Insights

It’s My Own Damn Fault

Taking steps to avoid unnecessary instances in which your direct customer is a price buyer is hard work and work that can’t be undertaken at the last minute.

One of our clients in a business-to-business manufacturing firm, an individual who probably still aspires to write the great American novel, gave the following description of his firm’s lot in life: “We walk into our customer’s headquarters building, through the same entrance where they take their own customers. It is lavish, right out of the designer magazines. The pictures on the wall and in the brochures in the seating area are aspirational. You look at them and say ‘I could live like that’, and implicitly think ‘I’d pay just about any price for their product’. Then they escort us down the hall and through a door hidden out of view, off to the side. As the door closes, we notice we’ve entered a part of their building where it’s dark and damp. The floor is dirt, and the walls are unfinished, and you occasionally see the skeletal remains of other suppliers off to the side. The people there are out of some B-grade movie about the dark ages, and voices keep saying ‘We need you to cut your price”.”

While evoking memories of reading Paradise Lost in high school, his description is far too frequently one that we hear from business suppliers, organizations that serve direct customers who produce high-end, high-priced products, but whose relationships with suppliers are constantly focused on price. Life on the bulls-eye, targeted by competitors and purchasing executives alike, is a reality for many business suppliers, and there are tools for managing that situation when it is inevitable¹. But in general, situations like the one described by the executive above, in which the customer is selling a premium-priced product but treats their suppliers as commodity providers, are the relationships that drive suppliers crazy.

Suppliers in this situation look at the end markets served by their direct customers, where price is of relatively low importance, and detest the contrast with their own situation, where their direct customers are battling for every last nickel at contract negotiation time – and often at unexpected off-cycle times. They see their direct customer’s healthy margins, and contrast them with their own always-under-pressure margins. Statements about injustice in the world (and far less flattering comments) are commonplace from executives in such supplier organizations.

The question that such suppliers constantly ask is “How did we get into a situation where the only thing that seems to matter to our customers is price?” It’s an important question, and one where the unfortunate answer often is, in the words of Jimmy Buffett, “It’s my own damn fault”.

Misaligned Customer Chains

Understanding the factors that drive purchase decisions, and the relative importance of price vis-à-vis other factors like product, technology, service, and brand, can be a critical ingredient in shaping a winning growth strategy. Many business markets involve long, complex customer chains, with the relative importance of product features, services, price, and other factors differing in importance at each stage of the customer chain. In some instances, there is alignment, with all of the customer chain participants sharing roughly similar priorities. All of the customers may be price buyers, or they may all look for state-of-the-art technology and features. In some regards, these are the easiest customer chain structures for a supplier to understand and serve, in that if they can be responsive to that “common decision driver”, their odds of success are great.

In other customer chains, however, the factors that drive purchase decisions may differ considerably from one stage of the customer chain to the next, as the quotation earlier about the sharp contrast between the lavish customer center and the supplier’s dungeon suggested. At one stage of the customer chain, the purchase decisions may be driven by price, while at another stage product or service considerations may be of greatest importance. Such unaligned customer chains pose tremendous challenges to suppliers. This challenge can be met, as numerous case studies attest², but doing so requires creativity and a carefully-blended mix of the elements of Go-to-Market Strategy.

One version of such an unaligned customer chain is common in business markets. It involves a customer chain in which a supplier’s direct customer’s purchase decisions are driven mostly by price, while the end customers at the later stages of the customer chain focus more on product and service elements, with price being a less-important factor. This is the customer chain structure described earlier by the executive that we quoted. It is the structure that drives suppliers crazy and that provokes questions about how the suppliers got into that situation and what they can do about it.

There are, of course, some instances in which the reason for the lack of alignment is obvious. Suppliers of salt used to melt the snow in the parking lot of a direct customer that manufactures a luxury product for end customers, for example, most likely understand that they and their salt are for all practical purposes totally unconnected to their direct customer’s product or its end customers.

