The Types of Financial Losses You’ll Experience From Undisciplined Pricing 💸
Types of financial losses: Did you know that your pricing revenue model is a leading indicator of business growth and profit loss?
According to countless business transformation case studies. The state of your price management system is one of the best ways of finding out whether you’re going to make enough money out of your new business strategy or not.
Table of Contents:
The Types of Financial Losses You’ll Experience From Undisciplined Pricing 🏜️
Nokia: A case study on Types of Financial Losses
In the 1990s, Nokia was the top producer of mobile phones in the world. They were the dominant player in the cellphone market. Then came the smartphones – which pretty much replaced the Symbian consortium system (the dominant system preceding IOS). Nokia was the dominant user of the old Symbian consortium system. While Apple and Samsung used the IOS and Android system – a system that offered people more apps and user-friendly navigation.
Nokia tried to regain lost ground by introducing the Windows phone created by Microsoft. But the apps were difficult to use and limited in numbers. There weren’t enough in the marketplace to get a viral network effect going. The Windows phone didn’t take off with the public.
A sticking point for Nokia at this time was that they saw themselves as an engineering firm for technology systems and a manufacturer of phones. They were a product-focused business: Focused on improving the technical details of their technology.
At this point in time, Nokia wasn’t really considering selling to end consumers with a new, direct to market online retail strategy. They were working within the confines of a traditional B2B transactions model with large wholesalers and retailers. Their pricing revolved around complex and lengthy tenders and legal contracts. It would have been very difficult for them to transform the business model to keep pace with the change around them under this traditional B2B pricing and revenue model – even if they wanted to.
Tied to contracts with powerful wholesalers and retailers, they were likely hamstrung for a time. They couldn’t sell directly to the end consumer. They were involved in lengthy tender pricing processes and difficult sales negotiations; and tough pricing discussions with procurement teams. The business at that point was essentially dependent on wholesalers to distribute their goods for them. And retailers to sell to end consumers on their behalf – both locally and abroad.
Over time, Nokia would have found it very difficult to understand its value chain or monitor its product life cycle. Two very important elements of a pricing strategy and price-setting process. Their phones were accelerating through the life cycle as Apple and Samsung were creating new iPhones and better systems. The list price strategy would have been more aligned to their internal metrics and costs rather than customer willingness to pay.
Price Skimming Approach
All the while they were using a pricing skimming approach to set prices for new products, and not adjusting prices fast enough to push the right products or update their product pricing strategy.
The accelerated product life cycle driven by iPhone innovation was probably a destabilising experience for Nokia. Like many businesses, they would have started to price match competitors to stay in the game. Unfortunately, at this point, their sales volume would have already declined significantly. Moreover, their manufacturing costs and cost of goods were probably increasing due to excessive discounting on high-value items.
Within no time at all, retailers would have realised that Nokia’s brand power was not as strong as it once was. From here, there would have been a large cut back in the range of Nokia phones being displayed in outlets.
Business researchers also found out that its technology was not the same level as Apple’s offer. Which meant that they could no longer legitimately command the price premiums they once did with outdated technology. Even the brand name ‘Nokia’ wasn’t enough to retain their advantage over their rival competitors.
Could Apple’s iPhone be heading the same way?
Nokia is not the only company that has faced severe business and pricing problems. Apple technology is also accelerating through its life cycle – just like Nokia’s did twenty years ago. Apple is working hard to reinvent its offer and review its prices. Sales revenues have dropped significantly since 2018. It lost one-third of its trillion-dollar market cap in the last quarter of 2018 and 10 per cent in the first quarter of 2019.
iPhone pricing problem
iPhone pricing problems are pretty simple: They are facing price pressure – not just because of changing economic situations or a fluctuating dollar. iPhones are just too expensive for the average consumer. The new features added this year to the iPhone XS, XS Max and XR – like more powerful processors and vivid colour screens – just didn’t align with consumers. The XS Max is the most expensive iPhone ever, starting at $1,100.
