By David S. Bauders, CEO SPARXiQ
In the world of sales and pricing, contracts and special price agreements (collectively known as “CSPs”) create a vexing problem for many distributors and manufacturers. As sales teams negotiate with prospects and customers to secure, expand or rescue accounts, they make a lot of tough decisions to establish pricing and terms that both win the business and deliver profitability. Although often reserved for larger, more strategic accounts or projects, CSPs are often established in ERP systems for customers of any size or level of importance.
Here is a sample pricing-methods mix and profitability for a common industrial company:
Depending on the industry or vertical, CSPs may represent 20 to 50 percent or more of a company’s revenue. Carrying deeply discounted pricing, CSP margins are commonly 500 to 1,000 basis points (five to ten margin points) or more below everyday, system pricing levels – producing a net profitability reduction that ranges from one to five full margin points. For a distributor that averages operating profitability of four percent, this effect can potentially impact operating profit (and thus enterprise value) by 25 to 125 percent of baseline profitability.
CSP Management Challenges
The devil is in the details. As sales reps establish CSPs, they often work in Microsoft Excel or Word or even email to develop and communicate pricing to end customers (and their internal sales and pricing teams). These pricing structures take precedence over general system pricing.
Generally, CSPs are established with valid timeframes (e.g., for one year, or until 12/31/XX). Day after day, year after year, these files are added into the ERP system, often without systematic maintenance or housekeeping. Over time, they tend to consume a greater share of the pricing methods mix – and hence create an increasing drain on overall profitability. From a review and maintenance perspective, managing these files is a huge nuisance. The problem is further compounded by organizational walls between IT, pricing departments, sales, and purchasing – which inhibit access to information, analysis, review, action, and implementation.
Over time, many companies find that they have thousands of individual CSPs, each with dozens, hundreds or even thousands of line-items to review. Between quantity, complexity, file structure, and timing, CSP management becomes a truly daunting task for most companies. If we think of a company’s pricing architecture as a house, CSPs represent the cluttered attic with a random accumulation of odds and ends brought and forgotten, year after year. For many companies, what was supposed to be just the attic ends up being the majority of the house!
Where CSPs Can Unintentionally Drain Profitability
Given CSPs’ adverse margin levels, the question becomes: how do we ensure that CSPs serve their evolving sales purposes while delivering profitability? While CSPs may have been appropriately set up at the outset, many factors creep in to distort this benign source of sales growth into a black hole that consumes profitability. Here’s what can go wrong with CSPs and how it impacts your bottom line:
- Cost Increases
When costs go up, but CSP pricing is fixed (net pricing), margins go down. A critical CSP metric is what percentage of CSP revenue is on fixed versus adjustable (margin- or discount-based) pricing bases. - Inactive or Underperforming Customers or Customer-SKU Combinations
Customers who underperform versus volume, cost-to-serve, or other profit levers can quickly convert money-making CSPs into money-losing CSPs. - Wasteful Discounting
Broad-brush, peanut-butter discounts are indiscriminately applied to low-sensitivity products, customers, and customer/product combinations. - Missing Vendor Cost Supports
In many cases, vendors are willing to support special contract pricing, but sellers fail to secure or maintain appropriate cost support, causing further profit leakage.
- Customer Lifecycle Considerations
Pricing that was established to secure the business, sometimes from competitors, may need to become aggressively low – to incent switching. As the customer recognizes value and attaches to a supplier, with switching costs that deter changing suppliers, it is appropriate to carve out wasteful discounting from the original agreement. - Continuous Adding of New Products to Customer Agreements
To equalize all pricing to a given customer, the assortment of products in the CSP keeps growing, expanding CSP share of revenues, while the additions are likely to fall in margin over time due to expanded discounts or absorbed cost increases. - Rolling Expiration Dates
As the CSP library becomes increasingly complex and daunting to manage, review or remediate, many commercial teams simply extend the deadlines of expiring CSPs. When the CSP process spins completely out of control, we sometimes see expiration dates of 12/31/99 – as in, this agreement’s terms are perpetual.
Looking across these issues, it’s obvious why CSPs can naturally snowball into a profitability black hole. CSPs are numerous, complex, dynamic, in disparate file formats. A mere five percent shift in CSP share of revenue and a two percent decline in CSP margins produces a 40 percent decline in EBIT and enterprise value. This downward spiral of CSP pricing becomes paralyzing, as no one has the time to review the tens or hundreds of thousands of line items involved.
The Promise of AI and Machine Learning Technologies
Fortunately, new AI tools, combined with price optimization systems, can scan the tens or hundreds of thousands of line-item records to quickly and efficiently suggest changes that will boost sales and profitability performance. Machine learning, applied to expert-guided contract optimization, can quickly and efficiently suggest to contract managers and sellers the myriad enhancements to improve sales and profit performance.
Implementing AI tools for CSP management provides the insights and prescriptive guidance that help sellers prune or adjust CSP terms:
- Suggest the removal of inappropriate products, customers or product/customer combinations.
- Suggest missing, high-leverage products to CSPs to drive wallet share.
- Suggest the migration of prices toward prescribed increases.
- Convert static net prices to dynamic discounts or margins, to pass through cost increases in the future and prevent margin erosion.
- Request missing or under-supported vendor cost improvements.
- Carve out low-sensitivity tail spend to redirect toward more profitable system pricing.
The scale and complexity of CSPs has until now meant that few companies can truly master this critical driver of sales and profitability. AI technologies are now bringing a massive lift to productivity and profitability while helping sellers refocus on serving their customers. Companies that embrace these tools will outcompete in winning business while driving industry-leading profitability.
Additional Resources for Distributors
Looking for strategies to optimize your pricing?
Explore our resources and start with The Complete Guide to Choosing a Pricing Solution for Distributors.
