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.

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.

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.

Anyone who watches football on Sunday probably has Toyota’s “Saved by Zero” jingle permanently (and annoyingly) ingrained in their head, and recent news shows that Ford is employing a similar tactic to boost sales. In addition to joining its colleagues on Capitol Hill to ask for some federal financial help, Ford has come out with an employee-pricing-for-all strategy after the company’s sales plummeted by 30 percent last month.

The use of employee-pricing tactics is touted as “an interesting experiment in fixed pricing” by the all-things-automotive gurus at Edmunds.com. And indeed, being offered an “insider’s” rate is certainly an enticing psychological gimmick. Actually, the folks at Edmunds call it a gimmick and a spade: “You can call it employee pricing or rebates or incentives or deep discounts, but the bottom line is the bottom line: Cut prices, sell more.” (Last week’s “Family & Friends Discount” offered by Gap, Inc. is another example).

When it comes to pricing, there is obviously a huge psychological factor: People associate any lower-than-retail pricing as scoring a deal and when billed as an inside deal, the result is to feel way more special than one’s fellow consumers. Certainly not a new ploy, but as evidenced by some of the U.S.’s largest retailers, a tried-and-true way to move a lot of volume in a short amount of time.

What is the long-term implication of these strategies? While it’s true that the thinness of everyone’s wallets results in less buying, the downturn doesn’t negate the need for informed, reality-based pricing as a foundation for our economy. Downturns, big and small, have happened before, and that data can be injected into pricing approaches today. No matter what the economic climate, we need to work toward pricing – whether it’s for cars, cable-knit sweaters, or lamb chops – that is informed by the cost, supply and demand factors that matter for profitability.