Managing Price, Gaining Profit - 國立中興大學

1 Transaction prices represent one of the most attractive - andoverlooked-opportunities to boost Price, Gaining Profitby Michael V. Marn and Robert L. RosielloThe fastest and most effective way for a companyto realize its maximum Profit is to get its pricingright. The right price can boost Profit faster than in-creasing volume will; the wrong price can shrink itjust as quickly. Yet many otherwise tough-mindedmanagers shy away from initiatives to improveprice for fear that they will alienate or lose cus-tomers. The result of not Managing price perfor-mance, however, is far more damaging. Getting theprice right is one of the most fundamental and im-portant management functions; it should be one ofa manager's first responsihilities, a nuts and boltskind of joh that determines the dollar and cents per-formance of the leverage and payoff of improved pricing arehigh.

2 Compare, for example, the Profit implicationsof a 1 % increase in volume and a 1 % increase inprice. For a company with average economics, im-proving unit volume by 1% yields a increasein operating Profit , assuming no decrease in , as Exhibit 1 shows, a 1% improvement inprice, assuming no loss of volume, increases operat-ing Profit by %. Improvements in price typical-ly have three to four times the effect on profitabili-ty as proportionate increases in such extreme Profit leverage, pricing is onefunction that a company can always improve. Oneconsumer durable products company increased op-erating Profit dollars hy nearly 30% with a improvement in average prices. An industrialMichael V. Main is pricing consultant in the Cleveland,Ohio office of McKinsey &) Company, Inc.

3 Robert is principal in McKinsey Company's New YorkCity BY PAUL MEISEL1% Costequipment manufacturer boostedoperating profits by 35% by care-fully Managing price levels up amodest 3%. According to our re-search, a wide variety of husiness-es, including those in consumerpackaged goods, energy, and bank-ing and financial services, haveachieved comparable if a company's managersmake the right pricing decisions90% of the time, it's worthwhileto try for 92% - the payoff is thathigh. But the price lever is adouble-edged sword. The mes-sages of Exhibit 1 also apply in re-verse: a mere 1 % price decrease foran average company, for instance,would destroy % of the com-pany's operating Profit issues are seldom simple and isolated;usually they are diverse, intricate, and linked tomany aspects of a husiness.

4 But while most man-agers have a handle on the bulk of pricing issues,many overlook a key aspect of this most basic man-agement discipline: transaction price realizing it, many managers are leavingsignificant amounts of money-potential Profit -onthe table at the transaction level, the point wherethe product meets the consumer. Most companiesuse invoice price as a reporting measure, hut thedifferences between invoice and actual transactionprice can mean significant reductions to bottom-line companies that have identified this prob-lem are handling it by applying two basic concepts:the pocket price waterfall and the pocket priceband. Reduced to their essentials, these conceptsshow companies where their products' prices erodebetween invoice price and aetual transaction Price, and they help companies capture untapped oppor-tunities at that Three Levels of Price ManagementThe pricing puzzle is more manageable whentaken in pieces.

5 Price management issues, opportu-nities, and threats fall into three distinct but close-ly related levels:1. Industry supply and demand. At this highestlevel of price management, the basic laws of eco-nomics come into play. Changes in supply (plantclosings, new competitors), demand (demographic1. Comparison of Profif Levers*..Creates Operating Profit improvement *Bassd on overage economics ot 2,463 companies In Compustat aggregateshifts, emerging substitute products), and costs(new technologies) have very real effects on indus-try price examining pricing in this contextshould understand the pricing "tone" of their niar-kets-that is, the overall direction of price pressure(up or down) and the critical marketplace variahlesfueling that pressure. This knowledge allows man-agers not only to predict and exploit broad pricetrends but also to foresee the likely impact of theiraetions on industry price Product market strategy.

6 The eentral issuehere is how customers perceive the benefits of prod-ucts and related services across available a product delivers more benefit to customers,then the company can usually charge a higher priceversus its competition. The trick is to understandjust what factors of the product and service packagecustomers perceive as important, how a companyand its competitors stack up against those factors,and how much customers are willing to pay for su-periority in those research tools, like conjoint analysis andfocus groups, can help managers understand cus-tomer perception of benefits. And understanding atthis second level of price management helps guideboth the product's price positioning and the fine-tuning of product and service Transactions. At this last level of price man-agement, the critical issue is how to manage the ex-act price charged for each transaction - that is,what base price to use, and what terms, discounts,allowances, rebates, incentives, and bonuses to ap-ply.

7 Where concern at other price management lev-els is directed more toward the hroad, strategic po-sitioning of products in the marketplace, focus atHARVARD BUSINESS REVIEW September-October 19928 STRANSACTION PRICING2. In the Pocket Price Waterfall, each Element Represents a Revenue Leak[dollars per square yarO}$ \ $ transaction level of price management is micro-scopic-customer by customer, transaction hytransaction, deal hy three discrete levels of price managementare clearly related. If, for example, a company fore-sees an industrywide supply shortage of its product,repositioning the product hy lowering the pricewould he a mistake. In the same way, the product'smarket strategy should set the context for transac-tion-level pricing decisions: a move hy Toyota todiscount its Lexus luxury sedan at the transactionlevel would conflict with the market positioning ofthat model as a high-benefit, fair-priced alternativeto competitors like Mercedes Benz, BMW, or , many top managers perceivetransaction pricing decisions as unimportant andoften relegate them to low-ranking managers oreven entry-level clerks, with some flexihility at thesales force level.]

8 By doing so, companies may beforegoing one of the most substantial Profit oppor-tunities Transaction Pricing OpportunityThe ohjective of transaction price management isto achieve the best net realized price for each orderor transaction. Transaction pricing is a game ofinches where tens, hundreds, or even thousands ofcustomer- and order-specific pricing decisions dailycomprise success or failure-where companies cap-ture or lose percentage points of margin one trans-action at a time. But top management neglect, hightransaction volume and complexity, and manage-ment reporting shortfalls all contribute to missedtransaction pricing complexity and volume of transactions tendto create a smoke screen that makes it nearly im-possible for even the rare senior managers whoshow an interest to understand what is actuallyhappening at the transaction level.

9 Management in-formation systems most often do not report ontransaction price performance, or report only aver-age prices and thus shed no real light on pricing op-portunities lost transaction by pocket price waterfall and the pocket pricehand have proven valuable in lifting this smokescreen and providing a foundation to capture oppor-tunity at the transaction Pocket Piice Waterfall. Many companies failto manage the full range of components that con-tribute to the final transaction price. Exhibit 2shows the price components for a typical sale bya manufacturer of linoleum flooring to a starting point is the dealer list price fromwhich an order-size discount (hased on the dollarvolume of that order) and a "competitive discount"(a discretionary discount negotiated before the or-der is taken) are subtracted to get to invoice companies that monitor price performance, in-voice price is the measure most commonly in most businesses, particularly those sellingthrough trade intermediaries, invoice price doesnot reflect tbe true transaction amount.

10 A host ofpricing factors come into play between the set in-voice price and the final transaction cost. Amongthem: prompt payment discounts, volume buyingincentives, and cooperative advertising you subtract the income lost through thesetransaction-specific elements from invoice Price, what is left is called the pocket price-the revenuesthat are truly left in a company's pocket as a result86 HARVARD BUSINESS REVIEW September-October 1992of the transaction. Pocket price, not invoice Price, is the right measure of the pricing attractiveness ofa manufacturer offered a series of discountsand incentives that affected its product's pocketprice. The company gave dealers a 2% paymentterms discount if they paid an invoice within 30days. It offered an annual volume bonus of up to 5%based on a dealer's total purchases.