There are many such instances in which unaligned customer chains make sense, most typically when the product or service the supplier provides does not provide end customer value or is invisible to the end customer. Capital equipment, factors of production that aren’t end product ingredients, and services often fall into this category. Does the end customer care which conveyers are used to move the product through the factory? Does the end customer care which electricity supplier powers the plant? Does the end customer care which plant watering services keep the direct customer’s office attractive? In such instances, the responsibility for avoiding price-based purchase decisions rests almost entirely on the supplier’s ability to convince their direct customer of the differentiated value they provide, with success in this regard usually involving reasons that aren’t associated with the direct customer’s end markets. Suppliers in this situation can avoid becoming trapped in a vicious cycle of price-based competition and suffering endless pressures from procurement managers, but they can’t rely on the purchase decision priorities of end customers to do so. The responsibility for differentiation and the ability to gain a price premium is in their own hands, and depends on their ability to deliver value to their direct customers.

But beyond such instances in which the lack of alignment is basically a result of a lack of real connections along the customer chain, what we have observed over and over are situations in which the supplier has to conclude “It’s my own damn fault”. Such situations are sad indeed, in that they could have been avoided and the supplier could have participated in a positive relationship with their direct customer, enjoying shared successes and attractive margins. Instead, those suppliers create an environment in which the focus of their relationship with their customer is price, and the world in which they operate is one of constant pressures and shrinking margins. The examples that follow of suppliers that got into a situation through their own damn fault in which their customers focus mostly on price can help other firms to avoid such unhappy situations in the future. Three specific suggestions as to how firms can avoid such fates and avoid situations where relationships are unnecessarily centered on price are drawn from these case studies. In the final section, we provide some insights as to the ways in which best-in-class firms incorporate pricing strategy into their long-term growth plans.

Understand the Real Competition along the Customer Chain

One of the most surprising examples of a firm that created an environment in which their direct customers were focused almost exclusively on price involved an electrical products manufacturer that made quite a few products that were viewed by all as the best the industry had to offer. They sold through electrical distributors (their direct customer) who in turn served contractors and industrial firms (the end customers). This manufacturer’s products were used primarily in industrial and commercial applications where performance mattered and in applications where the products made a real difference in terms of the life-cycle costs of operation. All of the ingredients were there for this firm to enjoy the benefits of differentiation and to capture the value that it was creating for customers at all stages of the customer chain.

How did this firm undermine its own success and shift the focus to price? It did so by excessive authorizations of distributors and other sales channel organizations. In every territory, they acted as if “more is better” and signed up distributor after distributor. What the sharp buyers at the later stages of the customer chain learned was that they could create a fierce price-based competition among the many authorized distributors in each territory, and get to low price points without ever having to consider any products other than those made by this manufacturer. And, of course, these end customers did exactly that and quickly got price concessions from the competing distributors. In turn, the distributors, seeing their margins dropping, began to place every pressure they could on the manufacturer. They were convincing, with sales data to back them up, that they couldn’t sell the product unless prices were lowered considerably. The results, in financial terms, evolved to look more like those of the manufacturer of the salt for the parking lot described above than those of a firm that manufactured best-in-class, highly-sought-after products. And it was their own damn fault.

The mistake made by this manufacturer was failing to understand the business environment at each stage of their customer chain. Rather, they implicitly assumed that their own situation carried forward to the other customer chain participants. From their perspective as a manufacturer, the competition was the other manufacturers making similar electric products. And they had largely won the battle against those competitors, with their products ranked as superior by almost everyone. But for their distributors, the competition did not involve those other manufacturers. Rather, it was the other distributors that the manufacturer had given authorizations to. As a result, the distributors resorted to the only strategy they could identify, naming that of participating in a vicious cycle of price-based competition.

The lesson is clear: make the effort to understand the business environment of every participant along the customer chain (especially focusing on who is seen as the competition) and make sure your strategy is contributing to alignment, rather than fostering the opposite.

