Robert Kugel's Analyst Perspectives

CFO and Finance Should Take Leadership Role in Pricing

Posted by Robert Kugel on Apr 21, 2017 9:18:05 AM

Pricing is an issue that affects almost every for-profit company that doesn’t sell purely commodity products. A corporation’s approach to pricing can range from highly disciplined to ad hoc and from fully centralized to decentralized. The issue of centralized or decentralized depends a great deal onvr_Office_of_Finance_23_adoption_of_advanced_analytics_updated-2.png the markets the company serves, its organizational structure and its culture. However, a disciplined approach to price setting and negotiation is always superior to an ad hoc approach. This is especially true for non-commodity B2B businesses, which I believe have lagged other types of business in managing their pricing strategically. (Some would argue that there is no such thing as a pure commodity business, but that’s another issue.) Increasing pricing discipline in the company is one way for the CFO to engage more strategically in managing the business.

As a rule, finance departments shouldn’t determine prices because they lack front-line engagement with markets and customers. But the CFO should be involved in ensuring that the approach to pricing is disciplined. Finance departments are the logical source for performing the analyses necessary to support such a disciplined approach because that’s a principle function of the financial planning and analysis (FP&A) group. Yet our Office of Finance benchmark research finds that few finance organizations are engaged in the kinds of advanced analytics that are necessary for effective pricing management. Fewer than one-third reported that they routinely measure product (29%) and customer (26%) profitability. Only 15 percent use analytics in pricing optimization.

Like almost all business issues, improving pricing discipline requires addressing an often interrelated set of people, process, information (data) and technology (mainly software) conditions. The people issues center chiefly on roles, responsibilities, communications and compensation. The process issues revolve around establishing highly repeatable successful processes for managing pricing – standardizing who does what and when. Some companies even have a dedicated pricing department. Some of these groups are fairly tactical, charged with managing the creation of price lists, allowable discounts and other necessary elements of the implementation of pricing policy. Other pricing departments are more strategic. Their members understand pricing theory and how to apply it to their company’s circumstances and use specific pricing processes and systems to achieve the company’s strategic objectives. The most effective of these types of pricing organizations involve multiple stakeholders, especially from sales, sales operations, marketing and finance.

As important and complex as the people and process issues can be, my focus here is on some of the larger software and data issues, especially as they relate to B2B businesses that mainly use a direct sales model. CFOs ought to understand how these two elements are essential to the pricing process.

Data issues plague most business processes at some point. Nobody has yet invented a magic wand that can make them go away. Data quality is often overlooked because it’s nobody’s full-time job and successfully dealing with it is tedious. Data quality problems arise for several reasons. Common ones are that the necessary data isn’t recorded or is recorded incorrectly. Problems also may result from multiple systems being used to record pricing in different parts of the corporation and from the use of spreadsheets to bridge incompatible systems or to correlate different sets of data.

Attempting to manage pricing without addressing data quality issues at their source is a futile exercise. If the company is not recording some aspect of a transaction, it needs to ensure that its systems are capable of collecting the needed data, and it must train employees to do that accurately. Incomplete or inaccurate data usually leads to bad decisions. Because pricing has a major impact on profitability and market share, the impact of bad data can be quite negative. Consistent, accurate and timely data is essential for the pricing analytics that drive pricing decisions. Accurate data is also essential to achieve acceptance of change management initiatives that involve new pricing policies, especially if the company uses a direct sales model.

It’s essential to use capable software to manage pricing analytics, the price-setting process (including negotiations) and, for companies that use a direct sales force, sales compensation management. In an earlier research note I touched on applications that support price and revenue optimization and pricing management[IN PROCESS] in general. The pricing management software category (as we define it) incorporates pricing analytics and, in the case of software designed to optimize pricing, analytics needed to usefully segment buyers.

Price and revenue optimization (PRO) software is a type of pricing management application. 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 greater market share. It enables companies to surf the demand curve using dynamic rather than fixed pricing to achieve the  most desirable trade-off between revenue volume and profit margins. The trade-off is defined by strategic factors such as the company’s market position, its product and service portfolio, and its marketing strategy.

