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As its name suggests, demand-based pricing is a method that uses the buyer’s demand, based on an estimate of a good’s or service’s perceived value to the buyer, as the central element in setting price. Pricing strategies are most important because they can have a disproportionate impact (positive and negative) on a company’s bottom line. Managing prices has always been an activity of keen interest, but it has become even more so over the past decade as a result of the constrained pricing environment.
Price and revenue optimization (PRO) is a business discipline used to effect demand-based pricing; it applies market segmentation techniques to achieve strategic objectives such as increased profitability or higher market share. PRO first came into wide use in the airline and hospitality industries in the 1980s as a way of maximizing returns from less flexible travelers (such as people on business trips) while minimizing the unsold inventory by selling incremental seats on flights or hotel room nights at discounted prices to more discretionary buyers (typically vacationers). Today, it is a well-developed part of any business strategy in the travel industry and increasingly used in others.
I’ve identified six components that corporations must consider and manage well to be successful in using PRO: strategy, external factors, people, process, information and technology (software). Here are some thoughts on each of them.
Above all, companies must have a realistic pricing strategy that is closely aligned with their capabilities, product strategy and competitive position. In a scale-driven business, for instance, it probably doesn’t make sense for a small player to try to be the low-cost provider. Instead, pricing software enables these companies to find ways to maximize pricing in a price-conscious market by designing offerings with valued features and services that add to their margin.
Pricing strategy and execution must take into account external factors. In particular, different cultures and businesses often have their own attitudes toward fixed and negotiated pricing. In some cases, especially in consumer markets where fixed prices have been the norm, people may consider price optimization “unfair.” Companies that try to implement a PRO strategy must realize that they may encounter resistance and be careful in how their marketing and communications position their approach to pricing. That noted, despite some annoyance, people have grown accustomed to highly variable airline and hotel pricing. Also, there may be legal and regulatory issues that impinge on a company’s pricing flexibility.
As to the people dimension, management needs to ensure that the groups involved are behind the effort. It’s extremely important that incentives (especially sales compensation) are properly aligned with the price optimization objectives that I recently covered. In many cases, ongoing training will be necessary to continually refine techniques and deal with issues that arise. For some organizations, a “center of pricing excellence” may be a useful way to build on its experience and entrench a culture of price optimization. Exactly how this is handled depends on whether the company has a centralized or decentralized structure to manage pricing.
People and process meet in the ongoing evaluation of price-setting practices by a cross-functional team that incorporates all stakeholders. Initially these people will meet frequently (at least once a month), but it may only require a quarterly review as PRO matures. There also must be a well-defined price analytics review process to ensure the methodologies the company is using are sound.
Easy, rapid access to the data needed to support the use of pricing algorithms is a prerequisite for successful implementation of a pricing strategy. Such data feeds the analytics and facilitates rapid pricing-decision cycles. Our research consistently shows that access to the appropriate data is an issue for a majority of companies and that this issue grows in proportion to the company’s size.
Lastly, the company must acquire the right software, implement it properly and tailor it to its needs; it also should be easy to deploy and maintain. When it comes to pricing, there can be subtle differences in the needs of particular types of business; prospective buyers should focus on vendors that have strong references in their specific industry.
Robert Kugel – SVP Research
I recently attended Kinaxis’ users’ group meeting and learned some interesting things. The company, which has been around since 1995, provides software for large corporations with complex supply chains. Over the past decade its product has evolved well past its roots as a material requirements planning (MRP) support tool. It is now an analytics suite that facilitates supply and demand planning, analysis and optimization with a focus on sales and operations planning (S&OP). This is a discipline that is much talked about but less well practiced, done effectively by only a handful of very large companies (Cisco, for example) and smaller ones that have defined their functional strategy around S&OP and logistics management. In our S&OP benchmark research, we assessed the degree to which companies have a broad cross-functional representation in the process (a critical aspect of an effective S&OP effort) by asking which parts of the business were involved. When it comes to five of the most important ones – executive management, manufacturing, operations, sales and finance – our research showed that only 21 percent of companies have four or five participating, while 45 percent of companies have none or just one.
I think that an emerging source of sustainable competitive advantage for product companies is the ability to optimize their matching of supply with demand by having visibility of both. “Visibility” in this casemeans that data about the supply chain is delivered in a way that enables managers to know whatever they need to know, whenever they need to and at whatever level of detail they need, and that allows them to analyze the data and take action based on the results of their analysis. The essence of supply chain visibility is the ability to know the location and status of all physical components, from raw materials to finished goods, as they move from suppliers through the stages of production to delivery to customers. It requires complete data that is immediately available, supported by a full set of analytics to speed modeling, assessment and decision-making. Moreover, visibility is no longer just about the supply chain. One of my notable take-aways from the Kinaxis users’ conference was that the discussions focused as much or more on demand management as on supply chain management.
