis was virtually impossible without the benefit of the price manager’s role.

Enhanced, Cross Department Communication

Enhanced communication with the sales team is another benefit of a centralized pricing organization.  To achieve better communication, processes must be examined in light of the desired organizational change.  Cross-departmental communication can be facilitated through the use of common tools and by clearly defining the guidelines for how prices are quoted to the customer.  For example, one successful meat packer’s pricing team is accountable for establishing the final price quote for each transaction, while giving its sales team visibility to the same forecasting and optimization technology used for price setting so that both groups are consistent in their understanding of market trends. With this visibility, sales representatives have more “pricing courage” and provide better pricing guidance to customers, resulting in improved relationships with key accounts.

Effective Process and Technology Training

Training both the sales and pricing teams on the new processes and tools is also imperative for success during the transformation.   Understanding how to navigate forecasting and optimization applications may be fairly straightforward, however, understanding the use of these more sophisticated technologies within the pricing process is less so.  Effective training integrates both the process and technology use cases.

Active Executive Sponsorship

Too often organizations assume that by simply communicating a change and providing training that immediate execution will occur.  Training is only one aspect of managing the transformation, active sponsorship at senior levels must be present.  Executives who support structural and process changes as well as the implementation of new technologies and tools ensure that true transformation occurs.   Holding managers accountable and identifying champions for change from among the pricing and sales or buying groups are just two of the roles that executives play in managing the transformation.  Additionally, executives and managers must support shifts in the organization’s compensation structure to better align them with profitability goals.

AMR’s research points out the benefits of centralizing the pricing function as well as the risks.  Process redesign, implementation of improved forecasting and optimization technology, training and strong executive support represent the strategies for mitigating risk and achieving true transformation.   The true measure of the transformation is the attainment of profitability goals – that’s the real bottom line.

Professor Clive Granger, winner of 2003 Nobel Prize in economics, passed away on May 27, 2009. Few will argue that he revolutionized the field of economic time series forecasting. Professor Granger was particularly interested in prices and applied his theoretical ideas of causality and co-integration to financial stock market price time series.

He questioned bad econometric practices when he saw them….

“Before Dr. Granger’s studies, it was common practice for economists to take methods intended for stationary time series and use them to analyze nonstationary ones. But Dr. Granger — working closely with a colleague at the University of California at San Diego, Robert F. Engle — demonstrated that this approach could produce erroneous results” (http://www.nytimes.com/2009/05/31/business/31granger.html).

…and determined theoretically-sound concepts to overcome the underlying challenges.

“For want of better techniques, economists often applied statistics designed for stationary data to non-stationary data. But in 1974, Granger and his post-doctoral student Paul Newbold, building on the earlier work of the British statistician G Udny Yule, showed that pairs of non-stationary time series could frequently display highly significant correlations when there was no causal connection between them. For example, the US federal debt and the number of deaths due to Aids between 1981 and 2000 are highly correlated but are clearly not causally connected. Such “nonsense correlations” called into question the meaningfulness of many econometric studies.” (http://www.telegraph.co.uk/news/obituaries/finance-obituaries/5407598/Professor-Sir-Clive-Granger.html).

Professor Granger was awarded Nobel Prize in 2003 for his foundational work in the area of co-integration.

“His innovation has completely changed the way that economists estimate and build dynamic models of the macro economy,” Torsten Persson, an economist at the University of Stockholm who served on the Nobel Prize Committee for Economic Sciences, said at a ceremony honoring Dr. Granger in 2003. “Nowadays co-integration methods are literally used everywhere — by academically minded researchers in universities, as well as more practically minded investigators, be it in central banks or the private sector” (http://www.nytimes.com/2009/05/31/business/31granger.html).

As practitioners in the field of pricing, we owe a lot to Professor Granger and his lifetime of dedicated work.

The Two Faces of Price Volatility

Price volatility in agricultural commodity-based industries wears two faces. Media headlines often portray the ugly visage: market shocks such as the H1N1 outbreak and the spike in demand for ethanol disrupt industries that already face razor-thin margins. On the other hand, it’s often said that swings in market prices provide opportunities to make money, particularly if you’re better prepared to handle price shifts than your competitors. Which face is the true one? Should you try to eliminate price volatility, or actively manage around it?

One answer lies with understanding which factors cause prices to move up and down, whether those factors are at all predictable, and whether the resulting price changes represent dangers or opportunities. Agricultural markets generally exhibit strong seasonality – regular cycles of weather, biological processes, and consumer demand result in a certain amount of predictability in price swings. Such patterns are particularly apparent in the protein industry, which will be a focus of this blog entry. This kind of price volatility can be managed; a good forecast model can allow you to appropriately adjust your forward sales profile to up- and down-markets. The ability to spot market turns earlier and more accurately than your rivals is a competitive advantage. It allows you to adjust your prices sooner, so you avoid taking too long a position in an upswing or facing a fire sale in a downswing.

