1.4 Pricing Challenges and Six Sigma Pricing
There are many challenges pertaining to pricing processes within the company that cause "defects" by way of excessive discounts or excessively high prices, sometimes even to the same customer. Excessive discounts hit the top line and bottom line of the company directly. Excessive realized prices may appear attractive to the company, but customers eventually do find out if the seller has charged different divisions markedly different prices for the same product or has offered other customers higher discounts without clear explanation. These customers affect revenues by either leaving or decreasing their business, or they affect profitability and price by negotiating for extra discounts in future transactions.
Defects in pricing can be detrimental to a company's growth prospects in the long term as well. Band-aid solutions that do not fix the cause only worsen the situation. Negative experiences feed customers' perceptions that a company is difficult to work with as a partner. The occurrence of defects erodes confidence among stakeholders internal to the company as well. For example, pricing and sales personnel may offer extra discounts if they are not sure about the validity of a price point when customers complain, thus eroding margin.
Business strategy developed in the boardroom might be brilliant, but poor execution means poor results in regard to realized prices or profitability. Senior managers may feel they do not control prices because of external market factors. However, they can bring about internal discipline to control several internal factors that contribute to the gap between strategy and execution.
Six Sigma Pricing can provide this internal discipline. Even if a company applies Six Sigma Pricing to pricing operations and to transactions, shared understanding of the pricing-related roles of different groups and individuals helps in strategic pricing as well.
Let us first look at challenges that relate to pricing and pricing processes. It is these challenges that engender price-related defects.
Challenge 1: Interfunctional Divergence
Usually, processes within a single function or even across two functions tend to have good controls. Whenever we have more than two functions, it may be the case that the functions do not have the same perception of the process or its objective. This is the case with pricing processes in marketing, finance, sales, and product management because of overlapping roles and ownership, at least in the members' perceptions.
Stakeholders in various functions and levels within the company do not necessarily have the same objectives. Salespeople compensated on sales volume want flexibility in pricing so they can increase volume wherever there is an opportunity to do so. Marketing people are the brand builders guiding the value of a product. This can put them at odds with sales personnel who might think the list price (or proposed contract price) is too high to bring in large volume. Pricing personnel may use their analysis to present their view that the proposed transaction price or proposed contract price is too low relative to existing similar products. Finance personnel may raise questions regarding why realized or proposed prices cannot be higher than their current values.
The pricing function attempts to impose controls on prices to focus on overall pricing. However, different functions may have incentives to bypass these controls when it does not suit their objectives or their view on what would benefit the company in the future. Senior managers who could resolve these interfunctional conflicts may not be close enough to the operational level of pricing in many companies to intervene every time. Unresolved issues render price controls in these companies ineffectual and the processes ad hoc.
Pricing-related processes are also ad hoc in many companies because there is lack of a shared understanding of the role of pricing and of pricing processes. These companies have not paid much attention to pricing as a function. Therefore, results that a company obtains are not necessarily commensurate with the investments made in hiring senior-level pricing managers and in implementing pricing software technology. Use of technology in environments where interfunctional divergence is reflected in poor controls on pricing and in poor shared understanding of the pricing process is only an ill-conceived panacea.
Still there are industries with pricing operations expertise, for example car rentals and airlines, that have learned to consistently extract positive, if lean, margins even in bad times. The good news is that in other industries, attention to pricing operations is growing. Some companies now have managers and directors of pricing strategy, even Chief Pricing Officers. The number of consulting firms and pricing software companies grows by the day.
Six Sigma Pricing can focus this attention to help the different stakeholders understand pricing operations and bring different functional perspectives together. It uses data and facts to provide a framework to review and design close-looped processes.
Challenge 2: "The Customer Is Always Right"
A customer-focused company always looks for better ways to serve its customers. However, being customer-responsive is not the same as being customer-focused. Customers want quick turnaround on pricing decisions, and there is no reason why it should not be so. But, when a company has tens of thousands of transactions a year, this can create pressure to lower the price in two ways. If a company does not have solid pricing processes, its personnel may give in too easily and too quickly to requests for lower pricing for a particular single transaction, or worse, over many transactions by improving contract terms.