Kinaxis’ RapidResponse software is designed to enable companies to continuously identify the optimal supply and demand balance in a volatile business environment under conditions of high uncertainty – in today’s world, in other words. The name, RapidResponse, reflects an approach to business management that recognizes that planning and decision-making time frames have shrunk considerably. The software tightly integrates all planning functions (both supply and demand) to allow better cross-functional collaboration. It provides a single view of the supply chain, a collaborative tool for more accurate and timely demand planning, and a platform for more effective collaboration with suppliers. The recently released RapidResponse Control Tower has advanced dashboards and data visualization. It also integrates key S&OP functional processes, supply chain management (SCM) and related functions, and as well brings together basic sales force, human resources and profit optimization analytics and project management functionality. RapidResponse is available either as a cloud-based service or an on-premises deployment.
Based on my observations and conversations, I would place the Kinaxis customers at the conference at the most mature end of our research-based Maturity Index for S&OP: They appear to be effective in applying information technology to improve communications, collaboration and processes. In this context several customers made points that are worth repeating. I will summarize two of their presentations.
Matt Red outlined Barnes & Noble’s attempt to extend its information chain for supply and demand chain analysis and decision-making out to the point of sale (POS) in the individual bookstore to track sales and inventory (especially of its Nook e-reader). There are both business and IT challenges to doing this: gaining cooperation from individual retailers and handling the data, respectively, top the list. I look forward to hearing a litany of lessons learned at next year’s event. Still, the company’s approach could turn out to be a powerful tool, especially in the realm of consumer electronics, where product lives are short, supply chains are long and the important holiday selling seasons are abbreviated. When used with predictive analytics, a data chain that starts at the store-level POS can (in theory) compare actual to expected sales to gauge where promotions and pricing changes can be applied instantly based on ongoing day-to-day sell-through. With such a system in place, vendors can monitor and measure their channel inventories better. Applying more immediate sell-through data enables much faster reforecasting cycles and therefore better adaptability to specific market conditions. It also has the potential to be a powerful tool for managing inventory, understanding effectiveness of advertising and promotions, and performing other analysis related to market demand.
Joe McBeth from Jabil Circuit put his finger on what I believe is one reason why S&OP has failed to become strategic in a majority of companies. He pointed out that the focus of mastering logistics and optimizing supply chains ought to be on maximizing profitability, not just minimizing inventories (as in the case in most supply chain organizations). The former is an income statement objective; the latter targets the balance sheet. To be sure, inventory management is important and has a direct impact on profitability. Yet it does not explicitly deal with the complex trade-offs that businesses are making in balancing revenue optimization and risk tolerance with decisions that must be made daily in purchasing and logistics organizations. He also related his company’s experiences in the wake of the Japanese earthquake and tsunami last March and the recent floods in Thailand. After the tsunami, Jabil was able to provide management, OEM customers and suppliers with a detailed impact analysis and risk assessment. In light of these experiences he commented, “In a constrained market, the guy with the best information wins.”
From the conversations I had at the event, there appears to be limited integration of the S&OP team’s forecast and the finance department’s revenue estimates. This is consistent with the findings of our integrated business planning benchmark that just 20% of companies directly link their sales forecasts to the financial forecasting and budgeting efforts; more than half (55%) said the connection is indirect. The issue with having an indirect link is that typically there is a lag between when the sales forecast is made and when the financial forecast and budget is complete. In the case of the annual budget, this may be a month or more out of date. In stable conditions, the change in outlook may be small, but today’s volatile environment makes that less likely. The S&OP process will never displace financial planning and budgeting, but it can be highly complementary. Provided that a robust cross-functional team (including Finance) is involved in its preparation, the revenue forecast developed through the S&OP process ought to be directly linked to financial forecasts. There may be several reasons why Finance is reluctant to directly embrace the S&OP team’s projections. To me, one of the most obvious is that (as noted above) these teams lack the broad participation that fosters collegiality and accurate forecasts.
To be competitive, companies engaged in product (as opposed to services) businesses – especially those that have some combination of complex supply chains, complex product lines and short product life cycles and/or shelf lives – must uses sales and operations planning effectively. Our research suggests that above all, for a majority of these companies their S&OP efforts must be more broadly based. Having the right technology and easily accessible data also are necessary components of a successful S&OP effort. I suggest that larger companies with complex products and supply chains examine RapidResponse to see if it can help them manage their businesses more accurately and effectively.
Robert D. Kugel – SVP Research