Before taking pricing action manage discounting
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
TL:DR Before taking pricing action manage discounting
Raising prices without managing discounting is like pouring water into a sieve.
Diagnosis
Prepare a price dispersion graph, plot the correlation coefficient, look for clusters above and below the line
Dig into the clusters using the pocket price waterfall as a diagnostic tool figure out why there are price leaks
Document all the reasons given for providing discounts
Treatment
Create a system of reasons for giving a discount (implement in Ibbaka Valio, your CRM or your CPQ)
Develop discounting guidance and rules, including both maximum discounts and target discounts
Support sales with tools and training to help them use value rather than discounts as a way to close deals
To manage discounting understand why sales offers discounts
Many companies are under pressure to take pricing actions in 2023. Investors want higher prices. Customers want price relief during a recession. Inflation is causing some people to raise prices while customers are becoming more cost conscious. There are a lot of moving pieces to consider, but the first thing to do is not to change prices but to take a look at discounting.
Before taking any pricing action, take a look at how you are performing on discounting.
Changing pricing before getting discounting under control is like pouring water into a sieve.
How do you get control of discounting?
Understand the extent of the problem by looking at price dispersion
Find the leaks using a pocket price waterfall
Understand the reasons for price discounting
Set up discounting guidance
Provide a system for offering discounts
Provide guidance on target and maximum discounts
Set up sales to succeed
Support sales with training and sales tools
Give sales the right incentives
Understand the extent of the problem by looking at price dispersion
The best way to do this is to create a pricing dispersion chart. The Y-Axis is the price actually paid and the X-Axis is the volume as measured by the pricing metric.
The line in this graph is based on the R Squared correlation coefficient. It this case, volume predicts about 70% of the price. This is a bit low, but in fact much higher than what we see at many companies.
Looking at the curve and the correlation is not enough. You want to know if there are groups of customers that are systematically getting higher or lower than expected prices.
One question we have learned to ask is what tier is driving the variance. Is there more variance amongst smaller customers or larger? We see both patterns. Some companies have a lot more discipline with their larger customers and there is more variance with smaller customers. Other companies are very strict with small customers but are willing to negotiate discounts for larger companies. This is an important diagnostic tell.
In the above figure there are some clear groups. The cluster in ‘red’ are all beneath the curve and are dragging average pricing down. One needs to ask why this group of customers is paying less than other customers that are getting the same thing.
Then there are some smaller clusters above the line, colored green. These customers seem to be paying more for the same thing. Are they getting something extra? Or are they just not as good at negotiating.
Some companies have multiple price metrics that combine to generate the price paid. In this case there are several ways to approach the price dispersion analysis. One could look at each pricing metric independently. Sometimes almost all of the variance comes from just one of the metrics. In other cases, two metrics can interact to cause the over/under patterns. With pricing, the details matter and averages can be misleading.
Find the leaks using a pocket price waterfall
There can be many reasons why prices fall below list prices. The classic way to analyse this is with a pocket price waterfall. The price waterfall starts with the List Price and then deducts all of the different discounts and rebates that chip away at the pocket price, the money that you get to put in your pocket after all of the on invoice and off invoice discounts, rebates and concessions.
Nathan Phipps has a good article on this in the Wiglaf Journal that is worth a careful read (the above image is from that article).
Understanding what is causing the price leaks is a good first step to seeing how to plug the leaks. And you need to plug those leaks before you invest in raising prices.
Understand the reasons for price discounting
There are many reasons for discounting. One of the best ways to get discounting under control, and to show sales that you respect their challenges, is to create a list of reasons for why discounts are being given. Here are some of the reasons we often hear from sales.
We need to discount to close the deal.
The competitor offered a lower price.
The buyer expects a discount.
relatedProcurement needs to show it is negotiating prices.
The price is too high for the value we deliver.
We don’t yet deliver all of the value we promise.
The economy has changed and buyers need lower prices.
We need to make an investment in this … customer, segment, geography.
On that last point, discounts can be seen as a type of investment, but one only makes an investment with an expectation of a return. So when sales describes a discount as an ‘investment,’ it is fair to ask when and how we will see a return on that investment.
In some cases sales is not sure why it is offering a discount. It has become a habit. We often see sales teams that offer discounts before a buyer requests them, giving away revenue and margin.
The price dispersion graph can also help you understand why discounts are being granted. That is why we start our analysis with this graph. Be sure to look at three things on this graph.
The shape and slope of the curve
Differences in variance across the curve (is there more discounting with large or small accounts)
Clusters above and below the line
Understanding the reasons for each of these phenomena gives deep insights into the reasons for discounting.
Set up discounting guidance
Provide a system for offering discounts
The best way to manage discounting, reduce variance and even to reduce overall discounting, is to have a system. The system is built on the acceptable reasons for providing a discount. These will vary by company, category and strategy, but some of the reasons we often use are as follows:
Align value to price (this is generally done by removing functionality the customer does not value and reducing price accordingly)
Make an investment in a customer or category (but only make an investment if there is a clear path to getting a return on investment)
Provide sales with some ‘gives’ that they can use in negotiations (the gives should not be limited to price discounts, also have a portfolio of value enhancers that can be offered)
Match a competitor price for equivalent value
Provide guidance on target and maximum discounts
Sales people will want to be able to provide discounts (for any of the reasons identified above) and good sales people need some agency, they need to feel that they have control over the sale and how it is negotiated. Overly rigid discounting policies are often counterproductive as sales finds a way around them or the system becomes riddled with exceptions, leaving you back where you started.
The best practice here is to provide sales with both guidance and a target.
Set a limit for discounts that can only be exceeded with manager approval. Set another limit that requires leadership approval.
These limits should be higher than the target discounts. Also set a target that is meaningfully lower than the limit and then incent sales to meet that target. Sales people are generally competitive and want to collect all the incentives they can. Rather than putting them into a straightjacket, motivate them to reduce discounting.
Set up sales to succeed
One reason that sales defaults to discounts is that they have not been given the tools they need to sell value. The best way to encourage sales to reduce discounting is to give them the knowledge, skills and tools they need to sell on value.
Give sales value-based sales training
To get discounting under control give the sales team value-based sales training. This means making sure that they understand, believe in and can communicate the value story. They will also need support in handling objections and in knowing when to scale back an offer to match the value the customer is willing to pay for. One may also ant to equip sales value incentives, a set of incentives they can offer instead of discounts.
Provide sales with value based selling tools
Training alone will not be enough. Sales will also need tools. This is where platforms like Ibbaka Valio come in. Value models can be too complex to use in the sales process and they need to be transformed into value stories.
Ed Arnold has done some very good work on this, see How to write a compelling value story.
Give sales incentives
Sales people respond to incentives. This is why we recommend having both maximum allowable discounts and target discounts. Sales should be incented to meet the discounting targets and not for keeping discounts within the maximum. An alternative approach is to compensate sales based on gross margin rather than top line revenues. Technically this is a better approach but it can be more difficult to explain to the salesforce and administer.