Seasonality is not the only source of market price changes. Other factors including market supply, access to export markets, changes in retail demand (think consumer downgrading from tenderloins to cheaper end meats in the face of the current recession, or the significant shifts brought about by the Atkins diet), and exchange rates also play significant roles. The predictability of these factors varies, and recent structural changes in agricultural markets have made spotting price shifts even more difficult. Feed prices, which are a driving factor in the price of beef, pork, and poultry, are now tied to the prices of oil through the increasing demand for ethanol. Energy commodities have historically exhibited greater volatility than corn, and some of this additional uncertainty has been translated to the protein and to other agricultural industries.

A common approach to managing unpredictable market price volatility is hedging. Unfortunately the salvage nature of the protein industry makes hedging difficult because orders are taken for products, but futures markets operate on the animal.  There can be significant variation of the product price relative to the animal. The correlation coefficient between product prices and animal prices can range from 0.9 on the high side all the way into negative territory. Hedging of long term contracts against futures may actually add to the contract risk rather than negate it. In general, it is very difficult to find the right hedge position to offset risk for specific transactions.

So market price volatility, while not exactly a benign face, at least provides you with opportunities to out-maneuver your competitors. Other sources of price volatility can be even more troublesome. The figure below shows sales data from a large U.S. meatpacker, altered to protect the source’s identity. We examined every transaction over the course of a year, and computed the percent deviation between the transaction price and the USDA market price. The graph’s horizontal axis shows the deviation from the market prices (0 means the transaction price equaled the market price), and the vertical axis shows the fraction of annual revenue generated by transactions at each deviation. 

Impact of Volatility on Revenue

Price Deviation (%)

While the actual data has been modified, the shape of the graph is correct. Most transactions took place near the market price, but notice that the curve is lopsided. More revenue (meaning a lot more volume) was generated at below-market prices than above the market. Customers recognize a good deal when they seen one, and they pick you off when quoted prices are too low. The result is that mistakes on the low side are a lot more significant than wins on the high side, so focusing on tools and processes that allow you to reduce this form of price volatility will lead to higher overall revenues.

The graph shows variability in the company’s product prices above and beyond any volatility in the USDA market prices. What causes this volatility? A variety of factors, most of which have to do with either the company’s supply position at the time of the transaction, or with the company’s pricing processes. Above-market prices may have been the result of a strong forward sold positions, while price below market may have resulted from a fire sale caused by too low a sold position. Alternatively a low price may reflect an inability to call the market, or a poor negotiation on the part of an individual salesperson.

So what is the true face of volatility: opportunity or risk? Both. Pricers should try to build a two part strategy. First, incorporate better forecasting technology to separate out random volatility from predictable market movements, thereby generating competitive opportunity. Second, stabilize pricing patterns that give customers the opportunity to exploit randomness and pick off low price events.

No surprise, we are in the midst of an economic downturn.  What are the three actions being taken by every company in this recessionary climate?  No surprise:

1.    Control costs, mostly by cutting back spending and reducing staff
2.    Dump customers, keeping only the largest, most profitable ones
3.    Stay the course, hoping to ride out the storm

Not much of a strategy, then again, many CEOs running companies today haven’t weathered an economic storm like this one.  It’s a fair bet that none of the Fortune 1000 executive ranks were managing a P&L during the Great Depression.  So we’re all in new territory, but everyone is relying on the old strategic formula.  Old habits die hard.

The playbooks and management strategies we’ve turned to in bull-driven, steady growth markets, those catchy business book titles from Competitive Advantage to Core Competencies to Quality Circles to Reengineering the Corporation to Customer Focus, need to make room on the shelf for a new breed of thinking.

Here are three business book titles I’d like to see hitting the shelves this year and what they would cover:

The Biology of Pricing: Profits Under The Microscopic

Most managers elect to focus on their company’s core competencies during troubled times.  But do you even know what your core competencies really are?  Forget hosting executive off-sites or surveying your employee base.  Your core competency is right in front of you, in every pricing decision you make.  If you can dig into transaction data, understanding your pricing decisions and resulting margins for each sale, you have the foundation needed to distill what you are really good at, who you are best at delivering value to, and where you should invest and divest your operations.  Look at your price waterfalls, segment your prices and margins by customer and product, and take a look at what’s really driving your company’s profitability.  Don’t forget to include trade spend, discounts and rebates, receivables and bad debt costs in your analysis.  The resulting visibility will guide you in building a strong foundation around your true competencies and will allow your company not only to survive the storm, but to thrive when the economy turns around.