Build Relationships Centered on Your Ability to Create Value

The second situation in which a supplier fails to thwart a lack of alignment and gets into a price-focused situation is far more common than the one presented above. One illustration involves a firm that builds a significant component of the infrastructure for power plants. Although each installation was unique, this firm brought technology and design capabilities that it could document were worth millions of dollars in operating savings over the decades during which such plants were operated. Unfortunately, the decisions on whether this firm won a job or it went to a competitor were made by third-party Engineering, Procurement, and Construction (EPC) firms that had a short-term perspective. Those EPC firms primarily cared about meeting the schedule, passing inspections, and coming in at or under budget. Their focus during the procurement process was on getting bids that helped them stay under budget, and an innovation that paid off later in the life cycle got little attention, and could even be viewed negatively if it had a higher first cost. As a result, while the electric utility firms who were the end customers had the potential of a huge benefit from superior technology and design, the EPCs who were this manufacturer’s direct customers made purchase decisions largely on price. The result was once again an unaligned customer chain, with the supplier facing a skilled price buyer who used every tool available to avoid leaving even a dollar on the table. And it was their own damn fault.

The mistake made by this supplier was failing to develop end customer relationships and sell their advantages to those end customers at a point in time early enough to matter. Had they done so, the end customers might have either identified this supplier as the preferred one, or at minimum provided the EPCs with spec’s that reflected the potential that this supplier could provide. Instead, this supplier had accepted this situation as a fact of life, devoting resources to building a team that was excellent at responding to Requests for Proposals and figuring out how to shave costs from their bids. In many instances, they first heard of a bid opportunity when the RFP was released by the EPC, a point in time at which it was far too late to make their case or influence the spec’s. Within this firm, there was constant friction, as the bid team red-lined solid engineering ideas to keep bids low, knowing that such ideas weren’t ones required by the spec’s provided by the EPC.

The lesson is clear: make sure you understand the factors driving purchase decisions at every stage of the customer chain, focus relationship development and information delivery on those stages where you have the ability to create value, and work to enlist the customers at those stages as allies who will help to create alignment along the full customer chain.

Many firms face this situation even when all the decisions are made within the direct customer organization, in situations in which there is a lack of alignment between the purchasing organization and with the “actual” end customers who use the supplier’s product as an ingredient or in operations. There can be many causes for such internal misalignment within a customer organization, and sometimes they can’t be overcome, but far too many situations like this reflect a failure on the part of the supplier to effectively make their case to the people and departments within the customer organization who can recognize value and insist on procurement processes that deliver it. Like the case of the supplier responding to RFPs issued by EPCs, failing to develop the right relationships can relegate a supplier to a situation in which their communications are always too late and to the wrong audience.

Understand the Business Models of Your Customers

The third example of customer chains that are not aligned is also quite common, and it again leads to situations in which price becomes the only factor of consequence. A case study involves a technology provider that makes equipment that is important in the data center environment. This firm sells through customer chains that involve VARs and integrators as direct customers, who in turn serve firms in industries like financial services, telecommunications, and government as end customers. The data center environment is one in which reliability is critical, with the goal of most data center owners and operators being that of ensuring “many 9s of reliability”. These end customers are indeed not price buyers. The VARs and integrators similarly voice messages about their own abilities to deliver on reliability goals, but in an example of “watch what we do rather than what we say”, they aggressively shop across technology suppliers to find offers of lower prices and do everything they can think of to reduce the equipment component of their bids. The equipment supplier thus faces a price buyer in their direct customer, even though the end customer’s orientation is centered on performance. And it was their own damn fault.

