Michel Duvivier
Associated-Partner
Just in Time Management Group
A STRATEGIC FRAMEWORK FOR IMPROVING ACCOUNT PROFITABILITY
Pricing is the biggest lever to the overall profitability of your business. Price-rises flow to the bottom line quicker than any other profitability improvement: a business with five percent margins that successfully imposes a five percent price rise doubles its margins. In comparison, taking cost out of the business is both hard work and uncertain. Why then is the balance of effort and resources in many companies tipped so heavily toward expensive cost reduction programmes?
This paper reviews how companies can structure a review of pricing and develop account level strategies for profitability improvement.
1. CONTEXT: THE INCREASING COMPLEXITY OF PRICING MANAGEMENT
Understanding and managing prices is getting more complicated not less, even with the arrival of new analytical technologies. While some products and services are marketed around simple and transparent fixed pricing, there are many more cases, especially in B2B environments, where the number and type of pricing deals continues to increase.
Internet and Transparency: Pricing can be extremely transparent on the Internet, and not only for retail customers. Search and comparison engines offer customers the ability to see and act on prices in different markets and compare your offer to that of your competitors on price alone. These have existed for over ten years, but are receiving increasing attention from custo mer and developers alike. The evolution is demanding realtime awareness of market pricing and reactivity from sectors that used to have relatively stable pricing structures.
The Long Tail: The Internet has created a segment of small customer accounts with infrequent arbitrage like transactions. These buyers may be very opportunistic, and pose a problem of pricing coherence with respect to your reg ular accounts.
Consolidation and increasing sophistication of buyers : Buyers continue to professionalise their approach to pricing negotiations – centralising pricing decision making and monitoring the actual usage and costs of your products. Mergers and acquisitions transfer price deals between companies, heading toward the lowest common denominator.
Service options with everything: The range of service options that are proposed to customers gets ever larger, and these may be priced in ways that are novel to the business. Instead of per product pricing, you also have to worry about pricing service contracts and many variants.
Innovations in pricing: Technology convergence and new sales channels offer a tremendous potential for pricing to be a source of customer- focussed innovation. Product and service bundles are the order of the day – from telecoms triple-play to service guarantees on household equipment as well as attractive pricing for ‘Software as a Service’
2. CHALLENGES FOR PROFITABILITY MANAGEMENT
2.1 KNOWING WHERE THE PROFITS COME FROM AND WILL COME FROM
The nature of your account base may be changing, even while the averages stay the same. Many businesses continue to grow their key accounts at the same time as smaller customers. Each of these trends can be putting your profitability under threat.
Many businesses derive a substantial proportion of their income from a few key accounts, while managing many more small accounts. The ‘tail’ of small accounts may be getting ‘longer’ as an increasing number of occasional customers are recruited through web and direct channels. Conversely the‘head’ - that part of your business generated by key accounts - may be getting bigger.
The trend for customers to centralise their buying power and leverage scale on a regional and local basis is accelerating.
But who makes the money for you? Are key accounts really so profitable for you, when they require lengthy negotiation, demand services to be bundled into the deal and an expensive sales and support structure? What about those small customers? They pay the highest average prices, but they make huge demands on your after sales service.
What consequence will your strategy have for the structure of your account base? As the tail stretches, or the head grows, what will happen to your margins?
2.2 QUANTIFYING RISK: EXPOSURE TO LOSING BUSINESS ON PRICE
We started this white paper with the reminder that pricing is the biggest lever you have on profitability and we encouraged you to put your prices up by five percent. Of course, the problem is that many customers won’t accept the price rise, and some of them may be upset enough to leave you.
You may not be in a position to lose a key account, especially when it represents a big share of your business. The trouble is that when the account leaves you, the revenue definitely goes with it but not necessarily the costs. If you don’t know precisely how to answer and plan for this question, you can almost certainly not effectively manage through price rises.
In order to answer the question, and build a risk exposure analysis, you need to have the right kind of understanding about your costs.
The first factor is to develop an Activity Based view of the cost base, (referred to as ‘ABC’ or Activity Based Costing).
Essentially this means identifying all the services which are made for customers and what drives the cost of each.
Next, it is important to understand within a given time frame how variable each costcentre is in relation to the customer’s activity. The basic, and wrong, assumption with straightforward ‘ABC’ is it assumes that all customer-driven costs are variable.
They aren’t over short time periods: you don’t immediately close your call centre when a major account leaves, but you may be able to reassign some of the staff or terminate temporary contracts over a period of several months. Over a period of a year or more you may actually close your call centre.
The ‘trick’ is to perform the analysis of risk over different time frames: short, medium and long term. Apply different variable percentages to the customer driven costs and reasonable assumptions about what business you will gain and lose. Taken together you can build a risk profile of any pricing campaign and mitigate losses by active management of key accounts.