Cost Cutting vs. Precision Pricing: The Enlightened Road to Victory

Cutting costs are easy.  It’s one thing you can control.  But it’s not the most significant lever in the profitability equation.  Price is.  And even if you do turn to cost-cutting, be wary of cutting across the board.  Today’s accounting rules and financial statements often hide the true dynamics between costs and production.  Again, this is where a thorough study of transactional pricing comes in handy.  By digging in to your pricing decisions, you can develop an alternative view to your cost structure that helps you determine which areas of the business are most profitable, and those that are a financial burden.  Cutting is a necessary part of growing a business.  But remember, trimming the sails is very different than tossing the crew overboard.  Make incisions from insight.

Firing Failing Customers

During tough times, most companies will hold onto all their customers and all that revenue, even if it means giving away services, cutting prices or offering additional incentives.  Under the guise of improved customer loyalty, many companies kill their profitability by giving away the store.  What’s worse is how much is given away to the unprofitable customers that should’ve been fired long ago.  Customer profitability is like religion, it is a powerful motivator, but not something easily understood, let alone put into practice.  But now is the time, and it starts with prices.  Transaction level pricing insight is the precursor to understanding customer profitability.  Once again, if you can determine margin contribution on individual pricing decisions by product, customer segment, you’re well on your way to determining which customers to keep and which to fire.  And by all means, fire the bad customers immediately.  They’ll come back when they are ready, and when you are ready, too.

The common theme, of course, is that business success and profits all lead back to optimizing your pricing decisions.  The books recommended should become required reading for managers today.

In these dark times, what business book titles would you like to see?

The art and science of price strategy is not easily understood, let alone mastered. P.J. Jakovljevic at Technology Evaluation Centers (TEC) has undertaken this field as part of TEC’s coverage of supply chain issues.

Jakovljevic demonstrates keen insight in the not-to-be-underestimated area of pricing and offers several interesting articles via the TEC blog. He recently posted Part 2 of his analysis of SignalDemand, which I encourage you to check out, along with his overview of other pricing technology vendors. Here’s a brief excerpt to give you an idea:

Pricing Science of Matching Supply and Demand

Other price optimization solutions really only consider the demand side of the pricing equation, and these results are insufficient for manufacturers to make decisions when they need information on capacity and production constraints as well. SignalDemand’s hand-picked team of scientists and mathematicians from prestigious universities have built a pricing science based on eight pending patents.

This sophisticated science drives the recommendations provided by the software application. When making decisions on margins, the idea is to account for all major profit drivers such as to

• align strategic business objectives with pricing decisions;
• understand demand drivers to forecast future sales;
• account for fluctuating costs;
• on the supply side, account for asset utilization, available capacity, and inventory situation; and
• determine the most profitable product mix for a given demand.

Accounting for all the above factors helps with much more complete, consistent and actionable information to better anticipate future costs, forecast demand, identify poorly performing products or customers, and explore projections in the context of historical sales.

I encourage you to check it out along with his overview of other pricing technology vendors and general supply chain coverage.

SignalDemand: Dealing with Supply- and Demand-side Pricing Matters — Part 1

SignalDemand: Dealing with Supply- and Demand-side Pricing Matters — Part 2

The TEC Supply Chain Logistics Blog

I first met Seth Godin, the prolific internet marketeer from the early Yahoo! days, in New York City. It was midnight and we were standing next to one another at the Marriott reception counter, checking in, both fresh from the United flight from SFO. We were both speaking at the DMA conference (me on email marketing, Seth on everything). We conversed on optimizing the check-in procedures, refining the experience. Not much has changed on that front, but here he is, circa 2009, talking about pricing on his blog:

Change your pricing

When a restaurant goes from a la carte to either a buffet or a prix fixe meal, it is able to find a new class of customers.

Could a law firm charge by the project? When I incorporated Yoyodyne, a fancy firm charged us a fix rate.

Netflix went from charging by the rental to charging by the month.

We use tolls to charge people who drive over bridges more than other folks. We don’t hesitate to charge people ordering steak more than people ordering pasta in a restaurant. Could the library charge frequent readers more? What about insurance companies charging more to young families (more likely to have a baby).

Ski areas have a huge fixed cost base (land, grooming, etc.) so they get greedy, sell too many lift tickets and the lines get long. Fixed pricing encourages people to ski a lot, at peak times. What if only cost $3 to get on the mountain, plus a small charge for each lift ride and a premium price for popular lifts at popular times? The technology is already there, the only reason not to try it is momentum.

If you’re a copywriter or masseuse or other sort of freelancer, how many retainer clients do you need to relax and spend more time on the work, less on the billing/looking part? What happens when an artist does this?

Why don’t airlines experiment with auctioning of seats, baseball card style? You could buy the rights to a seat for $200 (speculating, if you like) and then try to sell it off as the flight time get closer–it’s not hard to imagine an easy to use website for these transactions. The seat might change hands a dozen times, earning the airline a processing fee each time, and enriching those that want to start trading this expiring commodity. Sports teams are already trying to figure out how to make this work.

Changing your pricing changes your story.