With people still paying for their current devices, many consumers are reluctant to upgrade. Apple should consider adjusting their prices or changing their offer for the following reasons:
- Their prices just don’t change much year to year; indicating a fixed pricing approach across products and segments.
- Their price rise strategy is predictable: They tend to add a fixed amount across the range – not many variations across their product base. Indicating margin-based pricing rather than value-based.
- Additionally, their price bandwidths are too narrow. They don’t use excessive discounting which is good. But their high prices across all categories isolate a lot of consumers from the equation – even though they would have been willing to buy their older phones if they were just a bit cheaper.
- They are in danger of becoming a brand for rich kids, young professionals and executives.
- Their versioning strategy is outdated: When a new phone is launched everyone just wants that – and all the other phones are almost disregarded (unless of course they are tied to them on contract).
- They also use a predictable price skimming strategy to push new products. And to a certain degree keep all their product prices high. Regardless of where their products are on the product life cycle.
- The pricing team at Apple probably want to re-evaluate the iPhone’s price architecture and partnerships with major telcos to solve their new pricing issues. However, this might be tough because under their current business model Apple’s customers are tied to lock-in contracts enforced by telco providers. This means Apple’s business model innovation, like Nokia’s, is in stasis because of their pricing structure and ecosystem.
Apple’s business strategy
It appears that Apple’s strategy is firmly focusing on investment and buyer consolidation right now, rather than improving their pricing. The Apple TV streaming services are jumping in on the bandwagon. Everyone seems to want a piece of entertainment streaming like Netflix. They are also developing the virtual reality system – along with a self-driven electric car of the future. Diversification and consolidation is what Apple is going after now, as opposed to specialisation and affordability – the two things that got Apple to market leader in the first place.
- Your pricing is a summation of the total economic value of your business. Choose the wrong pricing strategy, approach or team to implement a strategy. And face many excruciating years of types of financial losses and downgrades. Until your business model is superseded and customers long gone.
- Without a good pricing system – customised to reach your business objectives, you can’t monetise the full economic value of any of the changes you’ve made to your business model, operations or IT infrastructure.
- As the saying goes, “nothing lasts forever.” So too it applies to businesses today. In the world of uncertainty and market disruption, your outdated pricing system is leaking all types of financial losses. The brick and mortar way of doing business will be gone. We’ve entered the realm of digital business and pricing. You need to refresh your pricing and revenue models to keep pace with both business transformation and markets.
Pricing is one of the types of financial losses driver. It’s also a great way to generate incremental EBIT growth if you want some fast, safe, cash along the way. However, pricing is also your number 1 driver of sustainable growth in an increasingly dominated global market. Which is something a lot of business owners and leaders don’t fully realise yet.
Make no mistake about it, the way you’re pricing now may be killing your business transformation prospects in the mid to long term. Including, any chances of recouping types of financial losses incurred from inaction or past price rise mistakes.
Underestimate pricing during a significant business transformation, and risk derailing strategy.
Put pricing issues on the back burner, and risk volume and revenue loss.
Believe IT, and operational improvements are more important than pricing, and pay large sums of money on technology for zero margin gain.
How to Deal with Massive Financial Loss Linked to Bad Pricing Decisions 🏙️
In a materials business based in the Inner West region of Sydney, there is a CEO. He is puzzling over a common financial control problem that many B2B businesses face…
This CEO has a large sales force using price to compete in many locations and market segments. It serves a lot of customers and has an extensive portfolio of products.
Most of its sales branches are forced to discount heavily to drive volume and aren’t making enough profit. They are losing margin due to overpricing and lost volume opportunities due to under-pricing. There are also a handful of sales branches selling near or above list price and making good margins.
There are productivity declines in the corporate head office. Morale is low. Sales managers want to improve profitability, but they don’t know-how. There’s a firm belief that discounting is the only way to compete in an increasingly competitive market.
