Stopping price leakages – the first step towards better pricing

When a company wants to increase its pricing power and profitability, a common way to get started is by evaluating possibilities to launch value-based or dynamic pricing or to move towards subscription-based pricing models. These strategies are undeniably powerful, but they do not necessarily suit all offerings or companies. For many B2B companies, the organizational pricing maturity is low and a strategic pricing project may be like biting off more than you can chew.

So, where do you start if the pricing maturity is low? A good starting point is to take a critical look at existing processes around price realization, or price getting. Even small improvements in an organization’s discounting practices can bring quick wins and significant profit improvement from leakage prevention.

Effort vs. value generation matrix for mapping the potential opportunities

At Capacent, we typically start by carefully assessing the overall maturity of our customer’s pricing through a round of interviews and a thorough data analysis. Together with key stakeholders from the customer’s organization, we review the findings and brainstorm for additional ideas and place all potential opportunities in the effort required vs. value generated matrix. The matrix makes it easier to decide where to focus the attention and where to start.

The picture presents an example of the matrix from a Nordic steel distributor with major industrial players as customers. Actions related to improving price-setting capabilities like value-based pricing and execution of price adjustments are included. But it is also clear that opportunities related to price getting, such as managing discount drift, cutting excessive discounting, and limiting free freight can bring a lot more value with less effort.

Price leakage waterfall contributes to transparency in pricing and profits

A very powerful tool for evaluating discounts is the price leakage waterfall that brings transparency to your pricing and profits. When calculating from the list price to the net price and all the way to the pocket price, it is possible to understand revenue leaks and where discounts are mostly given.

Focus especially on off-invoice or hidden discounts

When looking at potential leakages, it is important to differentiate between on-invoice and off-invoice discounts. On-invoice discounts are more transparent and easier to govern and in principle commercially justified. Therefore, the real potential usually lies in rebates, free services and other off-invoice discounts.

The graph below illustrates a leakage analysis focusing on freights. A total potential of 12 MSEK annually was identified in this case, and typically 50-70% of the total can be expected to be realized and sustained over time.

The various types of off-invoice discounts tend to get much less management attention and therefore can be more out of control. The problem with rebates is that they do not necessarily have the desired impact on sales. To be effective, rebates should be tied to purchased volumes and reviewed together with volume discounts.

The graph below shows the distribution of discounts given on production orders, and the tendency to round discounts is obvious. Since this is often a result of the human factor, creating understanding with facts and providing a clear call to action are needed to realize any goals you set.

Pay attention also to on-invoice discounts

In addition to the off-invoice discounts, it is beneficial to analyse the existence of on-invoice discount drift. This means that the volume discounts given are not distributed logically according to the true size and potential of the customers, and small and medium-sized customers may be getting discounts originally intended only for larger customers. Aligning the on-invoice discounts across customer segments can generate significant additional revenues for companies.

Capacent found additional 16M€ of potential profit for the customer

Reducing discounts seems like an obvious way to increase profit, so why do companies hire pricing consultants to help with the job?

One reason is that discounts are often hidden and especially in larger organizations difficult to manage. When discounts are buried under hundreds of thousands of rows of complex ERP data, you need a set of skilled analysts and consultants to figure out the truth.

Capacent’s Swedish pricing team conducted an extensive price leakage analysis for a Nordic steel distributor where the price waterfall analysis uncovered a whole range of revenue leakage points. The project team decided to focus on three areas – discount drift, rounded discounts and eliminating free freight.

″ In total, these accounted for an estimated 4,5% of total revenue and blocking the leakages represented 16M€ of potential additional profit for the company. ″

If you face discount management and any pricing-related challenges or aim to optimize your pricing strategies to meet your strategic business objectives, do not hesitate to contact us for more information on how we can help you on your path towards pricing power.

Authors

Elina Ojala is Senior Manager within Capacent’s Customer Profitability Team in Finland. She has several years of experience in pricing-related matters in payments and logistics industries. With her in-depth knowledge in pricing, she is interested in increasing customer profitability through price optimization and pricing process improvement.

Lotte Kylberg is Senior Manager and Pricing Lead at Capacent_x in Sweden. Lotte has 15 years of experience from developing and implementing strategic and tactical pricing with clients in a wide range of industries, such as industrial manufacturing and trade, business services, rental, retail and MedTech.