Insights

Avoiding The Vicious Cycle Of Pricing

While working on a growth strategy assignment with a major business-to-business supplier, we observed several fascinating contributions that emerge from effective strategic account relationship management.  Our client learned that a competitor had delivered proposals to three of its largest accounts, offering to “buy the business” with incredibly aggressive pricing.  Not surprisingly, these three customers asked our client for a response.

One of these customers was a long-time account, and the supplier->customer relationship was characterized to be at the Extended Enterprise Tier[1].  The strategic account manager working with this customer gained joint agreement to bring teams from the two organizations together to define cost-savings ideas. The goal was to identify cost-saving initiatives that would yield at a minimum the same bottom-line benefits promised by the competitor’s proposal.  Two meetings were held, one at a supplier facility, and one at the customer’s largest factory.  The working teams developed 17 action plans to reduce costs through collaboration by redefining the roles and boundaries between the two firms.  About half of these ideas were unique to the businesses involved and the product lines sold by the supplier to this customer.  The remaining ideas were ones that could be applied in many other settings, as suggested by the examples in the following table:

 

Action Plans for Taking Costs Out of the System
Coordinated Logistics – to eliminate empty backhauls associated with about 30% of the supplier deliveries to two of the customer’s facilities
Transparent Customer Service – customer access to the supplier’s customer service system to eliminate an estimated two person-years of effort spent in “asking and answering questions about order status and delivery”
Supplier-Provided Maintenance – at four facilities where supplier personnel could do routine, preventive, and corrective maintenance on equipment used by the customer, eliminating the need for a third-party maintenance contract
Standardization of Installed Systems – to ensure that all of the customer facilities used the same generation of the supplier’s systems, reducing parts inventories by over 20% and streamlining service operations
Coordinated Forecasts – linking inventory management systems to provide near real-time information on demand, projected to reduce necessary safety stock levels by 8%
One-Look Quality Control – integrating the two companies’ processes to avoid duplication and back-and-forth debates associated with product acceptance, reducing costs in this area by nearly 35%

 

The ideas developed by these teams were given a “sharp pencil” review and were especially evaluated in terms of implementation feasibility.  By and large, the action plans emerged intact from this review.  The outcome was a major win.  The identified cost savings far exceeded the price cuts offered by the competitor, by enough that both firms achieved margin improvements as a result of the process.  The value of the strategic account relationship was clearly recognized by both firms involved.

This same supplier tried to take this same concept to the other two firms at which it was facing price-based competitive challenges.  Both of these customers were relatively new customers, and the supplier->customer relationship was largely transactional.  In one case, the customer rejected the concept and gave the supplier two weeks to “match the market” or lose the business.  The decision was made to restructure the contract with this customer, and, while the business was retained, the attractiveness of this customer relationship was substantially reduced as the supplier’s margins dropped below acceptable levels.  In the second case, the customer agreed to try the concept, but the two teams basically failed to get beyond sparring with one another about service and delivery issues, and failed to surface any action plans on which they could agree.  Shortly after, the supplier lost this business to its competition.

The Vicious Cycle of Pricing

The latter two situations reflect the “vicious cycle of pricing” that impacts upon so many business-to-business suppliers, as illustrated in the following diagram:

In this vicious cycle, one round of price-based competition invites the next, and the pressures of this cutthroat environment make it less and less likely that the downward spiral can be halted.  The actions taken in this environment are all too familiar to many suppliers trapped within the cycle:  reduced spending on product development, elimination of services, pressures on channel partners to accept lower margins (leading them, in turn, to eliminate services), cutbacks in account management and customer service organizations, a redirection of resources to “new markets”, neglect of the supplier’s brand.

Fortunately, the vicious cycle of pricing is not inevitable, as illustrated by the supplier’s success with its strategic account in the case study presented earlier.  The lessons from this case, however, are complex and go far beyond the initial conclusion that strong strategic account relationships facilitate a defense against price-based competition.  We believe that there are two important additional lessons that emerge from this case history.

