In my last article, I touched on strategic pricing by discussing the tension between sales and pricing. Strategic pricing for most manufacturers and distributors isn’t truly a mature discipline (witness the continuing reliance on Cost-Plus, endless pricing overrides and the neglect of contracts and customer-specific pricing agreements), but it’s stuck in a deadlock between sales and pricing (and secondarily with sourcing and operations). Until an integrative approach resolves these tensions, pricing initiatives will struggle to realize the full promise of the pricing lever.
Now, knowing that strategic pricing has to evolve with modern times to support the growing interest in emerging sales strategies, the next step is to integrate pricing with the other key drivers of profit within a business.
But what do we integrate and how? I believe the 2020s will be the decade where pricing is integrated with the three other key profit levers of selling strategy, sourcing strategy, and operational strategy. The path toward this growth comprehensively integrates the four levers of profitability.
An Integrated and Holistic Approach to Profitability
A proper, systems approach to pricing and profitability links your pricing actions to your sales, cost-to-serve, and purchasing strategies. Let’s revisit the four levers of profitability that we refer to collectively as “The Profit Diamond™.” It provides a simple framework of the economic levers that drive profitability and therefore need to be managed. To improve profitability, we can impact the following:
- Sell price
- Cost of goods sold (COGS) in those verticals with negotiated cost supports
- Sales Quantity/Share of Wallet (SOW) and mix/quality
These levers have interdependencies of course, but isolating them helps the market-facing teams to manage them in practical daily activities.
The Result of Integrating Strategic Pricing for Profit Growth
The good news is that, in addition to resolving the tensions that limit the efficacy of strategic pricing, the new integrative approach unlocks new gains from the other three profit levers. Each of these levers is broadly worth at least 200 basis points. So, whereas the stand-alone pricing initiative might unlock 200 basis points or more, the integrative approach can unlock 800 basis points or more, beyond resolving the tensions that would restrain any one of the profit levers pursued in isolation.
In an industry where net income as a percentage of revenue is commonly 4% or so, and elite companies are perhaps at up to 8%, The Profit Diamond’s potential can increase net income by 100 to 200% — with a proportionate increase in enterprise value. This latent, untapped value is available to any manufacturer or distributor that commits to the analytics, systems and workflow solutions that operationalize the prescriptive remediating actions.
To unlock these transformative profit gains, the operational bar has been raised yet again. In addition to mastering the complexities of pricing, companies must mine even broader data sources to integrate sales analytics, purchasing optimization and operational efficiencies — at the customer, vendor and internal operations levels. So, instead of the unidimensional (1D) traditional perspective of strategic pricing, we are now seeing the world in 4D, if you will, as in the four points of The Profit Diamond™. That advancement will render obsolete the typical distributor’s DIY spreadsheet approach to pricing — and elevate the competencies required to master the opportunity.
Mastering a Systematic Approach to Integration
Companies that master the systems approach or consider The Profit Diamond concept will have an advantage over their competitors who persist with the traditional 1D approach to strategic pricing. The lack of an integrated, holistic approach will restrain the outcomes available from each lever and obstruct the synergies that integration enables.
Consider an industry that has persistently pursued this multidimensional optimization approach. A world-class airline today can’t really choose whether to optimize customer service versus efficiency versus on-time performance versus optimizing routes and hubs. The harsh truth is that a world-class airline must optimize and integrate all of these (and many more) dimensions. Despite the fact that the airline industry carries EBIT percentages roughly twice those of distributors, airlines have more rigorously implemented the disciplines to integrate and optimize all their operational profit levers. While manufacturers and distributors have not…yet.
As in any obvious arbitrage situation, the question is not whether these changes will occur, but rather which ownership or management regime will identify and act upon the opportunity. Industry consolidation will reward the party who acts upon this insight and masters its execution. Those rewards will create virtuous flywheel effects that repeatedly empower the agents of change to acquire and profit from the acquisition and conversion of the non-adopters.
Attain Better Operational Efficiencies and Better Pricing
Manufacturers and distributors who thrive in the years to come will be those who strategically link and operationalize the four levers that impact their profitability. They will attain greater share of wallet from their customers, better terms of trade from their vendors, better operational efficiencies internally and better pricing than their 1D competitors. Strategic pricing is an integral part of the 4D world, inextricably linked to the other levers and supporting their optimization.
If you’d like to learn more about getting the most from the four levers of profitability, we’d love to hear from you!