Robert Kugel's Analyst Perspectives

Price Optimization and Sales Incentives Deliver Profitability

Posted by Robert Kugel on Jun 24, 2011 2:30:43 PM

Two software applications I follow, price and revenue optimization (PRO) and sales compensation and incentives, can be highly complementary when used together. Unfortunately, since they typically are developed and sold by different kinds of software vendors, scant attention has been paid to the value of using them in tandem. I advise companies that have adopted a PRO strategy to use an incentive management application also to support and reinforce their optimization efforts. It is also part of our research agenda and education on sales  for 2011 and beyond.

Price and revenue optimization is an analytics-driven business discipline that uses market segmentation techniques and historical data to set a price that represents the most an individual buyer is willing to pay. It is one example of how businesses have successfully applied predictive analytics to achieve both strategic and tactical objectives. Companies use PRO to achieve strategic objectives such as increased profitability or higher market share and tactically to adapt quickly to competitors’ moves.

In the 1980s the airline and hospitality industries were the first to adopt PRO as a strategic tool. Their experience illustrates the value of the PRO approach. Both industries sell to two distinct segments. On the one hand, there are travelers (typically those on business trips) who have less flexible schedules and are willing to pay more for last-minute bookings and convenient times and dates. On the other, there are those (typically vacationers) who want to spend as little as possible and can plan further in advance or have more flexible schedules. Both airlines and hospitality share the same basic economics: The opportunity cost of unsold inventory (an unfilled airplane seat or a hotel bed) is very large compared to their incremental cost of sales. Airlines and hotels were able to be early adopters of PRO because they had computer-based reservation systems that enabled them to use historical data to develop and endlessly refine predictive models used to automate pricing decisions and then apply them to their transactions. Well-established airlines with higher cost structures were able to use PRO to compete successfully with lower-cost upstart airlines, providing proof that it was a practical and effective discipline.

In the decades since, the cost of computing power has dropped, making PRO a practical option for broad set of industries, many of which are in the B-to-B category. This includes manufacturing, distribution, general business services and financial services.

Airlines and hotels share an important characteristic in that parts of their prices are fixed at the time they are quoted and have no room for negotiation. In many other industries, though, PRO is applied to negotiated sales where the sales agent has latitude in setting the price. In these circumstances I believe it is essential to integrate sales incentive management with PRO. This addresses the common tendency of sales people to offer the lowest available price immediately; this is especially true of inexperienced salespeople and those from fixed-price cultures who are less comfortable dickering with customers.

Sales compensation and incentive software, used in conjunction with PRO, gives sales managers and representatives flexibility to apply their judgment to specific situations. For example, sales people might be allocated a set amount of pricing discounts during a period and allowed to apply this as they wish. The software also enables companies to modulate the degree of pricing flexibility according to product (to move inventory or meet market share goals), region (to open up a new sales territory), customer or time of month or quarter (to achieve sales volume objectives). The software can make it easy to a adjust incentives and track results while virtually eliminating the administrative chores of tracking the data and presenting it in the proper context.

Both of these applications are part of what we call sales performance management and recently our assessment of vendors and products called the Sales Performance Management Value Index found an opportunity for the vendors to better integrate these two areas together. Our value index lays out requirements for this type of software and assesses how well vendors in this category address these requirements. In any instance where a company is using PRO and sales people have flexibility in negotiating prices, I think the value of any price optimization strategy will be enhanced substantially with a complementary sales incentive management initiative.


Robert Kugel – SVP Research

Topics: Predictive Analytics, Sales, Human Capital Management, Office of Finance, Operational Performance Management (OPM), Business Analytics, Business Performance Management (BPM), Financial Performance Management (FPM), Sales Performance Management (SPM), Workforce Performance Management (WPM), Price Optimization, Profitability

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.