The mistake the data center equipment supplier made was failing to understand the business models of the participants along the customer chain. The VARs and integrators make most of their money on the skilled professional services that they brought to their end customers, and winning jobs and keeping their staff fully utilized was what drove their bottom lines. Selling the equipment at even a loss makes economic sense to these direct customers in many instances, as long as it allows them to keep their money-making service offerings going and their key relationships intact. The lesson is clear: make sure you understand the business models of the participants at every stage of the customer chain, and address situations in which there is misalignment between what makes sense for your firm and what makes sense in the context of the business models of the other customer chain participants.

Solutions in situations like this are a challenge to identify and implement. Like tigers, the VARs and integrators through which this data center equipment supplier goes to market aren’t going to change their stripes. They will continue to understand that their business success is centered on their ability to win jobs and keep their professional staffs busy. For the equipment supplier to avoid misalignment with those direct customers, it had to contribute to one or both of those goals.

One Final Lesson and a Summary

The three lessons we’ve presented here share one common element. If your contract negotiations start tomorrow, or if your customer calls you in next Tuesday for a discussion as to why your prices are out of line with the market, none of them will help at all. On those occasions, the outcome will be determined by other factors – your ability to negotiate and the options available to your customer. Your firm may sometimes be successful, but over the longer term, it is quite likely that pricing pressures will persist and eventually result in a deterioration of your margins.

Best-in-class firms recognize that pricing must be an element of longer-term strategy, centered on the challenge of identifying how to create value for your customers as the route to capturing it for your shareholders. The lessons drawn from the three case studies are ones that must be part of such longer-term strategy, providing insights as to what will be required to be successful in the eyes of all of the participants along the customer chains that your firm serves. In all three cases, the “own damn fault” involved a decision that was inconsistent with the success of at least one customer on the customer chain. And in all three cases, the solution involved identifying and implementing actions that created a “win” for all of the customer chain participants.

As we noted at the beginning of this paper, there are many situations in which firms must face the reality of customers whose purchase decisions are largely driven by price. For those firms where that reality is unavoidable, there is no choice but to face it and implement a strategy that responds to the needs of their customers. But for those firms that unnecessarily place themselves into that situation, it’s a sad situation, one that is costing their shareholders rewards that could have been achieved through a longer-term perspective that is focused on understanding what is of value to each of the customers along the customer chain.

Taking steps to avoid unnecessary instances in which your direct customer is a price buyer is thus hard work and work that can’t be undertaken at the last minute. As the three examples provided above suggest, success requires considerable attention to understanding the business environment at each stage of the customer chain, the competitors that each participant faces, the goals that drive decisions for each participant, the business models through which each is creating value, and many other factors.

With an understanding of these factors, it is often possible to identify actions to avoid because they will motivate price-based purchase decisions and actions to take that will create alignment and shared successes along with your customers. Doing this successfully can allow a supplier to boast of strong earnings and point out proudly that “It’s our own damn fault”.

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Insights

It’s a Pricing Problem, Not a Price Problem

In an interview with an executive in a large national industrial distribution firm recently, I asked about the factors that have caused his firm to lose business.  He became quite passionate and animated, saying:

“I’ve lost more business in the past year due to pricing that any other factor.  Because of PRICING, not because of price.  With some of the manufacturers whose products we carry, you’d think we were calling to get a quote for building a combination space shuttle and Golden Gate Bridge.  It just shouldn’t be that complicated.  But some of these firms make it so hard that the sales team just says ‘We can’t get that’ rather than going through all the hoops.  That’s lost business.  And in other cases, we had customers find what they needed elsewhere before we could get back to them with a quote.  More lost business.  And since you’ve gotten me started on this, I should add that some of these processes consume so much time that any money we might have made on the sale is more than lost.”

It’s The Process, Not The Price

This individual’s concern about pricing processes is far from atypical.  When we studied the factors that create conflict between manufacturers and their sales channel partners, pricing processes was among those frequently making the list[1].  Only rarely did anyone cite price levels themselves as a source of conflict.  In today’s business environment, few firms are unable to identify and implement appropriate price levels for the markets that they serve.  But these same firms often have problems in administering and communicating price information.