The "need-for-speed" in responding to the customer can translate into putting aside any due process for a transaction or putting aside any consensus-building efforts around a contract's terms. The customer's assertion of the price being "wrong" or too high can go unchallenged in this situation in the absence of any fact-based analysis.
There may have been a genuine case of a wrong price in the past. System glitches, changes in personnel at customer or vendor location, changes in competitive offering, and miscommunication are among many other known problems that exist in a business environment. Sometimes a customer learns of another customer receiving an inexplicably low price from the vendor. When a sales representative is not sure of the problem source, either scenario spurs a discussion around dropping the price in the interest of keeping the customer happy.
In the absence of a systematic framework, being responsive to the customer invariably leads to the customer extracting a lower price or less favorable terms from the seller's viewpoint. Six Sigma Pricing provides for a fact-based systematic decision process that leads to consistent prices and a focus on the customer's needs rather than always simply lowering prices to be "customer-responsive."
Challenge 3: Continual Internal and External Changes
Pricing is complex also because of its sensitivity to the continual changes in the internal and external environment. Internally, a company may have seen turnover or may have brought in new leadership, resulting in changed policies. Every changed policy can entail changes in pricing processes, and the company might not train everyone in the new process.
Externally, economic cycles or massive changes, such as the 2005 oil-price increase, change customer needs and drive the company's response. External events like mergers and acquisitions have internal impacts. For instance, existing IT systems and legacy processes with specific customer accounts or products (owing to a merger with another company for instance) make controls difficult because of integration-related challenges.
Even in stable environments, many companies make unnecessary changes in processes and organizational structure that create undesirable variations in the output of their processes, particularly in the pricing. As with manufacturing or service processes, "variation is evil" for pricing processes as well.7 This is because the variations resulting from inconsistencies in pricing decisions lead to highly varying prices with low overall levels. Setting the price or discount for any transaction or setting terms for any contract should be a repeatable and consistent process—having variations can only lead to "defective" prices that are too high or too low. Companies need to appreciate that pricing processes should be consistent and repeatable, not just for transactions or standard contracts, but also for one-off deals for customized products.
Six Sigma Pricing can help bring control to operational processes to design and redesign transaction-level pricing processes. After all, the process to change processes is a process too and one that should be repeatable even in a dynamic environment.
Six Sigma Pricing assists in standardizing the pricing process. It helps ensure that the flow of communication from the customer to the salesperson through pricing and IT systems is smooth and timely and occurs in a closed loop system with controls that include defined exceptions for flexibility. Having standardized processes also helps with contingency planning if something were to go wrong. Standardization helps decrease inconsistencies in pricing while allowing the flexibility salespeople need to pursue sales opportunities and to close transactions profitably.
Challenge 4: Management by "Gut-Feel"
Managers may make pricing decisions based on their intuition (informed by vague memories of demand curves in Economics 101), and drop prices to increase unit sales or increase list prices to increase dollar sales. Such thinking is not wrong on a fundamental level, but the devil is in the details of execution: How sensitive is the "market" to price changes in one particular transaction? After all, an increase or decrease in list prices is one thing, the ability to realize a proportional change and desired result over thousands of transactions is quite another.
When dealing with a customer's influence on pricing, wouldn't we have more confidence in each situation if we knew the customer's purchase history, geographical location, and discount levels before addressing the customer's needs? Likewise, proposing large discounts to customers based on gut-feel about "tough times" would be on a more solid basis if such proposals were additionally based on analyzing the impact on profitability—vis-à-vis the likelihood of losing such sales.
Six Sigma Pricing helps supplement a decision-maker's gut-feel with fact-based evidence and analysis. Data-driven and fact-based evidence can take the emotion out of meetings where everyone has a different gut-feel. Doing so also results in consistent execution regardless of who is making the decision.