2.3 PRICING AS A SOURCE OF BUSINESS INNOVATION
Pricing can be a tremendous source of customer-focussed innovation. Examples of simplified and motivational pricing bundles abound: the telecoms sector has been a leader firstly with attractive product-cum-price deals in mobile telephony and now double and triple play bundles.
The same consumer-friendly pricing is finding its way into B2B services: just take a look at Software as a Service (‘SaaS’) providers such as Salesforce or online conferencing vendors such as Webex.
Another field for pricing innovation is in applying the techniques of Yield Management beyond its traditional travel market.
For two decades airlines, hotels and car rental companies have spent fortunes developing systems that continually adjust pricing to maximise the use of ‘inventory’ (increase prices when demand is high and drop them when they risk being left with spare seats, rooms or cars).
There is still a lot of work to be done to apply YM (and ‘Revenue Management’) techniques successfully to other sectors, but the techniques are being studied and applied by freight and logistics companies, power generators and even telecoms companies – all those who have a fixed network with uneven demand, can squeeze extra profitability out of down periods.
However, in many businesses the innovation can also have a flip side of increased complexity. The commercial team love to launch new and attractive pricing schedules, but may do so on top of many other existing deals. Inconsistencies and conflicts between the old and the new can turn into a major headache and potentially a business risk. They can eventually lead to a loss of control over pricing strategy.
3. TOOLKIT: GRAPHICAL APPROACHES TO EXPLORING ACCOUNT LEVEL PROFOTABILITY
% MARGIN SORTED BY ACCOUNT
If you plot the profitability of your accounts, sorted from largest to smallest you may find apparently little correlation between margin and account size. Maybe your biggest accounts are professionally managed and should normally not be loss making – but there are smaller accounts that are sometimes much more profitable. What can you learn from how these accounts are priced and managed?
CUMULATIVE EBIT BY ACCOUNT SIZE
The overall EBIT of your business is the sum of all these profitabilities: which you can graph as shown on the left. The unevenness in the line comes from the fact that profitability is not driven by account size.
CUMULATIVE EBIT BY ACCOUNT PROFITABILITY
Here we sort the same data but starting with the most profitable accounts and adding the profitability of increasingly less profitable business. Eventually we add the accounts that make a loss, until we end up with all the business accounted for and our overall EBIT.
MEASLES ANALYSIS: MARGIN AND ACCOUNT SIZE
When you plot the same data of margin against account size you can get a scatter plot that looks like a ‘rash’ of measles: bigger customers can be unprofitable and smaller customers profitable, but with a high degree of variation.
The challenge is to segment this data into segments and to build appropriate strategies for each. We discuss this in the next section.
4. ACCOUNT PORTFOLIO PROFITABILITY MANAGEMENT FRAMEWORK
Your overall profitability will almost certainly go up if you increase prices and reduced costs.
However, doing this in an undifferentiated manner is likely to be highly risky: your most profitable customers could leave with a consequent reduction in overall EBIT.
By segmenting customers into groups related to their profitability and size, the key objective for each segment is much easier to understand, and the risks assessed.
5. CONCLUSION
This paper has considered the current context, challenges and opportunities for pricing management, and its potential contribution to increasing the profitability of your business.
We have discussed a few of the approaches to understanding and improving account level profitability: exploring who is making you money, what strategy should be taken and how risk can be accounted for.
There are many other topics of relevance to improving pricing management – such as effective techniques for market research, structuring price negotiations, sales force incentives related to pricing and profitability, discounting authorities and structures, applications of Revenue Management to name but a few. Metamorphase can help you consider and respond to all of these and more.
6. ABOUT JAMES HOWE
James Howe is an independent consultant and interim manager in pricing, marketing strategy and organisation and a member of the Expert Team of Just in Time Management.
In 2006 he founded Metamorphase sprl and has subsequently worked with clients in the software, transportation, industrial manufacturing and non-profit sectors to define and launch new products and services to international markets.
His key skill set is analysing business data, defining and conducting internal and market based studies and building a case for change.
A distinguished graduate of INSEAD’s MBA programme (1993) and of Cambridge University (1988), James has published several cases on business strategy together with various INSEAD professors.
Formerly, James was a senior manager within DHL Express, where he was responsible for Pricing and Business Analysis on a global level, led the €100 million+ project to re-brand the company after its acquisition by Deutsche Post and defined and implemented new Yield Management systems in the airline. Earlier he worked as a strategy consultant with ZS Associates, a consulting company and as a business analyst with JP Morgan, a bank.
James is a qualified EFQM (European Foundation for Quality Management) assessor and trainer.
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