Scientific Pricing Framework: New Methods, Tools, and Techniques to Increase Profitability.
Motivation
Pricing is the gross margin inverse of asset management and procurement procedures. While the latter are designed to decrease cost (the lower margin boundary), the former is designed to raise revenues (the upper boundary). Pricing is typically market-based, but pricing decisions are very complex and when made in in an information vacuum, will sub-optimize gross margins for the firm. While most enterprise systems collect significant information on customers, only a small portion is delivered to the sales force and then only in the format collected. The sales force, therefore, is forced to make discounting and market pricing decisions on an aggregate basis. While aggregate pricing should be understood, customer by customer discount decisions require a deep understanding of the relationship, customer past history, credit status, and numerous other activities routinely tracked by the system. These decisions are carried out at every operation (branch), on a daily basis, by multiple individuals often with little system support.
The pricing/discounting decision is an information exercise and determines at least half of the firm’s profitability equation. Distribution profitability depends on increasing revenues and reducing operational cost. More often distributors tend to spend their effort on reducing cost by optimizing their resources such as implementing effective inventory management and efficient transportation systems than to explore opportunities to increase revenue and thereby increase profitability. Pricing decisions on products and services is the key to increasing revenue, profitability, and market share.
Solution Approach
Distribution pricing has traditionally been practiced as an art and not considered a science. Scientific pricing decision making is one potential focus area for profitable revenue management. Many distributors operate on a cost-plus pricing mentality, making pricing decisions (discounts) based on only product, volume, and customer information. Often, the laws of demand, supply, degree of competetion, and buyer behavior is ignored. It is important to understand and develop scientific pricing models and strategy using multiple decision criteria/variables such as product, volume, customer, geography, market structure, competetive environment, customer behavioral constraints, and the economics of information management. These scientific pricing models should then be enabled by the very systems that provide the data.
Methodologies
Even though most distributors understand to some extent other external drivers of pricing such as competition and market structure, understanding and implementing a holistic approach to pricing has always been difficult. This Consortium will research pricing strategy and variables designed to include break even analysis, price elasticity, price thresholds, product life cycle pricing and price sensitivity. Scientific pricing decision making is one potential focus area for profitable revenue management. Profitability depends equally as much on pricing as it does cost control.
The key project steps are:
- Texas A&M Research team will conduct a survey of current distribution pricing strategy, practices and enterprise system capability/functionality with the Consortium members.
- Conduct quantitative research to develop new and practical methods to maximize profits.
- Research in to pricing methods of products, services and bundled products and services.
- Quantify the external price drivers such as demand, competition, value to customer, etc and develop methods to incorporate it to pricing methods.
- Research in to price discounting by customer, product line and volume.
- Develop practical pricing methods that consider price elasticity, price thresholds, product life cycle pricing and price sensitivity.
- Develop IT based tools that demonstrate the methods developed.
- Develop profitability analysis methodology and key pricing metrics for monitoring and managing profitability.
- Develop Best Practices in pricing process administration, and developing metrics to monitor and improve the performance of pricing methods.
| Goals | Current Issues | Solution | Benefits |
|---|---|---|---|
| Increase Profits by Effective Pricing Management |
Poorly developed discounting practices, lack of pricing training | Research based methods and tools for pricing and pricing training for sales force | Maximize total profits and provide value to key customers. |
| Pricing over Product Life Cycle | Poor understanding of price elasticity, discounts and lack of tools | Develop strategies and methods to maximize total profits | Increase profits during new product growth, prevent obsolescence by discounting at decline. |
| Effective pricing of services and price bundling | Lack of methods to price services & understanding of service profitability | Methods and tools to price services and bundles | Maximize profits on services, kits, bundles, and projects. |
| Automated pricing mgmt, Profitability Analysis and Pricing Information mgmt. | No Best Practice methods and Information System support | Develop Best Practices, Profitability Analysis and Key Performance Metrics (KPIs) | Automation of pricing processes, management by exception, manage & monitor profitability. |
Value to Members
The consortium members will receive results, methodology and tools developed during this pioneering research in to Distribution Pricing. The key advantage for Distributors and Manufactures would to gain a competitive advantage by implementing the scientific pricing methods or using the tools developed to maximize profits. The key advantage to Technology and Enterprise software companies will be gain the knowledge base, methods and tools that can be implemented in their systems.
Apart from shaping the research focus and gaining valuable knowledge base, methodology and tools, each consortium member will be able to send up to a total of 20 people to three educational sessions that will be developed from this research. The educational sessions alone represent a $40,000 value.
What are the Benefits?
The benefit to the consortium member includes the opportunity to actively participate in this groundbreaking research into one of the most crucial and timely challenges facing the industry. Each member of this consortium will also be able to direct the scope of this research so that the results are actionable and sustainable. Additionally, members of the consortium will have the opportunity to send up to 20 people from their organization to the educational programs at no cost other than the travel expenses during the 2006 sessions. The educational programs will be scheduled three times every year following the conclusion of this research.
Deliverables
In addition to the body of knowledge resulting from this research, the following tangible outcomes will include:
Tools and methodology developed from the research and a book written by the research team
A 2 day educational seminar aimed at providing firms with knowledge into how they can apply the concepts, tools and techniques identified in the research
Consortium Structure and Fees
Membership in each consortium is limited to a group of 10 companies to be an effective research group. Membership will be on a first come first serve basis. The membership fee is $25,000 per company.
Consortium Members
- Automotive Distributors
- Drake Group
- F.W. Webb Company
- Intuit Eclipse
- Iscar Metals
- Johnstone Supply
- Oracle
- TTI
- Wilson Supply
