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Performance Based Pricing and Discount Structures

Performance Based Pricing

The market place determines price - right? Well yes, but if you can't make a profit at the price should you be there? But .. if your product has unique value attached to its brand or its attributes, sure you have to compete but you may have priced to deliver less of a profit than you expected or than the product deserves.

 

There are a number of "prices" for a product (see insert) due to the application of different trading terms, discounts or payments to customer. These typically vary across customers and products. Do you know which customers receive what discounts and how much they get? Most companies report Off-invoice (off list price) discounts by customer as these are captured in transactional systems when the invoice is generated. Some report rebates by customer, but most companies admit that not all rebates and particularly trade spend (such as co-operative advertising) is known or reported by customer. Often this information is spread out across an organisation and stored in separate data sources. Without understanding the effective available income across your customer base and products chances are you are making the wrong pricing decisions…

 

Figure 1 illustrates a typical company where, generally speaking, customer's price decreases as the customer's turnover increases, meaning the largest customers receive the highest discounts. The illustration identifies two 'problem' customers. One customer buying low volumes but receiving above average discounts for it's size and two of the largest customers receiving well below average discounts. While in this case the small customer may not have sufficient turnover to affect the market price, if the large customer 'wised-up' to it's high relative price the impact could be large. The desire for transparency and equitable pricing is understandable for some customers and the risk of punitive claims is real.

 

An additional indicator of pricing equality is to consider Cost to Serve compared with the discounts given away by customer. A high efficiency discount can be justified by a low Cost to Serve. Figure 2 illustrates two clusters of customers that raise concerns. A group of customers receiving relatively high discounts but being relatively expensive accounts to do business with, while the other group is the opposite. Are the discounts at play in this example paying their way?

Discount Structures

Giving discounts may be the same as just giving money away. Either discounts pay their way, or they are costing you. Does the discount encourage efficient behaviour by our customers or does it stimulate increased sales?

If the discount encourages efficient customer behaviour:

 

does the value of the discount match your cost saving associated with the improved behaviour?

 

does the discount have a strategic driver?

 

or do you need the discount to drive the behaviour or will the customer behave that way anyway?

If the discount is to stimulate sales:

 

do you know the return (extra sales $ per discount $)?

are you happy with the return on this particular type of discount compared to other similar discounts?

Every discount should have a clear purpose. Some discounts are historic or 'feel good' and are likely to have lost any impact they once may have had - is it on to keep giving away the money?

Typically discount structures are, at best, based on outdated cost structures, more commonly they have been based on historic deal making and bear little resemblance to the costs/benefits to which they relate. Do you have, for example, a Warehouse Allowance for centralised distribution with a major grocery customer? Chances are this discount far exceeds the costs you save utilising their centralised distribution network. What would happen if another major customer decided to adopt centralised distribution too?

Understanding Cost to Serve is a prerequisite for implementing cost based pricing and discounts. Cost based pricing relate discounts or trading terms to activities that customers can control, providing an incentive for customers to maximise their discounts while driving costs out of our business. Basing discounts on cost savings resulting from behaviour changes reduces the risk of giving away too much discount. By adopting this approach trading terms are:

Defendable

Transparent

Pay for performance

Encourage efficient product movement

Reduce cost through the supply chain.

A problem with introducing a new discount, say for full pallet orders, is that the discount has to be given to everyone who already qualifies. No customer behaviour may change, so no savings, but the discount dollars will have to be paid. Our approach is to scenario model the situation to arrive at a good balance of discounts, by value and mix - a balance that pays its way.

AdvisorBase is experienced in calculating cost based discounts such as full pallet picks, account settlement, ullage and volumetric terms. The AdvisorBase methodology employs scenario modelling so you can test the sensitivity of new trading terms regimes and reduce the uncertainty associated with changes of this nature. Using our coached project approach you can undertake price and discount analysis in-house under our direction.