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Price complexity and dangers of the looming margin crunch

02 October, 2008

In the current economic climate, companies face some of the most complex business environments for many years.

A range of factors are converging to crunch margins and significantly destroy profits. Witness the 88% profit decline of Goodman Fielder this year.

Rising commodity costs, increasing transport and logistics costs, slackening demand and increased regulatory compliance to such measures as Sarbanes-Oxley mean that companies are being hit from three different angles.

Attention to pricing management and increasing a company’s capability to manage pricing is a key strategic initiative that can be implemented to protect and improve both profit and revenue outcomes.

According to Ron Wood, Director of Pricing Insight, “Australian companies are just coming to grips with the need to invest in dedicated pricing management resources. The most critical investment needs to come from senior management in the form of focus attention and consistent follow up to ensure optimal pricing decisions are made. Jeff Immelt CEO of global diversified industrial General Electric list pricing as the number one focus of his executive management team”.

Wood suggests that companies can invest in training and education to build internal capability and expertise. Do not rely on consultants to provide a golden path, he says. Make sure that you engage your sales, marketing, finance and operations functions to develop a complete picture of your company’s value proposition to each of your customer segments.

Build pricing structures around these value propositions and rules of racing to ensure not only compliance, but commitment to the definition, communication and capture of value.

Pricing Insight list 7 key areas of focus for any senior executive to ensure they are on the path to implementing and effective pricing management system.

These 7 key areas are:

1. Develop your pricing structures using  a Value Based Pricing approach and avoid Cost Plus
2. Understand your sources of pricing power – where do you have pricing strength and weaknesses and why
3. Build your pricing architecture – just as you would construct a house with a detailed plan, have a plan and a blue print to build your pricing house. Foundations, walls, doors, floors and fences – this metaphor is a simple but effective way to think about your pricing.
4. Economics – understand in detail what makes your business profitable across products and customer segments. What low margin products help support your high margin lines? Be careful to avoid deleting products or raising price by 15% just to cover “COSTS”.
5. Pricing Tools are essential to the management of margins. If your business generates 100 million or more in revenue, a 1% change in price across the business equates to a million dollars in pure profit. How much more revenue do you need to sell to generate earnings of this magnitude? If gross margins are 20% then you would need to sell over 5 million dollars in revenue.
6. Engagement – the most critical element of all in any change management program is to get beyond compliance to a level of commitment that transcends rules, polices and checks.
7. Finally, stay focused. Attention to pricing usually arises from a severe event such as a profit warning due to excessive discounting, pricing declines that were not visible or an audit report that identifies reporting management and compliance risks. Monthly and quarterly pricing review and preview meetings are a key method to maintain the required levels of focus.

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