The CEO asks himself: “Why are branches performing so differently?”
He cannot figure out why there is no correlation between geography and product lines with high, and low performing branches. So, the CEO calls for a meeting with his sales director and sales managers.
He wants to know why branch performance varies so much and hopes they could explain it to him. Unfortunately, the sales manager’s explanations are diverse and confusing as individual branch results.
The CEO could not figure it out. Can you? What do you think is happening here?
First of all, this company has no price management process and insufficient financial control. It had no pricing policy, procedures or dedicated pricing team in place to drive strategy or improve execution to market. It is leaving lots of money on the table from not differentiating between the markets, customers, and products. There are limited analytical insights on competitive dynamics. It has not considered supply-and-demand volatilities.
Another problem in this case study is that their teams do not understand the price-value equation. They also don’t monitor and adjust price changes based on rigorous analysis of customer value drivers.
There is no:
- Real price expertise or know-how in the business
- Testing and learning about price changes is non-existent
- Teams are not working together because there’s no clear execution process in place
They don’t know who to turn to, where to get the information, how to perform price duties. Their pricing is a mess.
But, the business keeps selling its stuff (albeit at the expense of margin dollars), and the CEO believes this means pricing is not a priority.
What do you think?
Why is maintaining financial control so difficult to do?
Most companies we meet run highly efficient enterprises. However, when it comes to pricing most businesses (big and small) are surprisingly lax.
Even if the business is managing revenues of $500 – $1B, companies both big and small can’t seem to escape the relief accompanied with winning a deal. They either get complacent or resistant – either way, inertia slowly creeps in, and nothing gets done. Many do not take affirmative price action because they fear this will rock the boat.
It seems like we find a business’ level of financial control is a good indicator of their confidence and ability to execute a strategy to market and whether they believe they offer customers real value or not.
Furthermore, value is a mindset.
Financial control is a behavioural manifestation of a value set in motion (execution).
The final sale price is a tangible representation of the total economic value you provide to your customers.
How can I encourage more financial control in my business?
You should probably think about using a value-based segmentation framework – rather than grouping sales branches or customer by locations and product lines.
Location is a time-honoured segmentation principle. I realise, along with others such as size or type of average customer, however, it is a crude segmentation. Many companies do this and fail to account for the market environments of individual branches, stores, franchises, etc.
Think about the market environment: market changes are an input (an independent variable). How will you alter your financial control, strategy, structures, and operations according to the market?
If the market changes, then you’ll need to adjust your strategy or sub-strategies as well.
In a changing market, your ability to execute to market quickly is now as important as strategy.
In a stable market, a strategy is your guiding force.
For an unstable market execution agility, financial control and learning from price adjustments is your only vehicle to navigate unknown high-competition and disrupted markets.
As a result, changing your strategy, but not your organisation structure, execution lifecycle, and processes will make it much harder to execute strategy in the market.
Without the right people and processes in motion, inertia dominates, and outcomes and results do not eventuate or happen in underwhelming dribs and drabs.
The millions your business may have spent on external consultants refining its strategy or implementing software remains a PowerPoint pack or in a continual test environment. In addition, your business and customers will receive little tangible value.
“For every action, there is an equal and opposite reaction.” – Newton’s third law of physics
You need the right people, structures, and financial control to build an aligned pricing culture. Financial control doesn’t stop when optimal prices have been achieved and variability brought under control.
The market is also changing. This change means that you’ll have to adjust and change everything else, i.e., strategy, structure process refinement. Also, you have to begin to identify products that are no longer profitable and monitor customer churn.
Look for signs that prices are too high based on the utility of that product and the value it provides.
Therefore, a product’s value changes by customer and as the market evolves. It may be necessary to change prices as a result of new market information, even if you haven’t changed them recently. You need to be more sophisticated and accurate about your price changes because gut feel is not sufficient and leads to margin loss and all types of financial losses. Don’t settle for cost-plus pricing. Advanced price analytics and financial control require your pricing and sales teams to be aligned and skilled. A great strategy means very little when people or process are ill-equipped to drive price changes.
