Q and A On What Optimising The Tail Means 🤔 Podcast Ep. 116
In today’s episode, we are going to, I suppose, take a slightly different tact, and it’s not a Q and A, but it’s probably a little bit more question-oriented or question-based. So we’ve had a question come in from a listener and on a previous podcast we referred to the concept of optimising the tail and I suppose, you know, what does that mean clearly?
[00:00:54] In essence, what does “optimising the tail” mean?
[00:04:43] How to achieve EBIT growth by optimising the tail?
[00:10:18] How Taylor Wells helps businesses in optimising the tail?
[00:13:14] Proper Method Of Optimising The Tail And Your Price Points
Q and A On What Optimising The Tail Means
Aidan: So we’re going to look into that a bit today. And I suppose I’m gonna ask some questions and hopefully, Joanna can give excellent and concise answers. So, the first question to Joanna. Do you agree with this?
Joanna: Oh yes, I agree with this.
Aidan: So, she agrees.
Aidan: Okay, so I suppose the first question is, what is optimising the tail?
Joanna: Well, optimising the tail is founded. It’s a process of finding the right price based on price sensitivity.
Now, that’s the high-level answer in a short answer, but maybe I’m thinking I’ve got to unpack what all of that means.
Now in terms of optimising the tail, it’s based on, and my listeners will know, a very basic economic principle 1 0 1, really of the principle of price, the elasticity of demand, and optimising the tail is based on that.
So in a nutshell, if demand stays the same, when the price changes, it’s elastic. If it’s elastic, there’s a low price sensitivity, and if demand goes down, when the price changes, it’s elastic. , which means if it’s elastic, generally there’s high price sensitivity. Now, the reason I’m saying this to you guys is because you’ve got to look at the long-tail pricing.
Pricing, the long tail is all about determining the sensitivity of your products, right? So what we find with the long tail pricing is that the long tail products, you know, the tail end of products. Are, they tend to have very low price sensitivity, contrary to the economic principle, 1 0 1 principle of elasticity of demand, which if you look at an aggregate level, not on an SKU by SKU level, the price and demand, that tend to say if the price goes up, demand drops, but on an SKU by SKU level.
It doesn’t happen. And this is the crux of the long-tail pricing.
Aidan: So I suppose just a question there when we’re talking about the tail, Joanna, are we talking about like, and again, correct me if I’m wrong, is there, we’re talking about a huge number of SKUs or, you know, products or services that we’re providing, hundreds or thousands or whatever it is.
And when we’re saying the tail, are we talking about a certain smaller subcategory or category, what do we mean by the tail?
Joanna: Well, good question. So with the tail, I’m talking about a large number of products, in terms of what type of products consist in that tail. It can be across categories, but generally speaking, what you need to do to order and understand the tail, is order it and rank it by revenue.
Aidan: Is it a misconception that the tail is the unimportant thing? Are we saying it’s when somebody goes into a supermarket, maybe for example, but you’ve got your staples, your bread, your butter, your milk? Are we talking about the tail as being the little bits that people don’t think about? In an industrial b2b you spend 90% on your requirements and then there are just the little bits that just get thrown in and you don’t think about, is that, I might be wrong, but does that have an aspect there?
Joanna: Yeah, no, that’s exactly right. It’s often the area that companies ignore, but actually, it has the highest price premiums because of this principle of price elasticity of demand at an SKU level.
So often people don’t understand the value of that product at the SKU level and often discount it unnecessarily, even though you know that prices increased and demand has stayed the same.
It’s elastic in a sense. It’s got low price sensitivity and what they tend to do, and which is a more risky pricing move, is change the pricing at the head of products.
We call them the best sellers, the ones that have got high price visibility in the market. That’s where people normally play with long-tail pricing. What we’re saying is actually let’s optimise the tail. Not only do you have more price premiums as low price sensitivity, but it’s also sort of more onto the radar.
But you’ll get more incremental EBIT growth from doing that and safely.
Aidan: The term you use there under the radar, are you saying that, it’s almost like, is this a lower risk approach to the price optimisation? Are we trying to sneak it through?
