«Why executives should make pricing their personal mission I magine a world in which over 80% of companies have come under increased pricing pressure, ...»
Georg Tacke, David Vidal and Annette Ehrhardt
THE KEY TO HIGHER PROFITS: PRICING POWER
Why executives should make
pricing their personal mission
magine a world in which over 80% of companies have come under increased pricing
pressure, and almost 60% of companies are embroiled in a “hot” price war. The vast
majority of companies feel they can’t justify a price increase above current levels of
inﬂation. Even when they dare to raise prices at all, they manage to get only half of what they ask for.
What you just imagined is real.
These discouraging circumstances describe day-to-day life right now for thousands of companies around the world. At a time when every dollar, Euro, yen, or yuan in proﬁt is precious, even some of the world’s most prominent companies, such as consumer products giant Procter & Gamble, often struggle to make price increases stick. This struggle reﬂects weakness in pricing power, the ability of a company to get the prices it deserves for the value it delivers to customers.
But the excitement is unmistakable when a company does exercise pricing power effectively. In its second ﬁscal quarter (Oct-Dec 2012), that very same Procter & Gamble – which was ineffective at raising prices over the last two years – reported an increase in gross margins of 110 basis points “due to the impact of higher pricing and manufacturing cost savings.” The company’s optimism also rose sharply. The strong proﬁt growth – combined with surprisingly strong organic sales growth – prompted the company to revise its ﬁnancial forecasts upward for the rest of the 2012/13 ﬁscal year.
That turnaround did not happen overnight. It always takes a concerted effort for a company to develop pricing power and then see it pay off.
But exactly how strong is the link between pricing power and higher proﬁts? And if it is strong, how do companies generate that elusive pricing power? The Global Pricing Study The Key to Higher Proﬁts: Pricing Power - Page 2 2012, conducted by Simon-Kucher & Partners, the world’s leading pricing consulting ﬁrm, provided us fresh insights into that link. Combined with our ﬁrm’s experience over the last 28 years, these insights helped us develop clear and very speciﬁc answers to both questions, with implications for companies in all industries, regions, and categories.
The Global Pricing Study 2012, a comprehensive survey of over 2,700 executives and managers in over 50 countries, made one fact clear: the wellspring of pricing power is the C-suite. Companies whose CEOs make a personal commitment to pricing – and who take an active role in it – have much higher pricing power and much higher proﬁts than those whose CEOs do not have pricing high on their agendas.
In other words: proﬁts jump when CEOs take an active role in pricing and make pricing personal. Higher pricing power increases proﬁts by 33%, according to the study. Furthermore, companies with high pricing power are more likely to have a stronger proﬁt outlook, more likely to raise prices, and more likely to make those price increases stick.
But only a minority of companies succeeds in generating pricing power, harnessing it, and sustaining it in today’s era of low GDP growth in western markets and ongoing uncertainty in developing ones.
Pricing power Average profit margin of last three years (index)
The Key to Higher Proﬁts: Pricing Power - Page 3 What do those select companies have in common? Of course, their C-level executives don’t roll up their sleeves and perform day-to-day, nuts-and-bolts price setting. Instead, their C-level executives know that their express commitment and increased scrutiny on any issue will exert a strong inﬂuence on their company’s mindset. They can change the internal mindset on pricing in the same manner.
When an executive makes pricing improvement his or her personal mission, it automatically becomes a corporate one. This translates into pricing power and proﬁt improvement when
• Establish and enforce clear accountability for pricing strategy
• Support the development of a pricing organization with transparent pricing processes
• Ensure that revenue models reﬂect both the value their business units deliver and the costs they incur
• Communicate their pricing strategy and pricing identity, as the company’s pricing ambassadors, internally and externally That’s the golden combination that allows pricing power to develop and work its bottomline magic in today’s economic climate.
This eBook explains how to achieve that golden combination, by putting those four points into action. It serves as a mandate for change for C-level executives who want to take a closer look at their own organizations and start to generate, harness, and sustain more pricing power, then reap the higher proﬁts that go hand in hand with it.
Think back to the circumstances at the beginning of this eBook. As a C-level executive, you have two options
• intervene to escape the circumstances, thus enabling your organization to turn pricing from an underperforming asset to a powerful advantage
• accept those circumstances, which is tantamount to accepting perennial underperformance, with all the consequences that it brings in today’s uncertain economic climate.
If proﬁt growth is an essential part of your company’s mix of objectives, then you really have only one option: to intervene.
Intervention requires an element of courage, which you not only need to demonstrate personally, but also transmit to the rest of your organization. The rewards for showing this courage and seizing the initiative are substantial. Experience shows that the ﬁrms that increase prices ﬁrst are likely to enjoy increased proﬁtability compared to those that continue to delay price increases.
The Key to Higher Proﬁts: Pricing Power - Page 4 Michelin CFO Marc Henry said his company “is the prime mover regarding price increases” in the tire industry. Michelin also usually takes home the biggest share of the industry’s proﬁt pool, with an EBIT in 2011 of $2.5 billion vs. $2 billion for Bridgestone, even though the latter company had higher revenue ($31 billion vs. $28 billion) than Michelin. Goodyear, meanwhile, earned around $800 million in EBIT on revenues of $22 billion.
The commitment and courage required of C-level executives is signiﬁcant. There is no doubt about that. But the stakes and the rewards are high. When higher pricing power translates into 33% higher proﬁts, it is hard to imagine a better investment for your company to make than to follow the change mandate in this eBook.
