Why Manufacturers Should Take a Lean Approach to Pricing
By Barrett Thompson | Industry week
It’s well-established that manufacturers who follow lean principles create significant profitability improvements over time, all while meeting and exceeding customer expectations. From production line workers to the board of directors to sales and marketing, everyone in an organization can benefit from adhering to lean principles. However, those improvements aren’t always evident when the P&L is tallied.
The reason? Poor pricing methods, which result in over-discounting, effectively transfer the incremental profits from lean activitiesaway from the company and into the pockets of their customers.
Ironically, the solution to this problem is so close that it’s often overlooked—apply lean principles to your pricing process. For instance, treat every price as a “part” and work to decrease your defect rates, or in this case, sub-optimal pricing decisions, as you “manufacture” these prices. Look at the quoting process with an eye towards identifying and eliminating waste.
Building the Case
According to a research survey conducted by AlixPartners, LLP, 60% of the surveyed executives expect that of the savings made from lean manufacturing, only half will be sustained in the long term. Consequently, leading manufacturers are realizing that the gains they aspire to create through lean activities can only be fully realized by applying lean principles to how their products are sold. The reason is simple: The price charged when your product is sold to the channel or direct to end-customers has a tremendous impact on profitability. Each time you over-discount your price, you introduce waste into the pricing stream. And just as in the plant, small improvements in waste reduction for price add up to big results.
Consider this: How many widgets do you manufacture in a year? Let’s say 15 million. In that same time, you “manufacture” millions of prices. These prices go out on quotes and in price lists. Could it be you’re investing heavily in the product quality and the production process, yet failing to invest in getting the highest quality price possible?
This is an uncomfortable reality that many businesses don’t want to acknowledge, but it explains why some manufacturers have seemingly good results from localized lean initiatives yet fail to realize any sustained improvements in their overall P&L performance. In other words, gains made in the plant are given away in the field.
Waste in Pricing
The lean methodology of process improvement defines several classical forms of waste, a few of which are particularly acute in pricing. Manufacturers from a broad range of industry verticals are facing similar waste challenges in pricing. Consider these parallels:
Defects—output that is not correct and must be disposed of or reworked. Consider the process of setting prices within a company. Now, consider the final, or realized, price that is ultimately paid by the customer. Often times, they are quite different. Sales reps either ignore set prices that are irrelevant to the selling circumstance or they must send quotes through an approval process to be reworked. In either case, putting prices in market that require lengthy reworking or are disregarded altogether is extremely wasteful.
Motion—people doing more work than necessary to accomplish a task, especially moving between information sources. In most cases, sales and pricing people must perform extra work to complete their analysis before setting a price. They will spend anywhere from a few minutes to hours consulting in-house databases, looking at historic charts and graphs, and punching values into a spreadsheet to model various price alternatives.
Waiting—people not contributing because they are waiting for work or information. The bane of most pricing processes is the lengthy turnaround to receive a quote. Given that prices lack specificity to the deal circumstances to begin with, both sales reps and customers often have to wait several days for an approved quote. This inefficiency creates more waste in the business.
A More Progressive Take on Pricing
How, exactly, does lean pricing reduce waste in pricing? It employs two breakthroughs in pricing science which have occurred in the past 10 years. First, lean pricing approaches require knowledge of B2B price elasticity, which quantifies how individual customers will respond to price changes. Second, lean pricing uses optimization models embodied in software to make surgical adjustments to prices based on elasticity and business objectives, such as revenue growth, profit growth, or both.
The view that price optimization is too complex or rigid to facilitate lean principles has changed. Today, companies that rely on forward-looking predictive models to set prices are able to identify and reduce wasteful pricing processes while reducing over-discounting in every micromarket. This is achieved by simplifying and optimizing price guidance, ensuring rapid and measurable deployments, and providing a flexible and cost-effective optimization approach.
Although its roots historically lie in manufacturing operations, lean is a business philosophy that can be practiced in all disciplines of an organization, including pricing.