Is that a concept or are we trying to, obviously a lot of our listeners are interested in how to get through a price rise certainly this year, but, you know, but are we saying that this is? This will just is more likely to get through, do you think? Or is it more likely to not attract real procurement attention or they’re not likely to bash us down as much if we, in this approach—
Joanna: Look, here, we’re talking really about price scope, but in terms of the principles of, you know, long tail pricing, What we find is there’s a lot of visibility both from the business and their customers.
For these head best seller products, the head of the tail really those ones that’s highly visible on the market and what we find is people tend to change the prices there.
That’s the risky approach, what I meant about under the radar with the long tail approach. Is that often because of the demand and elasticity you can change prices and the elasticity doesn’t change so much cause there’s so much low price sensitivity?
It goes under the radar, naturally speaking. However, what’s really important here, is there’s no sneakiness or underhand, you know, things going on because you’ve got to always optimise everything within a price bandwidth. And here we’re moving on to the topic of price positioning. So really you’ve got to understand the price bandwidth.
Now, that’s your max and min price. Where does that SKU? How does it perform within its own bandwidth? Within its own bandwidth and with the bandwidths of the category?
You’ve gotta be really quite disciplined here. You can’t go above and beyond. You’ve really gotta work. And this is what the term is optimised within that range to get the optimal price points safely.
There’s no sneakiness. It’s all very scientific and mathematically based. However, overall we do find, once you’ve got your price positioning, you know, where your prices sit in the market, that you can start implementing more techniques like long-tail pricing and really start testing your price bandwidths by using elasticity modelling.
Aidan: To some extent, I feel like I am back in school here, and they say in school there are no bad questions, so I’m just gonna keep asking then. It makes perfect sense that this is a low-risk approach, obviously with the pricing project. We always go low risk to start with.
You don’t go in and, you know, massively discount or increase your core product. That makes perfect sense.
I suppose the question businesses would have will be if it’s the tail if it’s the stuff that maybe won’t get as much attention. Will we, you might get more percentage increases, et cetera, there, but will it actually, you know, move the dial, on the macro level, will it actually produce much cash or benefit, you know, if this is only the smaller tail of stuff, is it even worth the hassle, is the question?
Joanna: Well, again, this is an interesting point and you know, pricing, on its own, doesn’t get all the results. And really you’ve got to ask why is that product in the portfolio, to begin with. You know, good pricing, people have to work very closely with product people. And often when we are doing these pricing projects, we find that there are a lot of redundant products in the portfolio.
Redundancy is not good in terms of increased costs in the stock just sitting there in warehouses. Inventory costs are high and simply that’s because the products aren’t, yeah, no one’s buying them, you know, not all the time, but, or there’s not frequent purchase. So really you’ve gotta work with the product team.
A pricing person’s job isn’t really to determine what SKUs to rationalise.
That really should be done by the category and product team. But what we often find as we go through these optimisation projects is that you know, our pricing can indicate quite rapidly. Which product is redundant? Which type of product’s not shifting and why over a certain timeline?
And this is great because we can really advise there in terms of the product team, based on our pricing analysis and bring it to their attention fundamentally. But the dis ultimate decision and overview of that really does lie with the category manager.
Aidan: Okay. You know, I think, without getting too technical on this one, cause I think we’ll dig into bandwidth analysis, like, which to me sounds quite technical, you know, where I’m still using my calculator watch. So we’ll have to, we’ll come back to that one in a future episode. But I suppose one of the questions I’d ask is, you know, a lot of listeners, you know, maybe they’re not using pricing software, they’re not using the big expansive revenue management systems.
You know, analyzing bandwidths across SKUs that sounds pretty complex, is it?
Joanna: Yes. It’s complex but can be broken down into simple steps. And ultimately we work all of this out and in a framework using a process and methodology first, and we strongly advise that you don’t jump into buying a software at the beginning and then reworking that software to suit your business, why it’s very expensive.
And two, you haven’t worked out your pricing framework. First, work out the pricing framework and then get the pricing solution to fit in with that, you’ll save yourself a lot of hard take, a lot of pain, and a lot of time and resources doing it that way.
Now, in terms of complexity, you can break down complexity and make it into simple steps. And this is what we try to do at Taylor Wells. And we work with teams, pricing teams, product teams, marketing and sales to break that down in steps. Cause it’s not ultimately just the pricing team that got to price.