C ompanies whose C-level executives take an active role in pricing are 35% more likely to have high pricing power, and 30% more likely to expect strong EBITDA growth over the next three years.
The ﬁrst area of change to achieve that level of pricing power is to take a much more disciplined approach to pricing strategy. That begins with consistent leadership and guidance from the top down. Executives who help their companies create and sustain higher pricing power provide clear, consistent direction and guidance on pricing. They also establish and enforce clear accountability for pricing strategy throughout the whole organization.
Accountability, in turn, starts to take root when you demand that each business unit delivers an explicit pricing strategy. But you have to build up to that level, step by step. Each C-level executive must learn what kind of guidance each business unit needs, and also learn how to conduct a more robust discussion around pricing, before a team takes a decision, and not just afterwards. As an executive, what should you ask for? How do you challenge the pricing strategies in a constructive way?
The very ﬁrst step – proven to be effective in so many contexts – is to work with a more rigorous deﬁnition of “pricing strategy” and to put commitments and numbers down in writing.
What is that rigorous deﬁnition? A pricing strategy must include these elements:
• a clear intent
• a quantiﬁed direction for prices or price changes
• a timeframe for execution
• the word “because” The Key to Higher Proﬁts: Pricing Power - Page 6 “Because” is essential. It forces the strategy to draw on evidence from your company’s ﬁnancial and marketing objectives, your segmentation, your products’ perceived value, your portfolio, and your competitors’ moves.
In fact, a pricing strategy must derive directly from your company’s overall objectives. Without unequivocal guidance from you on what matters most – revenue, volume, absolute proﬁt, margin, or market share – it is hard for your teams to deliver explicit pricing strategies, and even harder for you to provide guidance on how to make adjustments. Your overall strategic direction will depend on changes in demand or customer segments, in the competitive situation, and in your own positioning. In that sense, your targets – and hence your guidance – is often relative rather than absolute.
What does this look like in practice? You’ll ﬁnd two sample strategies below:
These statements take time to prepare. Finding the evidence alone and agreeing on its implications can be a painstaking process. But these statements create clarity around the pricing goals and how they link to corporate objectives. They help you hold your teams accountable.
When we speak with executives the world over, most of them can proudly point to crisply deﬁned sales goals or manufacturing processes. You see them displayed on banners hanging in the lobby, or on posters decorating the hallways on the way to the shop ﬂoor. You may see hints about pricing, too, such as The Disney Company talking about “affordability”.
The Key to Higher Proﬁts: Pricing Power - Page 8 But far less common are the numbers and the commitments for pricing and proﬁt, never mind a deﬁnition for success in either area.
“Writing things down” means that each business unit needs to express its proﬁt orientation in numbers (relative or absolute) and deﬁne the pricing steps it will take to meet them.
This takes the mystery and emotions out of pricing discussions. Over time the mechanics of good pricing become ingrained, even second nature.
As an executive, you need to drill deeper into the overall strategic direction of all business units. In the spirit of what we said earlier, no one expects the executives to do all the pricing work on their own. Rather, they should challenge their direct reports and teams by asking challenging questions and demanding that teams provide the answers and the support for those answers.
If a business unit has done its homework properly, executives can probe with a handful of simple “what if?” situations. The four simplest ones apply to any company in any industry
in any part of the world:
• what will happen if we raise prices?
• what will happen if we cut prices?
• how exactly will we respond if our main competitor raises prices?
• how exactly will we respond if our main competitor cuts prices?
The answers should start with numbers, not stories. You can answer all four of these questions with a vast list of variables, but the most relevant ones are revenue, volume, absolute proﬁt, margin, and market share. Everyone involved in these discussions should already have a vested interest in improving those metrics. In many companies that excel in pricing power, the incentive plans – from salespeople all the way up to C-level executives – reward performance against some combination of those ﬁve metrics. This makes pricing power even more personal, and not just for the senior executives.
What the business units bring to these discussions depends heavily on your market structure and your position in it. For companies in an oligopoly, having an explicit pricing strategy serves as your touchstone and conscience when you feel the need to act to stabilize prices, prevent price erosion, or defuse a price war. For companies in other markets, it still serves as your conscience, but more as way to remain disciplined and true to your objectives when the temptation arises to use pricing as a convenient means to reach a short-term goal.
The Key to Higher Proﬁts: Pricing Power - Page 9 This also presents an opportunity for C-level executives to dig even deeper. We strongly recommend that each executive spend two hours every month examining a speciﬁc pricing topic. It could be contract language, negotiating strategies, terms and conditions, selling tactics, or even plans for market research.
The shadow presence of a senior executive can seem ominous for any team. But it brings two very positive beneﬁts to the organization which can help establish proof of concept, build conﬁdence, and further enhance pricing power. First, it creates a sense of discipline and helps foster accountability. The risk of being watched or judged sharpens the team’s focus even more.
But with that risk comes reward. Creating the right impression and meeting or exceeding targets under that scrutiny should bring recognition and create an appetite for more, not only for that team but also for others. Whenever possible, you should publicize the positive results internally and express them in money terms. Even small “victories” can have that contagious and positive effect if the senior executives position them properly.
C-level involvement drives pricing performance Companies with increased C-level involvement in pricing are...
The Key to Higher Proﬁts: Pricing Power - Page 10 Companies with active C-level involvement in pricing are 18% more likely to put through a successful price increase, according to the study. But more importantly, they are 26% more likely to get higher margins from their price increases than companies without the C-level involvement in pricing. Every point of margin you can get from a price increase is precious in today’s tough climate.