Pricing power: Why private equity need to hire more pricing managers  

Written by Joanna Wells, Author or TeamBuilder360 and Director of Taylor Wells

 

Private equity has been increasingly prominent in the Australian corporate landscape in recent years. PEP backed Link Group represented the biggest IPO on the Sydney market in 2015(market cap of c. $2bn). The private equity is commonly based on holding an investment for 3-5 years before seeking an exit (from a hopefully transformed business) by either a listing or a trade sale. The model has traditionally relied on financial engineering (utilising debt), combined with a renewed management focus (often through management shareholders driving the turnaround). Therefore, we note that the Link Group was managed by shareholders John McMurtrie (CEO) and John Hawkins (CFO), both with a considerable financial interest in a successful exit.

 

The points to gain from this revenue and commercial model are threefold; 1. The vital importance of engaged and capable senior management; 2. The potential utilisation of pricing power as a lever to increase exit valuations for a business and 3. The currently untapped opportunity presented to private equity of pricing power and optimisation role.

 

Importance of engaged and capable senior management

 

A fish rots from the head down; quite a provocative saying but anyone who has worked in corporates for any period of time will recognise this. Lack of vision, leadership and strategy can pervade an entire business enterprise. Thus, for a pricing function to deliver on its potential (no matter how skilled the pricing manager), that function will require a mandate and clear support from senior management.

 

Pricing power optimisation is a multi-departmental role and requires support from executive leadership to ensure that pricing benefits can be delivered. The team must be set up in the right way and be given the appropriate remit. We believe that a private equity-backed business with engaged management can provide this environment (i.e. to cut through office politics and turf protection) as all parties have a clear objective (financial) to achieve in a short space of time. As a leading lever to achieve “quick wins” in profitability, pricing should be key on any PE company’s radar.

 

Valuation multiples

 

Private Equity as with the financial community generally will commonly utilise certain metrics to value a company such as EV/EBIT, EV/EBITDA, P/E etc. multiples. Wherefore, these metrics will generally be a multiple of some definition of “profit”. Other things being equal (ceteris paribus for the economists out there), a dollar increase in revenue from price adjustments will result in a dollar (one for one) increase.

 

Pricing power optimisation as an empirically proven mechanism to provide 1-2% profit increases with a 1-2 year period should be a prerequisite component of the business model rationalisation and business turnaround required for an optimal exit. Taylor Wells believes that the majority of PE companies do not have sufficient in house expertise in pricing power currently to deliver on this potential value creation.

 

If the primary guide in the company value is the EBITDA. Thus, it is logical to concentrate on the guide with a bigger influence on the EBITDA to increase revenues. Analyses have shown that an improvement in pricing can impact an EBITDA 10-12X. While a reduced fixed cost for the private equity investment is around 2-5X leverage on the EBITDA.

 

It seems the high valuation impact of pricing has a bigger influence, so why isn’t Private Equity firm focus on pricing optimization for its portfolio companies?

 

There are Five Levels of World Class Pricing:

 

  • Level 1: Firefighting. It seems a large number of companies are always in firefighting mode in their pricing strategy. It is not working and the sales force is difficult to control. The price, volume and customer value is disrupted and sales teams are pressured to meet quarterly deadlines. Hence, they are forced to give huge discounts to close the deal. Therefore, the purchasing departments are the driving force in negotiating for the price with the best dealers getting the best price. Thus, the company’s revenue loss from a number of accounts will be huge because of low pricing, hidden costs and out of control discounting.

 

  • Level 2: Policing. Sometimes to get the pricing process under control is to hire a strong pricing manager to police and directly manage the pricing. Thus, a pricing book can be implemented and the salespeople to be trained on volume discounts. Although, some Excel spreadsheets or pricing software are applied to control the process if the pricing is based on costs and target margins it is still unreliable and unscientific.

 

Other Levels

 

  • Level 3 Partnering. To reach level 3, private equity companies need to redesign their pricing strategy to include micro-segmentation, a report on customer research and key performance indicators to succeed. Unfortunately, few companies ever achieve this on their own. In effect, they lack the processes and tools to make a value selling or challenge selling program for the sales team. Which would take a value partner stance to support the higher prices? Moreover, companies that achieve this level have 10-12X EBITDA leverage with a 25% increase in EBITDA resulting in a 2% increase in revenues.

