Written by Heather Cole, April 1st, 2021
As COVID 19 has changed the world, finance departments are challenged to rethink their business. In some sectors costs are souring while buyers are shrinking. With an eye on profitability financial planning and analysis (FPA) departments are running numerous forecasting scenarios. CFO’s understand how to manage the cost side of the margin equation, but what about the price side? Should finance set pricing? Does the finance team understand the real value of the products or services? What should finance's role be in pricing? And does your finance team have the right tools?
Cost + Basis Is Not Enough
Some organizations have looked at pricing as a Cost + Basis in defining their pricing. But is that the best way to drive profits? Let’s look at the effect of increasing the price 1 percent. According to a McKinsey article The Power of Pricing,
“Consider the average income statement of an S&P 1500 company: a price rise of 1 percent, if volumes remained stable, would generate an 8 percent increase in operating profits, an impact nearly 50 percent greater than that of a 1 percent fall in variable costs such as materials and direct labor and more than three times greater than the impact of a 1 percent increase in volume. Unfortunately, the sword of pricing cuts both ways. A decrease of 1 percent in average prices has the opposite effect, bringing down operating profits by that same 8 percent if other factors remain steady.”
So just a 1% decrease in price would require a significant increase in volume to maintain the same profit levels.
It is time for companies to look at what is actually pocketed from each transaction. Profits can erode from the list or base price in the form of customer discounts, incentives, promotions, cash discounts, freight, and other giveaways to gain the contract.
The pocket price is the list price minus discounts, rebates, promotions, free freight, and similar offers. The contribution margin of a sale transaction can be determined by subtracting the cost of goods sold from the pocket price.
For example, a company sells a product for $1,000 at list. The client negotiates a 20% discount for $200, therefore the pocket price is $800. If the cost of goods is $500, the contribution margin is $300.
But we all know that discounts, rebates, promotions, and payment terms are rarely the same for all your clients. To get a better view of your profits, you need to dive deeper down to profitability by customer and product.
According to Deloitte’s CFO Insights article “Pricing for Profitability: What’s in Your Pocket,” an effective pricing “strategy should rely on understanding economic profitability at the customer, product, and segment level—the so-called pocket margin.”
Finance’s Role in the Analysis
So what exactly is finance's role in pricing? For organizations to effectively drive profits there should be a team effort. Marketing understands the value the products and services bring to the market as well as the competition. Sales is in the trenches and understands the clients. Finance is in a unique position to provide a profitability perspective to pricing. Pricing strategies should align with corporate strategies. For example, are you looking to be the lowest cost provider or the boutique specialty product? FPA teams that take view at profitability from a customer-level can find opportunities to improve margins.
Does your FPA Team have the right tools?
The secret to unlocking profits using a customer centric approach requires the right tools for analysis. Finance teams need to have access to the right data, and advance analytics modeling tools to do what if scenarios. Could they use Excel? Sure, but we all know that Excel is prone to user error and challenging to maintain. Unfortunately for many financial analysts their organizations have not stopped to think about the time they spend data chasing and maintaining spreadsheets. Valuable time that could be spent analyzing data for valuable insights.
IBM Planning Analytics
IBM Planning Analytics is a power tool that can help financial professionals add significant value to the pricing discussion by streamlining models and allowing time for insightful analysis. The Planning Analytics’ multi-dimensional models allow for deeper dives into customer and product margin analysis. But IBM Planning Analytics can also be used to increase the accuracy of your forecasts and simplify your budgeting process. Check out this brief demo of IBM Cognos Planning Analytics. This is a valuable tool that can help finance's role in pricing.
Other Ideas to Increase Profits -
Now that we discussed what should finance's role be in pricing and the need for the right tools like IBM Planning Analytics, CFO’s need to also influence the other areas that have a role in the pricing discussion.
Ending Steep Discounts:
In many organizations the salespeople are quick to give steep discounts so they can win the deal. But are the discounts necessary? What if you encourage your sales teams to change how they sell your goods or services? What if during the sales cycle they proved so much value that clients did not ask for discounts? Yes, for many this would require a cultural change, but I can tell you from my own business, retraining your teams to learn a different approach can have a huge impact on your bottom line. To learn more about an approach I recommend check out the book Gap Selling by Jim Keenan. Here’s a link to a book review I did on it.
Teaching Negotiation Skills:
Do you offer your teams training in negotiation and influence skills? Hmm I didn’t think so. But why not. By training your sales and finance team to improve their negotiation skills, you could see profits rapidly. As a high-performance and executive coach I have a gift for you. For years, under my Heatherized company, I have coached CFO’s on the art of negotiation. I feel so strongly that this is a vital key to profitability for all companies that I am going to provide you complimentary access to my Negotiation Skills Training.
Time to Act
As a finance professional it is time for you to act. You now know finance's role in pricing, so let’s get started.
- Watch our Planning Analytics video to learn what power planning and modeling tools can do for you. IBM Planning Analytics
- Upgrade your Negotiation Skills, start by watching my Negotiation Skills Training
- Contact me and let’s discuss ideas how you can increase your profits. Email firstname.lastname@example.org.