Using pricing management software enables companies to be more agile and adaptive in their pricing process. Retailers of all types have found that using dynamic pricing enables them to compete more effectively and optimize their profitability. B2B price management differs in several respects, including smaller sales volumes of products and accepted business practices that limit how often they can change prices. But pricing management software can enable most B2B companies to better achieve their business objectives.

PRO is an important capability for sellers in markets where there is significant price transparency. It enables them to dynamically set prices according to the individual buyer’s preferences, price sensitivity and profitability. Yet comparatively few companies employ PRO. Our Office of Finance Research reveals that only 15 percent of companies use this approach.

A central piece of pricing management software is software that performs configure, price and quote (CPQ) functions. CPQ software, first introduced as packaged software in the 1990s, was originally created to simplify and accelerate the process of assembling an accurate price quote for a sale involving a complicated set of components. For example, buyers of large commercial trucks typically can choose from multiple engines, cab designs, transmissions and trailer types. There can be large numbers of permutations, and not every combination of components is valid. Getting a feasible quote back to a buyer fast can be a competitive advantage, and ensuring that the pricing is accurate can improve profitability. Software that can sort out this kind of complexity and produce a valid quote quickly has proven useful in many industries.

Over time CPQ software also has been used increasingly to manage revenue and margins. To minimize margin leakage, it can be used control the discount from list price offered to the prospect on each component of the sale. The software can give sales managers and representatives flexibility to apply their judgment to specific situations. For example, reps might be allocated a set amount of pricing discounts during a period and allowed to apply this as they see fit. The software also enables companies to modulate the degree of pricing flexibility according to the product (to move inventory or meet market share goals), region (based on quota attainment in the period to date), customer or time of month or quarter (to achieve sales volume objectives). This type of CPQ software also can prompt sales people to recommend complementary products and services to the buyer to increase the size of the transaction. In its basic form, the discount guidance and control applied to each sale component can be based on experience-driven judgment.

For corporations that use a sales force, sales incentive management software is essential to successful price management. Used in conjunction with a pricing management application, it provides the mechanism that rewards sales personnel for actions consistent with their company’s objectives. The software can make it easy to adjust incentives and track results while virtually eliminating the administrative chores of tracking the data and presenting it in the proper context. In contrast, using desktop spreadsheets to manage sales compensation does not support an active pricing management approach. Dedicated software enables sales managers to make rapid changes to sales compensation plans to adapt to changing market conditions or achieve specific sales objectives. It also enables them to understand the financial implications of those changes and make more accurate forecasts of sales compensation expenses.

Finance departments should play a role in the pricing process. Their input is necessary to set profitability objectives that consider the results of the best performing companies in their business. They need to monitor pricing as part of monthly and quarterly performance reviews. At the least, they should be able to provide analyses of the impact of volume and pricing on results – especially in identifying the impact and sources of margin leakage. Leadership by the CFO is necessary because of the change management aspects of adopting a new approach to pricing and because of the strategic impact that it can have on the company’s profitability and financial position. Taking such a role is something any CFO should consider.

Regards,

Robert Kugel

Senior Vice President, Research

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Topics: Big Data, Office of Finance, Continuous Planning, Analytics, Sales Performance Management, Financial Performance Management, Price and Revenue Management, Pricing and Promotion Management, Sales Enablement and Execution, ERP and Continuous Accounting, Sales Planning and Analytics

Robert Kugel

Written by Robert Kugel

Rob heads up the CFO and business research focusing on the intersection of information technology with the finance organization and business. The financial performance management (FPM) research agenda includes the application of IT to financial process optimization and collaborative systems; control systems and analytics; and advanced budgeting and planning. Prior to joining Ventana Research he was an equity research analyst at several firms including First Albany Corporation, Morgan Stanley, and Drexel Burnham, and a consultant with McKinsey and Company. Rob was an Institutional Investor All-American Team member and on the Wall Street Journal All-Star list. Rob has experience in aerospace and defense, banking, manufacturing and retail and consumer services. Rob earned his BA in Economics/Finance at Hampshire College, an MBA in Finance/Accounting at Columbia University, and is a CFA charter holder.