If you have revenues of over $100M and increasing complexity – customer, product, markets and growing revenues under management – we recommend that you think about installing a dedicated pricing team.
In conclusion, a pricing team would monitor and adjust prices according to market changes by keeping a close eye on price rises or adjustments. They would work with other functions, divisions and senior management to put forward price options, and suggestions in highly competitive markets. Most of all, there would be driving a culture of testing and learning. Therefore, this would improve process execution and drive more results and outcomes for price improvement programs or related initiatives.
Consequently, pricing could be your number one profit lever. A one per cent improvement in price yields more significant gains in operating profit than a similar increase in costs or volume. More price discipline in your business could enable you to maximise margins across markets and customer segments without risking volume.
However, real financial control requires senior leadership sponsorship as well. Invest in people, and financial control is likely to drive more complicated outcomes.
How to Recover From Financial Loss and Bad Pricing 🦚
Liberate yourself from loss-making habits and any types of financial losses
No matter the industry, product line or how great or innovative the commercial offer, B2B businesses across Australia find themselves in unpredictable and unprecedented situations with no real reference points, defences or decision making processes to fall back on. Pricing pressure is no longer an exception, but the norm; and margin erosion is a common complaint, topic and point of concern (and contention) at many executive management meetings. From volatile FX and commodity prices; new market entrants to professional buying teams, complex buying cycles and lower demand levels, there are many sources of margin erosion creating a proliferation of complex B2B environments, problems, and cracks in business and commercial models meaning price control is more important.
Why is this happening?
The business models, profit levers and price control mechanisms that drove revenue and profitability 20 years ago are significantly different from those that operate today. Many businesses were built on cost-plus pricing management (i.e., made up cost to produce product figures plus mark-up percentage); however, this is ceasing to be the case, as a growing number of B2B businesses across Australia opt for more sophisticated ways to manage price control and value.
Without many businesses even realising it, cost plus price control and costly internal pricing negotiations are preventing your sales teams from winning deals. Pricing arrangements built on cost plus mark-up are inflexible and uncompetitive and leave your sales teams open to procurement teams that are ready to cherry-pick prices by line item. All the while, the sales teams are left in the defence position, explaining numerous pricing discrepancies that customers have picked up in your list price and discount structures (as opposed to sharing meaningful stories on customer value and risks that could help or damage their business).
Don’t think that customers do not notice inconsistencies in your pricing either because they do. As the procurement function grows in numbers and sophistication so does their ability to detect poor price management. What’s more, customers are choosing to work or not with suppliers based on the strength of their price list. Large price bandwidths, erratic discounting, and poorly structured, non-incentivised volume rebates are all overt warning signals to discerning buying teams that a supplier is not in control of profitability or cash flows and maybe a risk to work with.
Price control structures that are derived from cost plus mark-up calculations only serve to trade-off hard-earned margins. They offer practically no room for your sales team to move and next to no opportunity to abate price-driven customers with more flexible value and price trade-offs. Cost-plus price control is like a distant relative or aunt, it doesn’t quite fit in with the demands of modern business and trade. But it is known, trusted and a predictable formula that always makes an appearance at the big events.
Cost-plus pricing does not cut it with customers, the board or shareholders now or in the future. There are a growing number of B2B businesses that are realising this too as they see first-hand the negative results that cost plus mark-up can have on profitability. A double-pronged attack from fluctuating and rising costs on the one hand and excessive discounting and volume-based ‘passive’ rebates on the other hand gradually eventuate in the jaws of death situation and certain earnings decline. Unfortunately, most management teams don’t know these things, let alone knowing how to describe how or why cost plus damages profitability and credibility with customers.
How can loss-making habits and any types of financial losses affect business culture (inefficient price control)?
