Over the last three decades, most manufacturers have been heavily focused on operational performance and supply chain integration. With increased competition on a worldwide basis, driving cost out of the equation has understandably been a top priority. Lean manufacturing is now the norm and there’s not a manufacturer on the planet who hasn’t adopted some form of kaizen, kanban, just-in-time, or six-sigma approach.
In many cases, however, this extreme focus on the operational aspects of their business can cause manufacturers to lose sight of other powerful profit-levers that are crucial in a downturn. These companies tend to act as though they only have one tool in their tool-belt. And when a downturn hits, their natural reaction is to grab that one tool and just start swinging it even harder and faster.
Blind to the other opportunities available to them, these manufacturers continue to focus all of their energy and attention on driving their operational metrics to even greater heights.
Of course, this isn’t necessarily a bad thing. Who can argue with becoming even more efficient in a market condition like this? The critical point, however, is that with any area of focus, there’s always a point of diminishing returns.
As a result of the extreme focus on operational efficiencies over the years, many manufacturers have made a lot of progress on that front. So much progress in fact that further improvements now come at a high cost and have a relatively minor impact.
But what else can you do? Where else can you focus your limited resources for greater effect? Is there another tool in the tool-belt that can provide more leverage in a downturn?
The Relative Power of Three Profit-Levers
At a high level, let’s examine three fundamental profit-levers available to a manufacturer -- increasing sales volume, reducing costs, and improving pricing.
Improvements in any of these areas can certainly have a positive impact on a company’s performance, that’s a given. But are all of these profit-levers created equal? Do they have the same level of power and influence? And even more important, does each of these profit-levers have the same improvement potential in a downturn?
Starting with the financials of a prototypical manufacturer, we can show the isolated profitability impacts of a 5 percent improvement in sales, costs, and pricing. Clearly, each of these areas is powerful -- but to very different degrees.
For example, it takes 3X more improvement in sales to equal the impact from pricing. And, improvements to realized price have more impact than improvements to costs and sales combined.
But raw power and influence are just one factor to consider. You also have to consider the realistic potential to actually achieve the improvements.
In a market condition like this, driving increases in sales volume is challenging to say the least. Manufacturers typically have very little influence over the end-user and direct demand. Unless channel intermediaries are taking aggressive actions on their end, indirect demand is what it is. Trying to change the dynamic can often do more harm than good, accelerating the downward trends across the entire sector.
Many manufacturers have already reached a point of diminishing returns on the cost side of the equation. It’s not that there isn’t more efficiency to be gained -- there’s always room for improvement. It’s just that the time, effort, and resources required to make something that’s already pretty good even better, often outweigh the benefits and impact. This is especially true when there are more achievable opportunities available.
Improved Pricing: The Untapped Opportunity
As manufacturers have focused on operational efficiencies over the years, they haven’t been able to give much attention to their pricing practices. As a result, there’s typically a lot of room for improvement in this area and most manufacturers have barely scratched the surface. In fact, it’s not at all uncommon for a $1B manufacturer to have $40-60 million of margin slipping through their fingers due to suboptimal pricing.
Relative to the opportunity to actually achieve sales increases or cost reductions, the opportunity to improve realized prices is virtually untapped for most manufacturers. And given the power of pricing, it really doesn’t take that much improvement to match anything you could do on those other two fronts.
Frankly, with the pricing technology available today, it’s never been easier for a manufacturer to improve its realized prices -- and do it in a hurry.
Imagine being able to reclaim 10-15 percent more margin dollars in as little as ninety days. That’s what today’s price optimization technology can do. Now imagine trying to drive that same level of improvement through an increase in sales volume or a reduction in costs. How much effort and resources would it take? And, is it even achievable in the first place? Given enough time, anything’s possible. But in 90 days? Not likely.
In conclusion, while it might be tempting to simply focus on the “old standbys” in market conditions like these, manufacturers need to realize that there’s another powerful profit-lever at their disposal. Even small improvements to the quality and accuracy of prices in the marketplace can generate big bottom-line impacts in very short order. And unlike some other areas that have been squeezed for all they’re worth, the opportunity for pricing improvement is virtually untapped.
So what are you waiting for? Take hold of the pricing profit-lever and start turning your fortunes around.
Zilliant, Inc. is a provider of price optimization software. For more information, visit http://www.zilliant.com/