 

 

Lesson One:  Price is Always Important

First, price is always important.  It will always be a visible and important part of the business relationship between a supplier and a customer.  An important part of the long-term plan for the  customer relationship – and therefore an important part of the strategic account executive’s job – must be focused on pricing.  In the course of the Whatever Happened to Growth? research project[2], we asked participants to identify how important were various factors in the purchase decisions of their strategic accounts.  They were asked to identify the relative importance of product, services, business systems, brand, and the overall relationship, in addition to price.  Only for a small number of strategic accounts was price viewed as “Of Little Weight”, given an importance of 15% or less in the decision criteria.

Even among some higher Tier account relationships, price was identified as among the key factors driving decisions.  Stronger strategic account relationships do not make price disappear from among the critical success factors.  Rather, such relationships provide an opportunity to address the importance of price in a constructive fashion as part of the relationship strategy.

Our research into business-to-business strategy has identified distinct strategies that can be used to address the reality of pricing.  One such strategy is suggested by the case study above:  identify and implement action plans to “take costs out of the system” through collaboration and via shifts in the roles and boundaries between the supplier and the customer.  Our research suggests that achievements in terms of all three of the key relationship management competencies[3] are necessary for this strategy to succeed.  Progress in terms of the Relationship Competency is necessary to produce the knowledge base, confidence, and trust necessary to identify and agree on the types of action plans suggested in the case study.  Strong Implementation Competency skills are critical to success, as these types of action plans often require proactive process changes and effective execution of new responsibilities.  Innovation Competency skills are necessary, as creatively finding cost-saving actions gets harder and harder as the journey continues.

We have developed several assessment tools to help identify the salience of pricing within strategic account relationships. In addition, we have developed growth strategy recommendations as to how suppliers can address the pricing realities of these business environments.  Examples of such assessment factors and strategy recommendations from among the many distinct pricing environments are suggested in the following table:

 

Characteristics of the Business Environment Associated with the Strategic Account Relationship Probable Salience of Price Strategy Opportunities
  • The customer is in a commodity market with little price flexibility and intense margin pressures.
  • The products and services sold by the supplier are largely undifferentiated.
  • The products and services sold by the supplier do not drive labor (or other costs) within the customer’s own manufacturing process.
Very High Salience – Expect Ongoing Pricing Pressures Achieve low-cost supplier status, develop low-cost channels and logistics systems, and identify ways to eliminate costs associated with product attributes and services that don’t create value for the customer.
  • The customer is in a commodity market with little price flexibility and intense margin pressures.
  • The supplier’s products and services only account for a very modest portion of the customer’s cost structure.
  • The customer’s labor (and other) costs associated with the use of the supplier’s products and services are significant.
High Salience – Expect the Customer to Develop Strong Cost Management and Supply Chain Management Competencies Develop products, services, and business systems to gain productivity enhancements and reduce life cycle costs.
  • The customer is in a less price sensitive market with the potential for differentiation.
  • The supplier’s products and services represent a significant fraction of the price of the final product, keeping the supplier under the spotlight.
High Salience, especially when the Customer Faces Margin Pressures as a Result of a Weak Economy or Other Factors Extend the relationship beyond the purchasing organization, and develop a strong ‘ingredients brand’ preference on the part of the customer and (where possible) on the part of the end customer to strengthen sales and prices of the customer’s product.
  • The customer is in a less price sensitive market with the potential for differentiation.
  • The supplier’s products and services only account for a very modest portion of the customer’s cost structure.
Modest Salience – for Suppliers that Work to Avoid the Vicious Cycle of Pricing Build a strong relationship with the customer to achieve ‘breakout’ joint product differentiation and competitive advantages through innovative business relationships and systems.