A cost-plus mindset is the antithesis of customer centricity or customer value. Cost-plus is a reductionist thought process that eventually disconnects the business from people, namely customers and staff. A cost-plus mindset is driven by what only can be called rough estimates of costs or guesswork. In a time when energy costs are fluctuating and commodity prices vary greatly week on week, why aren’t more management team asking: Is cost plus really a reliable way to set prices? Although cost plus postulates a logical argument in an excel spreadsheet, it really does not account for market variability and/or speak to the commercial mechanisms and human factors driving a deal.
A cost-plus mindset can also become deeply ingrained in a company psyche without a business even fully realising the full extent to which it is influencing sales behaviour and commercial decision making. So much so, that the mere suggestion of alternative pricing methods or practices such as value-based pricing can provoke awkward silences and/or dismissive comments in management meetings. If value pricing feels strange, awkward or silly these are signs that the business actually needs to rethink how they price.
A cost-plus mindset is also closely connected to a commodity mindset (have one and the other is sure to be lurking around somewhere). When a business has a cost-plus and commodity mindset, it is very typical to find that group discussions on possibly changing the status quo are overridden by statements like “value pricing does not work in a sales organisation,” “We sell commodities, where’s the value here.” “Our customers do not care about the value we offer, they just want a better price.”
Breaking a cost-plus mindset is not easy. As an MD recently said to me: “Transitioning from cost plus can feel like you are letting go of the steering wheel.” Taking the brave move to become accountable for past decisions and behaviours can be confronting. It is difficult to take the first step to test and validate your business model with customers in case they tell you what you don’t want to hear (but what you need to hear). It may even feel uncomfortable diagnosing the maturity of well-worn internal commercial management systems and price control structures that have served you well in the past (yet are likely to be the very obstacles creating many of your problems).
What you can do about it?
Diagnosing your real business problem is the foundation upon which to drive innovation. However, there are relatively few B2B businesses that actually objectively diagnose their business problems. Often businesses choose to do it alone or internally. Although this is better than nothing, such pursuits to discovering real business problems are largely unproductive because findings, recommendations and observations tend to be written with a latent desire to please or appease management concerns with good new stories and unrealistic perceptions of the market.
It is challenging to take honest feedback, let alone if you are a CEO with a successful track record of running multimillion or billion-dollar organisations. However, in unprecedented times, successful CEO’s (i.e., Carlos Ghosn being the prime example) spend most of their time listening and examining constructive and impartial feedback; good and bad and from a variety of different sources (internal and external).
Constructive and regular feedback adapts business pricing strategy, implementation and workplace culture. Objective feedback challenges biases and assumptions about price management and internal pricing operations and management. It is the basis upon which to lead and drive business innovation, internal change and shareholder value into the future.
- Not all CEOs seek or receive constructive feedback that well. There are many more business leaders out there that have for whatever reason become cut off from people; consciously and subconsciously opting out, becoming disconnected from the realities of business and complex human challenges.
- The position of CEO is lonely and unrelenting. People often fear to tell you the real situation (good and especially bad). It is difficult to get close to people because they are a vital resource of investment, utility and revenue generation. And, it is becoming increasingly difficult to find people with the right expertise, mindset and team working skills to break destructive behaviours and beliefs systems about what is and what is not possible.
- Curiosity, courage, accountability and an unrelenting focus and drive are key traits of good CEOs and vital components to running and operating sustainable and profitable B2B businesses.
Today’s and tomorrows’ successful B2B businesses are and will continue to be driven by a greater understanding of people. A deeper understanding of customers: meaning an actual understanding of the customers’ commercial problems. An alignment between the business’ value and pricing models: i.e., the key to unlocking more revenue, margin and profit. And, a deeply embedded value mindset across the entire organisation: i.e., a key determinant to driving business strategy (and breaking old habits and mindsets).
It is time that executive teams become aware of destructive price control behaviours and any types of financial losses. It is time we think about educating and reminding each other on why and how any types of financial losses are destroying commercial deals and profitability.
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