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Pricing software can spot pointless discounts and other profit-killers, but it isn't cheap.
Yasmin Ghahremani, CFO Magazine
June 1, 2008
In 2003, senior management at Emerson, a diversified manufacturing and technology company, realized there was a short circuit in its operations. Prices for the company's broad line of electrical products were declining year after year, and while savvy materials management helped to compensate, that strategy could take Emerson only so far. To keep profit levels up, a power boost was needed.
That boost came from several initiatives, including one in the form of price-management software (also referred to as price-optimization, revenue-optimization, or, more simply, pricing software), which attempts to help companies ascertain the optimum prices they can charge in order to maximize the bottom line.
Senior executive vice president Charlie Peters, who oversees Emerson's IT, marketing, customer support, and other functions, began implementing such software (from Vendavo Inc.) several years ago at a divisional level. All of the unit's sales were logged in (including descriptions of each transaction) and within months the software pointed out revenue leaks in the form of policy deviations. For instance, company rules forbade granting discounts on products that lacked competition, yet salespeople "were writing loose contracts that at times gave a flat 35 percent discount without even thinking about putting in exclusions for those products," Peters says.
That practice ended, as did other discounting deemed unnecessary. At the same time, visibility into the quote-approval process was improved, and Emerson began to require far more scrutiny from upper management for larger discounts. Furthermore, the software brought other managers, such as the division's CFO, into the approval process in situations where nonstandard payment terms were offered. Within months the division cut the average discount from 24 percent to 22 percent, and by the one-year mark its profit margin improved by several percentage points.
Gartner analyst Michael Dunne says pricing software regularly delivers 2 to 5 points of gross margin increase for many users, and up to 15 points for some. And while it's not cheap, the software typically pays for itself within a year.
Pricing software has been around for some time, but the market may finally be catching on: Gartner says sales were up 30 percent last year, to $150 million. But that still leaves plenty of room for growth. Revenue is often a notably under-managed part of the business, particularly for complex, global companies. Updating price lists alone can take months for manufacturers that have hundreds of thousands of stock-keeping units (SKUs). Enforcing the pricing rules is inconsistent and a compliance risk because records are usually kept in error-prone spreadsheets. "Obviously, revenues are more complex than payroll," says Zack Rinat, CEO of revenue-management software vendor Model N. "It's absurd to manage your revenue in spreadsheets."
Revenue-management processes, which include pricing software, can be broken down into three components: price analytics, price optimization, and price execution. Price analytics looks at how your existing pricing is (or isn't) working; it's how Peters discovered those mindless 35 percent discounts. (Not that Emerson is unique in that regard: when Model N did a study for a customer, it found that the sales force had given away $50 million in unauthorized discounts.) "Most companies identify major low-hanging fruit in the beginning of the project because of improvement in visibility," says Noha Tohamy, a research director at AMR Research.
Price optimization then asks what your price should be, given market conditions and retrospective models. It involves complex pricing science and forecasts. Peters first applied it to the Emerson divisions that conducted the most transactions and negotiations because the impact was likely to be largest there, but more recently he has extended it to divisions with fixed price lists. If a profit goal requires an overall 2.5 percent price increase, for example, the system optimizes individual product prices based on multiple dimensions (including geography, distribution channel, and brand) rather than raise every price on the list by 2.5 percent. Ultimately, however, it's about power and risk, in that "we'll increase price most where we have high power and low risk, and be most cautious where we have low power and high risk," Peters says.
Price execution is the component that helps salespeople price a deal on the spot. A semiconductor distributor, for example, employs this capability in its sales-operations deal desk. When a call comes in, the salesperson pulls up the customer's transaction history along with his "willingness to pay" score and can tell immediately what price the customer is likely to pay for the requested product. The salesperson can also see what similar customers are paying for that product, and how well the item is selling. If it's a fast-moving product, she may decide not to sell it at a discount.
As mentioned, pricing software comes at a price: the project cost, including license and implementation services, runs upward of $1 million. An additional cost comes in the form of data collection and cleansing, which AMR's Tohamy says often takes longer and proves more difficult than clients expect.
But according to a McKinsey study, a 1 percent price increase drives a 7 percent–plus boost in operating profit; a Gartner study is even more optimistic (see "How Pricing Impacts Profitability" at the end of this article). Having worked so hard to reduce costs, companies may decide that some time (and money) spent in assessing prices is the next major avenue of improvement.
Yasmin Ghahremani writes about business and technology from New York.