This problem is obviously much greater for firms that are involved in production to order businesses or in engineering service sectors, with each purchase unique along some dimensions, thereby requiring a team of engineering and pricing specialists to develop a quote.  But there is a very long spectrum of competencies across firms in implementing such pricing processes.  In one industry that we studied, we benchmarked firms whose time to quote varied by a factor of five.  Firms whose offerings involve options in terms of product features or services similarly vary in terms of their pricing competencies.  Some are easily able to develop tools that allow near-instantaneous responses to customer queries, while others seem to get swamped by even rather straightforward queries about various options.  And while far less frequent, we’ve encountered enough instances in which firms that manufacture standard off-the-shelf products score poorly in the eyes of their customers and sales channel partners on their pricing processes.

Several factors, as suggested in the table below, can help to identify the extent to which improvements in pricing processes are warranted.  If a firm that sees its own situation paralleling the characterizations in the “red zone” in the table, there is room for concern.

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Insights

Get Your Price

Blue Canyon Partners’ George F. Brown Jr. on how to invest in your pricing strategy.

When the issue of pricing arises in a management meeting, anticipation often follows that the discussion will be unpleasant, putting more pressure on the annual goals. Avoiding the subject until the last minute makes that outcome even more likely for firms that are sitting on a pricing bulls-eye, targeted by their competitors and supply chain managers in the organizations through which they reach market.

While pricing is a daunting topic, firms that proactively manage pricing strategy with the right tools in place can produce significant top- and bottom-line results. A point gain in realized prices can yield a much larger proportional improvement in profits. In our work with clients on pricing strategy, four lessons have emerged that can help you get to the point where pricing is a positive contributor to 2012’s success.

First, understand that not every price challenge is a real threat. Many of your customers make their purchase decisions because they see your product as being superior or because they have a strong level of confidence in the brand. Remembering – and, more importantly, reinforcing – the non-price advantages that won your firm business in the first place can allow you to avoid unnecessary participation in the vicious cycle of price-based competition.

One firm that we worked with had been succumbing to price pressures, and over a two year period had seen their margins drop by half. When we interviewed customers, we learned that price was far down on the list of “what matters”, and that customers in fact had a “wish list” for which they will willing to pay. When this firm responded to that wish list and “raised the bar” in terms of its product offering, it not only reversed the trend in terms of margin deterioration, but in fact actually picked up several points of market share.

Second, if there is ever a topic where strong analytics makes a contribution, it is pricing. One of your key goals in 2012 should be to build a strong analytics foundation to assess the external business environment and your own firm’s dependence on pricing gains to achieve profit gains. Over and over, we see instances in which there are sharp differences in the pricing environment from one product-market segment to the next. Knowing where and when pricing pressures are likely to be intense can enable you to make the correct decisions on price increases and determine the right responses to competitive challenges. A “one size fits all” pricing strategy might be correct on average, but wrong in every application.

An extreme example of how important segmentation can be emerged from work done with a firm operating in China. We found there that there were market segments that redefined the meaning of luxury, with ample number of consumers in those segments looking for extraordinary products with every imaginable bell-and-whistle and high-end packaging – and that these consumers were more than able to pay for those extraordinary products. At the same time, there were middle market segments and lower-tier segments where price was a more significant factor in their purchase decisions. By understanding what drives purchase decisions for each market segment, it was possible for this firm to match its product lines and price points to each segment, achieving significant overall gains. China’s markets represent an extreme example, but the same opportunity for segment-specific strategies exists in the US and virtually every other country market.

Third, keep on top of best practice approaches to pricing strategy. We recently worked with a company that successfully introduced a premium price product into an incredibly challenging market by implementing a strategy that “ gave customers an option that they could refuse.” In another instance, we saw a firm with a brand that was preferred by many customers shoot themselves in the foot by placing the product in too many channels, creating an inappropriate image that their product was one where “ deals were always available”. Implementing best practice concepts can yield some major gains for your company.