 

  • Level 4: Optimizing. Industries with rich data sources can use AI and machine learning computers to stay competitive and analyse pricing strategies. thus, industries like restaurants and online retailers are examples using AI to achieve level 4 and expect a good return on their investments.

 

  • Level 5: Mastery. The company that achieved this level has pricing mastery by optimizing on all product/service on the basis of value and hard analyses. Hence, it unlocks all the available market value and bigger EBITDA and better revenue than the competition.

 

Advantage of Prioritising Price

 

Though pricing doesn’t look important on the company portfolio surface, it actually has a big impact on the profitability of the company. Thus, it can not only increase the EBITDA leverage to 10-12X but shareholders keep the value for every transaction making higher EBITDA and long-term company value.

 

With an effective pricing strategy, you can eliminate hidden costs by using profit-driven key performance indicators. Therefore, the effect is a higher EBITDA and firm value.

 

Managers will often blame “market forces” as to the company’s poor pricing structure. Additionally, this is just an excuse for the poor incentives and lack of sophistication. But focusing on the pricing strategy of the affiliate companies, investors can expect better and bigger revenues.

 

Pricing power potential in the private equity model

 

Private equity houses tend to be staffed by former consultants, Investment bankers of financial industry employees. Thus, it is rare for the standard CV to have a significant commercial background in a B2B environment. Whilst this can be a clear advantage in cutting through corporate politics and focusing on the financial turnaround of the business, Taylor Wells believes that it can underperform in engaging, motivating and delivering on sales staff performance particularly from a pricing perspective. Topline revenue growth can often seem less tangible than more seemingly concrete and secure cost reductions.

 

A P&L has two components; revenue and cost-optimal results require optimising both aspects. Another common perception of PE driven businesses is that the cost control focus can lead to an unwillingness to invest in talented staff or sales force drive. A well-articulated pricing strategy and commercial strategy (not just reliance on pricing software tools) can deliver improved staff engagement as high performing staff feel rewarded and working to a cohesive strategy.

 

Implications

 

  • Private Equity companies tend to ignore the pricing schemes but instead focus on giving substantial discounts to encourage investments.

 

  • The pricing scheme must have the support of the upper management to implement it properly.

 

  • Many private equity companies do not have the expertise in implementing a most effective pricing strategy.

 

  • With the help of the pricing managers, they can bring price, volume and customer value together to optimize the pricing scheme.

 

Conclusion

 

  • We believe pricing power will become an increasingly common lever for PE companies to maximise value.

 

  • AI and other machine learning computers will analyse the date and present the right pricing scheme.

 

  • Price strategy is essential to the private equity company to maximize profits and increase company value. Hence, we believe pricing power will become an increasingly common lever for PE companies to maximise value.

 

 

 

Why private equity need to hire more pricing managers is written by Joanna Wells Author of TeamBuilder360 and Director of Taylor

 

Taylor Wells is a specialist advisory firm that has developed a search, evaluation and recruitment process; in the field of pricing, commercial and analytics.  Our business was started after identifying weaknesses in the traditional agency recruitment model. Thus, its purpose is to support management and HR to eliminate the risk of a bad hire. Our workshops and diagnostics ensure pricing or commercial teams are deeply engaged; with the sales and marketing teams to achieve greater levels of margin and earnings growth.  We have developed our own digital platform to identify and evaluate talent. And we partner with subject matter experts to help us operate efficiently.

 

Director of Taylor Wells

BA/ MA Psych. CANTAB, Msc Org. Psych, Dip.Couns Psych

Read the book: TeamBuilder360

From losing good staff, changing the businesses’ commodity mindset, dealing with procurement, making sense of complex pricing arrangements. Managing talent and skills gaps, you face many challenges daily. Thus, the pressure of business, work and everyday life is unprecedented. Therefore, it is now more difficult than ever to choose the right path for the business.

The right pricing and commercial teams can help you generate low risk, and sustainable revenue, margin and profit growth.

Leading companies like GE, DuPont and Caterpillar have all invested in their people and pricing. Over the past 10 years, they have improved their HR initiatives to build powerful and rare pricing teams. To drive revenue, margin and profit growth.

TeamBuilder360 shows you how to build teams that work together to drive revenue; margin and profit growth using a teambuilder360 canvas. And a wealth of real-life examples. It also gives you advice and guidance on how to build a more productive and successful career in pricing; without compromising on important career choices and goals.