Why Pricing is the Key to Digital Transformation Margin Growth
By Zilliant
Jan 21, 2020
It’s no secret that manufacturers across the industry spectrum are embracing digital transformation to stay competitive and innovative. The speed of technological advancement and the risk of lagging behind the rest of the market combine to make digital the table stakes of 2020.
According to the RSM US Manufacturing Outlook Index, “80 percent of manufacturers say that digital transformation has become a higher strategic priority in the past three to five years.”
It’s an inevitability that most manufacturers, if they haven’t already, will soon invest in trends like the Internet of Things (IOT), machine learning, supply chain digitization, cybersecurity and predictive maintenance.
Just don’t forget that pricing and deal management must be a main course on your digital transformation menu. Pricing, after all, is the top lever you have to increase revenue and margin. So if you’re overlooking it, the rest of your digital investment may wind up producing little overall financial gain.
We’ll use the industrial parts and equipment manufacturing sector as an example of the significance of evolved pricing.
If you’re in industrial manufacturing, you no doubt keep a constant eye on costs. Regardless of your product mix, how you sell or to whom, material cost fluctuations represent a moving target that hinder profitability. When you factor in stagnating growth, the trade war and increasing competition, you quickly realize it’s simply not feasible to manage it all with outdated tools, or techniques like overly broad cost-plus pricing.
If you manufacture discrete products…
Costing can be simpler in this mode of production, since you know what components you need from the Bill-of-Materials and can plan ahead accordingly. Unfortunately, this also means that cost-plus pricing tends to become the go-to strategy. While it’s easy to markup cost across the board to target a certain margin goal, overly broad cost-plus approaches don’t allow for any consideration of customer willingness to pay. Customers are unique, so selling to them in a uniform way leaves profit on the table.
It’s imperative to separate customers and products into price segments and measure price elasticity for each segment. With that information in the hands of the pricing team, prices can be raised where feasible, blowing cost-plus margins out of the water, or lowered where needed, maintaining volume and share. Additionally, precise segmentation gives pricing teams the ammunition needed to drop customers into a profitable matrix system. For negotiations, pricing can be delivered to sales reps as a Start/Target/Floor deal envelope that is highly relevant for each selling circumstance. In customer-specific pricing scenarios, manufacturers should implement a deal management solution and a corresponding deal management process to maintain the health of agreements and efficiently manage approvals.
If you manufacture configured products…
Many of the custom engineered parts, products or equipment that you produce are only made that one time, therefore each pricing decision is unique. There are two complications these manufacturers run up against: (1) how do you price something that you’ve never made, let alone sold, before? (2) you’re not dealing with a single SKU, but rather parts and pieces that get configured into a final product. Thus, it has to be designed and costed before you can even consider price.
Once that work is done, you must determine how much pricing power you have (i.e. how differentiated you are) versus your competitors and drive a price accordingly. Most will gather all the built-upon costs and add a markup. But how rigorous is the decision-making for said markup? Is it a guessing game based totally on gut-feel or what you consider a rule-of-thumb fair margin? For those that haven’t transformed their pricing, the answer is usually yes. This means there’s almost certainly money left on the table, and in some cases overpricing, which results in lost sales and customer dissatisfaction.
There are better ways to arrive at a markup if you get scientific. You can (1) build up to a cost and apply price optimization to determine the optimal markup based on the product configuration and selling circumstance; or (2) build up to a cost, apply a markup to a list price and then optimize for discount guidance. Either tactic brings real transaction data and customer/product price elasticity into the decision, delivering sizable growth to the bottom line.
If you manufacture aftermarket parts…
One of the decisions manufacturers make is how best to engineer and price products upfront to ensure they get the downstream aftermarket business. The original product price serves as a guideline for the aftermarket price of its component parts. There’s a danger in pricing it too high upfront and shooting yourself in the foot down the road.
Combining that with the highly variable nature of who you’re selling to in the aftermarket creates a classic price optimization scenario. How do you produce a competitive list price with so many buying personas to account for? How to purposefully assign customers to a matrix that produces market-aligned prices? What kind of discount guardrails can you provide to sales reps to help them negotiate customer-specific agreements or spot transactions? If selling online, how do you enable automated negotiation functionality? The answers lie in the power of price optimization.
Conclusion
Industrial manufacturers create and sell products in very different ways with different costs to wildly different customer segments. Whether you fit into one of the above types or some combination of the three, it’s a struggle to arrive consistently at the best price using outmoded tools and processes. Solving this puzzle requires data science, advanced price management and deeper customer/product segmentation capabilities.
Digital transformation is here, and the ones to succeed in modern manufacturing will be those who put pricing at the forefront of their evolution.