Obviously, you’ve got, we’ve already talked about, you know, product consideration, sales considerations we need to learn about and draw in the right inputs to put into the price optimisation process to then build the right model for the business. I think Aidan is that kind of what you’re asking or were you asking something else before I go off on a tangent?
Aidan: Well, I suppose I’m just asking really about the complexity. You know, it does sound a bit like a task that potentially you would want a pricing professional to be doing. It does sound, I’ll be honest, it sounds, we’re getting into a little bit of complexity, and I suppose it’s just, is this applicable to most companies?
You know, how many SKUs do we need in a business to be, you know, obviously it’s a lot of companies b2b. If you’re selling parts, you could be selling thousands. Clearly, you could be selling regularly. How many SKUs are we talking about as a minimum basis for this approach? I’m assuming that there’s no piece of advice we give that would be suitable for every company.
Maybe just talk a little bit about what sort of company it would be suitable for and you know, just the level of complexity and who would be doing this work maybe.
Joanna: Yeah. And in terms of, we’ll start with the basics there. I mean, good questions in regard to the number of products.
We tend to recommend above 300, to really get the most out of this optimisation project. And we also recommend Revenues of 50 million and above to really get a significant impact, EBIT and margin level from this. Otherwise, you really just one or two products. It’s more like a, you know, a startup type of scenario.
Not really gonna drive huge amounts of revenue doing that. So you need to really be thinking about price scope. Price scope looks at and reviews how many products we’ll be optimising and the size of the revenue that would involve. And from there we’ll be able to determine, a good sort of size of price.
And then from there, you can start convincing the board and whomsoever you know, this is worthwhile doing. I think there’s a point to this, is this worthwhile? This is the start of what we call a pricing strategy.
You gotta think very carefully before you jump into the optimisation of all of these points.
have we got enough products? Are they the right products? What’s the level of revenue? What did we get before? What’s the historical data? What amount of products are involved in customer pricing? Fixed pricing? What type of products can we put on a list that we can optimise?
You can’t just optimise any price point. You can’t because they’re already tied up in an agreement. So you’ve got to really think about this before you go into any type of price optimisation.
Bottomline: Optimising The Tail
Aidan: Look, I think that’s really my question in this today. I suppose my takeaway from this is, it’s a reasonably advanced, it’s not as high as dynamic pricing or that, but it’s not something you get someone from, accounts or sales and just tell ’em to run me a little pricing optimisation process.
So it’s something that a professional will be doing or someone who focuses on pricing. It’s something, the $50 million number, cuz clearly, you know, you need enough. That is the banging for your buck to actually make the work worthwhile.
And you’ve gotta have a certain number of SKUs. It’s a reasonably advanced, not super advanced, but it’s something, it’s not gonna be the first pricing optimisation you run or the first pricing project you run in your business. But it’s certainly something that will give you an uplift, will give you profitability, increases, and it’s certainly something that should be on your radar.
Maybe not for this year, but maybe next year would.
Joanna: Yeah, absolutely. And this would be something that, we would do and work very closely with our clients before even recommending, that they need a pricing manager. First of all, we look very carefully at their business. Look at their inventory, look at their products, look at disposable addressable revenue that could be gained from and price optimisation of which could be managed and used under price optimisation.
And then we could start making more specific recommendations. But the rule of thumb is you really do need more than 300 products and 50 million plus in revenue. And I always recommend that this would be led by a pricing expert if a pricing expert team to start with.
But it’s, you know, pricing in itself is very organised and we need to bring in the right people from across the organisation right from the beginning to drive the actual process. Long tail pricing optimisation is just one of the many techniques that we go through. It’s just one of the analyses, one of the checks in our optimisation model.
There are so many more inputs and variables to consider, but as we’re focusing on this particular methodology, I suppose, yes, there’s a lot of depth in there.
There’s a lot of pricing knowledge that somebody would need. So this is why we would recommend and even train a Pricing Manager to be able to do this and understand it and implement it competently to be able to get the returns that we’ve stated at the beginning of the project.
Aidan: Perfect. I think we’ll leave it there today. I hope all the listeners took something from this today. And I suppose give us your feedback as always on all the platforms, iTunes, SoundCloud, or wherever you listen. So have a great weekend.
Joanna: Yeah, thank you very much.
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