 

Lesson Two:   Relationships Can Be Differentiated

The second lesson that emerges from the success story within the earlier case study is that relationships, not just products, can be differentiated.  This statement – an obvious truth to some strategic account managers – has been overlooked by many organizations.  We find proof statement after proof statement, from companies whose products are identical to those of their competitors, but whose relationships are impervious to competitive assault.  The results from the Whatever Happened to Growth? research project again provide support for this assertion:

Stronger-Relationship-Management-Competencies-Are-Linked-To-More-Stable-Account-Relationships

These findings suggest that firms with stronger relationship management competencies face fewer competitive challenges.  These competencies have created a differentiated relationship.  Through such differentiation, these firms are able to avoid the vicious cycle of pricing.

Our experience suggests that relationship differentiation is an ongoing process, an endless racetrack.  It requires constant attention to identify the next opportunities to raise the bar and constant investment in the actions that are necessary to take advantage of these opportunities.  Recently, we worked with one very successful supplier within what is widely recognized to be a highly competitive global marketplace.  During this assignment, we collaborated with strategic account teams to develop a best-in-class strategic account management process.  One of the tools incorporated into this process required an annual assessment of our client’s success in differentiating its relationship with each of its strategic accounts.  The scorecard below (for one of this firm’s strategic accounts) suggests the attention that must be paid to moving along the differentiation racetrack:

In each area – and particularly those characterized as “red light” and “yellow light” situations in which the status quo was considered threatening or worrisome, respectively, to the firm’s ability to remain differentiated – this firm’s strategic account team is required to define the actions to be taken to ensure that there is ongoing progress towards the task of achieving a differentiated relationship.  Even in the “green light” situations in which the firm’s position was thought to be secure, ongoing attention to action plans and to “raising the bar” is evident in the scorecard summary.  These action plans must be fully detailed, including clear “What – Who – When” specifics.  A process for monitoring process involves quarterly reviews with the executives responsible for strategic accounts and a cross-functional team in areas central to the firm’s business success.  While the assessment tool relevant to the task of managing relationship differentiation can differ from one firm to the next, incorporation of some such tool into the overall process is an important way to ensure that the firm remains on the track and in the race.

Our findings suggest that even those firms who achieve differentiated status are rarely able to realize premium prices.  Instead, differentiation most often leads to a share premium and to a more secure, growing relationship.  In fact, our belief is that it is an extraordinary achievement for a supplier to avoid the vicious cycle of pricing, gain a share premium, and have stable customer relationships.  Moreover, in even the best situations, premium prices are a transitory phenomena, and suppliers must be careful to ensure that the transition from premium prices to market prices does not become the first step towards the vicious cycle.

Summary:

Business-to-business suppliers and their strategic account managers know that pricing is among their most significant and important responsibilities.  Price pressures and the impact these pressures have on profits increase with the size of the customer relationship, as does the incentive for competitors to try to win the account through lower prices.  It is therefore essential that proactive steps be taken to avoid the vicious cycle of pricing and ensure that strategic accounts continue to contribute to growth and profitability.  These proactive steps involve two primary responsibilities:  formally making price action plans a part of the relationship management plan, and continually searching for initiatives that can keep the relationship differentiated.  While neither challenge is easily met, they define the path that strategic account managers must follow to avoid the vicious cycle of pricing.


[1] George F. Brown, Jr. and Atlee Valentine Pope, A Blueprint for Success with Major Customers, Evanston, IL:  Blue Canyon Partners, Inc., 1999.

[2] Atlee Valentine Pope and George F. Brown, Jr., Whatever Happened to Growth?, published in Velocity, Fourth Quarter, 2001.

[3] See Atlee Valentine Pope and George F. Brown, Jr., Growth Is a Project, published  in Velocity, First Quarter, 2002.  At the Extended Enterprise Tier, the supplierècustomer relationship is complex and multi-dimensional.  There is typically a  breadth of products and services involved, and the relationship involves many collaborative dimensions – product design, inventory management, sales force training, etc.

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