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Performance Based Pricing
and Discount Structures
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Performance Based Pricing
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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.
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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…
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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.
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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?
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Discount Structures
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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?
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If the discount encourages efficient customer
behaviour:
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does the value of the discount match your cost
saving associated with the improved behaviour?
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does the discount have a strategic driver?
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or do you need the discount to drive the behaviour
or will the customer behave that way anyway?
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If the discount is to stimulate sales:
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do you know the return (extra sales $ per discount
$)?
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are you happy with the return on this particular
type of discount compared to other similar discounts?
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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?
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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:
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Defendable
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Transparent
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Pay for performance
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Encourage efficient product movement
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Reduce cost through the supply chain.
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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.
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