Just about every firm that I work with makes significant investments in their products, with specialists in product technology, design, and other dimensions looking for ways to improve the next generation of offerings. And that money is typically very well spent, with customers rewarding the improvements that result from such programs. The same opportunities for gains through innovation apply to the topic of pricing, but far fewer firms make the investments that are necessary to realize such gains. One executive in a health care products firm recently commented to me that “We invest a lot in pricing – mostly by throwing away our investments in products by giving it back every time we see a competitive threat”. There are far better ways to invest in pricing. Companies that take a strategic approach to pricing and bring best practice concepts into their decisions put money into the hands of shareholders.

Finally, it always is important to remember to “create value to capture value”. While the results of new strategies to create value will probably contribute more to 2013 and beyond than to 2012, the concept underlies all successful pricing strategies. If you are delivering value to your customers, you can be rewarded for it, through a price premium or otherwise. If you aren’t, any success you can achieve is likely to be short-lived, at best. Asking the question “How can I deliver more value to my customers?” in 2012, and taking action consistent with the answers to that question, can make the discussion of pricing a much more pleasant event in future years.

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Insights

Sitting on the Bulls-Eye

One of my all-time favorite Far Side™ cartoons showed a deer with a target on its chest.  The caption has another deer commenting, “Bummer of a birthmark, Hal”.  In our work with firms serving business markets, we’ve come across many organizations that feel their organizations are the ones sitting squarely in the bulls-eye, with supply chain managers and competitors alike taking aim on an ongoing basis.

The challenge faced by such firms involves the threat that they will have to succumb to the vicious cycle of price-based competition, resulting in the erosion of their profit margins and the denigration of their products to commodity status.  Neither is a pleasant prospect.

There are three instances in which it’s almost always correct for a firm to assume that it’s sitting on the bulls-eye:

1. If your firm is among the largest suppliers to a customer, assume you’re on the bulls-eye.  Your competitors are thinking “Wouldn’t it be great to supplant them?”, and the purchasing managers in the customer organization are thinking “We’d be heroes if we can get a couple of percentage points off that bill”.
2. If your firm’s ingredients or services are among the largest elements of the cost structure of some customer’s product, assume you’re on the bulls-eye.  Competitors think “This is where we want to be, because that’s where the money is”, and purchasing managers see that “A dollar saved here drops right to the bottom line, and there are a lot of dollars that can be saved on that ingredient”.
3. If your firm’s products are among the highest-priced products bought by a customer, assume you’re on the bulls-eye. Competitors say “Let’s take that high-ticket business”, and purchasing managers say “It takes as much work to get concessions on a $1000 product as it does on a $1 product, so let’s go for the elephants and let the ants alone”.

Over the years, on some occasions, I’ve heard executives say “Maybe that’s true in general, but not in this instance”. In almost every case, within a year or so, I’ve gotten a call lamenting the fact that their company was now sitting on the bulls-eye. It’s smart to recognize the inevitability of that outcome and take actions in advance so that your firm doesn’t get pulled into a vicious cycle of price-based competition. There are three actions that can be taken to improve your outlook.

The first strategy recognizes the fact that there are many instances in which price is not the most significant factor in a customer’s purchase decision. The saddest situation involves a supplier who elects to respond to a lower price competitor by cutting price, even though the customer’s purchase decisions were based upon other factors like product technology or services. For such suppliers, their next step is usually degrading their product and service to avoid cutting into their profit margin. This is an instance of using both edges of a double-edged sword to cut your own throat – one edge was participating in a vicious cycle of price-based competition unnecessarily, and the other edge was downgrading your position to that of competitors by cutting back on the product and service elements that allowed you to be successful in the first place.

