Best-In-Class Price Architecture For A Industrial B2B Business 🏜️
What is the best way to improve the price architecture in an industrial B2B business i.e., to drive profitability without losing volume or hard-earned margin and revenue?
In times of uncertainty in raw material prices, any increase in prices can put industrial companies in the awkward position of having to improve their pricing. But the problem is businesses usually apply modest increases at year-end to offset the rising costs. Another problem is most of the industrial companies try to stay afloat by cutting budgets and trying to improve procurement.
When they found out that it’s not working, the companies began to reexamine pricing. Accordingly, they need to find ways to counter the rising costs that could potentially deliver the most value. Consequently, industrial companies must review their pricing architecture. Also, they have to face tough competition and the rising prices in raw materials.
Moving to value-based pricing
And for some industrial companies, the increase in raw-material costs is creating questions about their old reliance on “cost-plus” pricing.
This trusted approach does guarantee profits, but they may not be optimal. To find better pricing strategies, industrial companies are willing to move to value-based pricing. This strategy is based on a customer’s willingness to pay.
This shift may sound easy to follow. However, since those companies offer hundreds or thousands of products across multiple brands, it will be a daunting task. The reason is that every product each has a different value.
But with advanced analytics, it can help industrial companies overcome all these hurdles. It will allow them to determine value in all major product categories. Such as standard units, configured products, engineered products, spare parts, and kits. In that case, it’s plausible by using different analytical methods.
With these insights, industrial companies can accurately analyse the extent of potential price increases. Moreover, the underlying analytics are much more accurate now than they were a few years ago. Thanks to upgraded algorithms and greater availability of data.
We will explore how to use value-based pricing that could potentially deliver the most value.
We’ll argue that the increase in raw-material costs is prompting greater questions about their traditional reliance on “cost plus” pricing. This trusted approach may have outlived its purpose.
It is our belief that B2B business should move to value-based pricing. As the new pricing strategy is based on a customer’s willingness to pay.
In the wake of underlying price calculations, companies should take this opportunity to re-evaluate other factors in their industrial-pricing strategy. This includes both category-specific problems and issues that affect the entire portfolio, such as offers for discounts.
When these insights are combined with analytics, industrial companies will be able to increase margins to an extent that previously seemed impossible.
Catalysing change in B2B business industrial pricing
With the recent rise in raw-material costs, many companies are making significant, midyear price changes to counter escalating internal costs. These cost increases are only part of the problem for industrial companies. This is due to major governments worldwide imposing tariffs and duties that are further increasing raw-material costs.
For instance, many heating, ventilation, and air-conditioning (HVAC) companies raised prices in June 2018, rather than waiting for the traditional months of November or December. The reason behind is the tariff rates of importing raw aluminium have increased.
The magnitude of the price increases has also been higher in 2018, with one leading HVAC player increasing prices by 5 to 8 percent for products across its portfolio, compared with the historical 3 to 6 percent.
As a result, some industrial companies, especially in sectors that have experienced eroding margins, are resetting their overall industry profitability.
The problem here is that most of the industrial companies aren’t using advanced analytics to determine the new numbers. They’re just adding a few percentage points on top of their usual markup and moving up the schedule.
It could also mean the new prices may be well below the amount that customers are willing to pay (or in some cases, so far above it that sales could dip).
So before making any further adjustments, it’s advisable to apply a more structured approach to pricing that focuses on value.
Determining baseline pricing performance for B2B business
The first step to better industrial pricing will involve examining current performance. This first step will uncover problems that have long gone unnoticed.
An example of this is one industrial company, managers had historically raised list prices by 2 to 3 percent annually, believing this increase allowed them to maintain profitability even as inflationary pressures intensified. But the pricing review revealed that price increases varied greatly by brand. In addition, even when the company raised list prices by 3 percent annually, the average sales price (ASP) did not keep up. For some products, the gap was widening between list price and ASP because the company often increased distributor discounts to keep its customers happy.
A combination of factors had pushed the company into this position. First, it lacked an integrated business-intelligence system that tracked detailed pricing information for each product. Each brand also relied on different pricing tools and independent sales forces.
This made it difficult to see how industrial pricing and profitability varied across brands and regions. Further, the company incorrectly scoped the costs for many of its products. Because it relied on outdated information. Thus, leading to large gaps between the booked margin and realised margin.
Taking new approaches to product segmentation and list pricing in B2B business:
After determining baseline performance, industrial companies must find some solutions to difficult pricing issues.
Since they know that prices are will be based on a customer’s willingness to pay. But they still lack the analytics to determine how far that “willingness” will cover.
1. Pricing standard for made-to-stock units
For standard units, companies use attribute-based pricing. To achieve this, they’ll need to separate the portfolio into groups of similar products and identify the most important features in each one. Such as size, material, or performance—based on their experience in the field.
