Understanding—and Leveraging—the Human Side of Pricing
Price lies at the heart of the buyer–seller interaction, and an inherent conflict exists between a company's desire for long-term customer relationships and its effort to get fair value for its products and services. Most organizations encourage their sales teams to build strong relationships and to know their customers on a personal as well as a professional basis. Unfortunately, these bonds often become ends unto themselves, obscuring their original purpose, which was to establish profitable, long-term customers. Companies must continually analyze customer interactions at the transaction level and determine the value to both them and their customers. By understanding the worth of a product to buyers, a manufacturer can better differentiate its offerings from the competition. Similarly, by quantifying the buyer's value to the company, the company can decide which relationships warrant investment and which should be treated as opportunistic transactions. Both analyses contribute to a balanced, healthy customer portfolio.
A key driver of the buyer–seller relationship is sales force compensation, because poorly aligned incentives result in weak margin performance.
Consider the experience of a medical device manufacturer that compensated its sales team by unit volume. The products were new and evolving rapidly, so the company pushed for high rates of market penetration. Competition was fierce, and, for the sales team, getting buying groups to choose the products carried nearly as much weight as physician preference. Critically, compensation was entirely volume driven with no cap placed on sales earnings. The more you sold, the more you earned. The results were predictable: the sales team constantly pushed for prices to be reduced to challenge the competition.
At one point, as prices continued to fall, senior management actually believed a competitor had discovered a cost or manufacturing advantage. In reality, the company (the marker leader) should have looked at the behavior of its sales team: it, not a competitor, was driving the perceived price war. Eventually, a careful analysis of the situation led to an important policy change. Margin was included, for the first time, as a key compensation metric. This single change quickly altered sales behavior, and the decline in price began to level off almost overnight. Unfortunately, two other consequences of the volume-driven compensation policies were not so easily remedied. First, customers, taking advantage of every new price discount, had purchased supplies to last for years. Future sales had been pulled forward, skewing demand elasticities. Worse, buyers had been conditioned to expect that every sales visit would result in fresh price reductions. The situation took years to reverse. New products were affected by the effects of the earlier price war, while the existing product set suffered from chronic low profitability. The unintended consequences of a misguided focus on volume were far reaching, long lasting, and severe.
Another human challenge for pricing involves countering the tactics customers use to drive down price. Strategic sourcing is a practice that has been in existence for decades. Today, every well-performing company follows this approach to achieve the best possible price when purchasing goods and services. If you are a manufacturer, it is likely your sales force has been subjected to painful interactions with procurement agents who know and have quantified every aspect of their relationship with you as a supplier. Consider how often a member of your team has been hit with a variation of the following comment: “I know we don't buy large volumes of this particular product, but our aggregated spend across your portfolio is well over $100 million. We therefore expect a 5 percent price reduction across the portfolio for this, and every subsequent, year. After all, our volume is helping you move down the cost-experience curve, and we should reap some of those benefits.”
The flip side of strategic sourcing is understanding what drives profitability at the transaction level with a particular customer. Firms need to arm their sales force with the information that lets them counter the traditional procurement approach. In many cases, they may still be able to provide that 5 percent discount while actually improving margin performance.
In general, successful pricing management requires a company to build the right sales team and to provide it with the correct training and tools, while aligning compensation with the desired outcomes. Once again, the need to take an integrated approach to pricing is obvious. A company can create the best, most optimally priced offering in the world, but if its sales force cannot execute it (or worse, the company's compensation structure incentivizes its salespeople to negotiate outside established guidelines), then the company's investment in price-setting capabilities has been wasted.