Manufacturers must walk a delicate pricing tightrope. Many products are built to specification and stability is king. As a result, you would rather stick with the steadiness of cost-plus pricing rather than risk struggling with variable pricing — even if it offers the possibility of taking your business to the next level.
Not only is it daunting to consider a new pricing model that will work with so many customized items, but the very exercise of calculating value-based pricing seems like a distraction from manufacturers’ core competency of getting the product right. The old thinking is that if margin is “good enough,” why distract from the process of keeping the factory humming? Similarly, why change how the sales team has always structured deals?
The answer is because settling for what’s always been done is costing you both profits and sales volume. Bottom line, the processes that made many manufacturers successful for their first several hundred million in revenue are now the very things holding them back from their aspirations.
Remaining chained to an undifferentiated and ad hoc pricing mentality can keep manufacturers mired in under-performance. Companies that fail to properly segment their business and price accordingly under-perform in two ways. First, they lose out on deals in segments where the same-old, same-old margin may be too high. Secondly, they inevitably leave money on the table when that stagnant margin may be orders of magnitude less than what the customer is willing to pay.
Benefits to Value-Based Pricing
An organization that utilizes value-based pricing over same-old, same-old stands to gain tremendous big-picture benefits in the long run:
- Pricing is less susceptible to minor fluctuation of costs — whether they come from raw material fluctuations or simply which engineer scoped the routings — there by keeping customers happy with consistent and predictable pricing.
- Capturing the value delivered to premium-bearing segments improves not just profitability but also feeds improved cash flow to kick-start growth opportunities.
- More refined pricing strategies enables the business to lower prices in select scenarios where share may be threatened without conceding price in more profitable segments, resulting in net higher sales.
- Counter-intuitively, and perhaps most importantly, value driven pricing strategies are typically also much faster to quote than cost plus strategies. Shorter quote times means more wins and higher revenues for both the business and the salesforce.
The struggle is often one of where to begin, particularly for organizations with a strong manufacturing tradition but limited marketing or product management expertise. There is no requirement that organizations flip a switch and change their processes overnight. In fact, that is likely a recipe for disaster. Instead, think about select end uses, product families and selling situations where you can realistically begin positioning alternatives according to value and where costing precision can be replaced with general cost accuracy. Here’s what this kind of gradual progression looks like in action.
How One Company Solved Margin Compression
In one real-world example, a metal tubing manufacturer was suffering from margin compression due to low cost foreign imports. Leadership recognized that the situation was deteriorating, and sponsored a cross functional team of stakeholders from sales, marketing, finance and IT to look into a solution. They recognized that the competitive threat was primarily in commoditized end uses where loose tolerances were acceptable. They also recognized that there were categories of products where they may be the only supplier in the world capable of meeting stringent requirements or working with particularly difficult materials.
- Instead of running an application engineer’s costing tool to get pricing, they designed and published to the field a price catalog for most standard products.
- Next, the company competitively priced the generic products in response to the new external pressures. As a separate spin off initiative, manufacturing gained insight on where to prioritize cost down efforts appropriately.
- They significantly raised the prices on products that utilized their specialized manufacturing capabilities — in some cases, as much as two times the amount.
The results of the company’s efforts were significant:
- The field and the empowered CSRs reduced quoting time in some situations from days to minutes.
- While the low-cost competitive threat remained, the organization was able to isolate and manage the scenarios in which they needed to respond with price downs.
- The company began capturing a return on its investments in higher quality and precision segments. While some customers balked at the price increase, the vast majority of them accepted it. The manufacturer experienced no loss of volume, resulting in an immediate improvement in operating margin.
- Salespeople in the field were now armed with clearly defined “good” and “best” offerings, putting additional tools at their disposal when consulting with customers.
As this quick case study proves, the power of improved pricing requires mere pennies on the dollar to pay large dividends.
Getting an industrial business to value-based pricing requires buy-in across the organization to really take hold, from sales people to product managers and all the way up to executives. It also requires more than lip service to achieve. To implement such a program at your company, start modest, and use small wins to gain acceptance and trust from both management and the field. The results will pay for themselves.
Justin Bailey is a business consultant with Vendavo.