Chemical pricing strategy is key during an upturn

Prepare your pricing

10 November 2009 16:12  [Source: ICB]

As the economic recovery gets under way, companies tend to focus on volumes. But pricing strategy is key for packing a greater punch

Consultant's Corner:
Andrea Maessen, Simon-Kucher & Partners

Rex Features/Chris Eyles

THE GLOBAL economy is showing increasing signs of recovery. Demand is picking up and raw material costs are on the rise again.

The good news is that volume seems to be improving, even if the recovery is still slow and fragile. The bad news is that raw material prices are rising as well. Crude oil surpassed the $80/bbl mark in November, the highest level in 12 months.

The challenge in pricing now is to turn this "bad" news into an opportunity without endangering volume recovery in the market. Here are some recommendations to meet the challenge.

ADJUST CORE PRODUCT PRICES
Of course, adjusting prices for core products is the most difficult and dangerous - difficult because core products show the highest price awareness and sensitivity; and dangerous because price increases may not be followed or accepted by the market.

To avoid a loss of credibility or in the worst case a volume loss, price adjustments need to be planned carefully.

First, make clear that these adjustments are needed to recover margins. A price increase of 3% for a core product requires an equivalent price increase of 10-15% for noncore products to achieve the same effect.

Second, ask yourself how your customers will react to the price increase - without bias. Not all customers are willing and able to switch suppliers, neither in the short nor in the long run. This is especially true if you take into account the most probable reactions of your competitors to your price moves.

If your competitors are facing similar margin challenges - which most of them do today - they will need to take measures too. In recent projects, simulation analyses revealed that markets are much less elastic than expected.

Once the price shifts are planned and targets are fixed, they need to be communicated internally and externally, and backed up with a strong rationale.

Raw material cost increases might be the reason for the price adjustments, but they are not the cause. Margin recovery is the prime objective and, subsequently, the return to price levels that reflect the value of your products (and services). The message has to be crystal clear. We often hear directives like: go for price increases, but don't lose volume. Such mixed messages from the management will dilute any price increase effort and weaken the price execution. Therefore, management commitment and guts are crucial at this stage.

ALIGN NONCORE PRODUCT PRICES
All noncore products side and complementary, or niche products, show a lower price awareness and sensitivity than core products. Over-proportional price increases for all noncore products are feasible (compared with the core products). For noncore products with insufficient profitability levels, over-proportional price increases are mandatory.

Price alignments of noncore products are typically an underestimated source of margin potential, especially in large product portfolios. They provide a chance to establish a more consistent price structure and logic with highly plausible lines of argument.

SRENGTHEN PRICE EXECUTION
The implementation of a price increase is the moment of truth in pricing. Successful price execution strongly relies on the price confidence of the sales teams. And what is needed to achieve high levels of price confidence?

First, make value propositions and value arguments clear to the sales teams. Link the product features to performance levels and performance levels to customer benefits. Prepare your value arguments in absolute as well as in relative terms compared to your competitors.

Some of our clients use spreadsheet models that allow an estimation to be made of the economic value created for the customer by using their products. They integrate competitive alternatives as reference points to quantify and communicate how much more money the customer will make with their product than with the alternatives.

To what degree do your products increase process speed, reduce maintenance intervals, or lower labor costs? How much value do you add in terms of quality, usability, or effects to your customer's end-product or to the products further down the value chain? These are questions that sales teams have to be able to answer concisely and on the spot.

Second, introduce decision support tools for large account negotiations that help the sales managers fully understand the true balance of power and the mutual dependencies.

A comprehensive assessment of the customer's value to the business and the business's position at the customer is needed. How stable and relevant is this customer's volume? What are their alternatives? How big are the switching costs? And is it worthwhile to fight for volume if you are in a No. 3 or 4 position, and just serve as a vehicle for your customer to put pressure on their key suppliers?

Structured deal preparation and the simulation of potential reactions from the account and the competitors help companies to stay firm and pursue the price targets.

Use value-added services to reinforce the targeted price increase and trade-off price concessions if needed. Avoid the procurement trap that disconnects the value delivery and value capturing at your account.

To bridge the interface between those who use the services (value delivery) and those who have to pay for them (value capturing), lists and classifications of services help to shed light into the "black tunnel" of services.

Typically, sales teams are not fully aware of the value (and cost) of all services and extras that the organization provides to the customer.

Some of Simon-Kucher & Partners' clients use service price lists as a device to support their arguments. They include charges for rush orders, charges for order changes or cancellations, charges for special product tests, charges for renting instruments (such as dispensers or measuring instruments), charges for (excessive) sampling or for training - just to mention a few. The service price list enables sales managers to argue the value delivered, thus defending price targets or trade-off services against price concessions.

A JOINT EFFORT
Price increases are needed for margin recovery. They are feasible if thoroughly planned and prepared. And their implementation will be successful if the sales team has the strength to stand the heat.

Management must show determination and the sales team needs to be confident. Both need to be disciplined.

For managers, disciplined means to stick to the targets and manage the risk. For the sales team, disciplined means to stick to the rules even if this means losing a friend.

It is a joint effort for both management and sales teams. Of course, this is easier said than done. But it is in fact what draws the line between being "good" and being "great" in pricing.

Andrea Maessen is a partner with consultancy Simon-Kucher & Partners where she leads the chemical division. She has more than 10 years' experience of helping organizations to optimize their pricing strategies and processes.

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