After studying these data, companies can use analytical models that assess all attributes and determine what each one contributes to the product value. The models will show various factors when assessing value, including historical pricing data about products with similar features. Inevitably, business leaders will derive the model output in combination with their own market knowledge.
Unlike engineered products, which are customised to individual customers, industrial companies can sell large quantities of standard, made-to-order units. With that, it’s important to consider price in relation to volume. Hence, the rule is simple: high-volume customers get better prices.
2. Configured, made-to-order units
It can be difficult to price products that are uniquely made to meet customer preferences, especially if the customer base and feature set are large.
For instance, some companies may have several hundred products with thousands of customisation features, resulting in more than a million potential offerings. In such cases, companies should first dis-aggregate pricing. In other words, finding out the value of the base model and each individual attribute, similar to the process for pricing standard units.
3. Engineered-to-order units
Customers order engineered units are products to be built from scratch according to the customer’s specifications. The problem is industrial companies don’t have any similar products that they can use to establish baseline pricing.
More often, deals for these units are linked to a specific project, and the exact unit specifications may be uncertain at first. To find the price accurately, industrial companies must determine all the features that they are likely to include. Along with the customer’s willingness to pay for each one.
During the planning stage for engineered units, customers frequently alter the specifications described in their original order. To maintain their margins, industrial companies must again use a standard value-based methodology for pricing these alterations.
For instance, these projects typically have long lead times. Another factor is the procurement costs for raw materials may be much higher than those estimated at kickoff. Companies then add the potential for such increases into their initial estimates. Otherwise, they risk underpricing their units.
4. Spare parts
In some companies, spare parts and consumables typically account for about 20 to 40 percent of revenue but make a much larger contribution to a company’s profitability. Just like in other categories with numerous SKUs, companies are reluctant to move from cost-plus pricing. But a value-based approach can work within spare parts. Provided that companies make a few category-specific changes.
When determining the value of spare parts, industrial companies should first look at attributes like provenance (whether they are proprietary or nonproprietary) and the frequency of purchase. They should also estimate a customer’s willingness to pay by examining what distributors charge customers. Another basis of determining value is a spare part’s list price as a percentage of the base-unit or kit price.
5. Kitted parts
Companies set kit prices by adding up the cost of all the items that they contain. While this approach does allow for consistency, unit pricing might be a better alternative.
For instance, industrial companies might offer a kit that contains dozens of components that typically must be ordered from different suppliers. The unit price would factor in the value of convenience to customers, many of whom want to avoid tracking down and ordering multiple parts.
That convenience factor also includes customers might appreciate that kits eliminate uncertainty about whether different parts will work well together.
Setting discounts and commissions based on performance and customer segment in B2B business
Industrial companies don’t typically have a standard approach when setting discounts. Some companies base discounts on a product’s sales volume or performance tier. While others apply standard discounts, regardless of volume. The other method includes rewarding distributors based only on their willingness to follow with certain conditions (such as agreeing to engage in extensive customer outreach in certain segments).
For instance, some industrial companies may provide the highest discounts to distributors that carry a large inventory of long-tail SKUs because they want end-customers to have immediate access to essential spare parts. But others might prioritize distributors that have highly trained support staff who can help end-customers understand complex products.
To build confidence in their new initiatives, industrial companies must build performance-management systems, supported by tools, that emphasise the importance of pricing. Some industry leaders have created tools that allow sales representatives to enter key details for all deals, such as the size and frequency of transactions.
In addition to pricing, industrial companies can take some other steps to improve margins on customised units. With the configured products, industrial companies must also examine each customer segment when developing attribute prices.
The increase in raw-material costs could be an unexpected blessing for industrial companies. Faced with lower margins, they’re taking a special interest at pricing for the first time in many years. Thus, asking themselves whether their cost-plus approach is truly the best option for their B2B business.
If companies want to avoid pricing mistakes and obtain real pricing transparency. They need to create a more detailed transaction database that has an accurate price, cost, volume, and margin information.
Despite the complexity of different values in thousands of products, companies can determine accurately customers’ willingness to pay by using advanced analytics across all product categories. These observations, combined with category-specific issues, will help industrial companies set optimal list prices.
Shifting from cost-plus pricing to value-based pricing can help companies to improve return on sales by an average of 5 to 10 percent. And that means pricing could be the lever that delivers the greatest and most immediate impact in a market. In a time where companies face increased competition and soaring costs.
For best results, industrial companies should follow a consistent discounting approach. Through all products that consider factors such as sales volume, market demand, and desired distributor behaviours. The specific considerations included in the calculation, as well as their relative importance. That which would vary by company.