One firm in the tool market had been responding with price reductions to ever-tougher challenges from low-price imported tools. When it studied its market carefully, it learned that there was in fact one segment of tool buyers that made their purchase decisions on the basis of price. But there were other segments where product features and services were far more important. The responses this firm was making to the challenge in the price-focused segment were exactly the opposite of what was required for success in the other market segment. When the firm redirected its strategy to product enhancements and collaborated with its dealers on service improvements, it was able to gain market share at premium prices, despite the ongoing presence of the low-priced tools.

Even when you are sitting on the bulls-eye and the arrows are coming your way, not all of them are going to hit. Be aware of when price is a critical factor and when it is not. In the latter instances, your strategy should be to emphasize the factors that set your firm and your products apart from the bare bones, low-priced alternatives. And, like the tool company cited in the example above, the winning strategy often involves raising the bar in terms of products and services. The worst strategy is to simply respond to the basis of competition your competitors have selected.

The second approach to preempting the problems associated with sitting on the bulls-eye focuses on anticipating challenges and taking proactive steps to thwart them. A simple version of this strategy says that it’s always smart to anticipate future price competition, and always smart to have a plan already implemented to avoid problems when it happens.

One firm with which we’ve worked puts into place a value engineering study on the day each significant contract is won. The purpose of this is to identify how this firm can get to a lower price point over the life of the contract – with quite significant reduction targets given to the team assigned the project. As options are identified, this firm does two things: it implements them, and it goes to its customers with “good news” about the price path that can be achieved through ongoing collaboration. Rarely has this firm ever had to respond after the fact to a competitor’s price pitch or to supply chain managers upset about how “the old prices are out of line with market”. And in many instances, this firm has translated value engineering successes into higher margins at the same time that they’ve brought lower prices to their customers.

There are four factors that determine how severe pricing pressures will be. First is the capacity balance of both the supplier industry and the customer industry. When there is excess supply capacity in either industry, pricing pressures are likely. Second are the various forms of “protection” that might exist for the product line in question. Protection can range from legal factors (e.g., patents) to structural factors (e.g., high levels of investment required to enter the industry). The more protection that exists, the less likely is price pressure. Third are industry conditions. The faster the growth, the more important security of supply becomes, and the less likely is pricing pressure. Finally, the quality of the relationship between the supplier and the customer is important. While relationship can never overcome deficient products or pricing far off market, strong relationships are as important to customers as they are to suppliers. The stronger and longer-standing the relationship, the less likely that pricing pressures will translate into a lost customer relationship. For firms sitting on the bulls-eye, knowing how severe the threat is allows a response to be calibrated to the situation.

The third strategy for managing life on the bulls-eye is the most important of all. It involves a focus on the customer, thinking about what creates a “win” for the customer. There is no better way to blunt a competitive threat or to disarm a supply chain challenge than to have advocates from within the customer organization say “This supplier is critical to us and is doing a great job”. Understanding what constitutes a great job and what creates a win for the customer is the route to creating champions in the customer organization who will make such a statement.

We worked with one company that made a control system that was used by its customers in their own equipment. When we studied the economics of these relationships, we found some customers where the total cost of the control system was as much as 20% of the cost of the equipment that they produced, with more than half of those total costs associated with integration and manufacturing, rather than the price of the control system. At the other end of the spectrum, we saw other customers where the total cost associated with the control system was less than 3% of the cost of the equipment produced by these latter firms. This control system supplier saw a great opportunity to create a win for the customers where these total costs were high, in the 20% range, by reengineering their product to facilitate integration and manufacturing. When they did so, they created champions in these customer organizations and a huge barrier to competitive challenges.

In another project, we worked with a packaging supplier that saw an opportunity to bring a new packaging innovation to one of its largest customers. This innovation, in fact, cost almost 50% more than the previous generation of packaging. But it was a market place success – first validated by market research and subsequently by sales. The new packaging “jumped off the shelves” as customers saw something different and interesting. The customer that adapted this new packaging attributed a substantial gain in market share to the shelf appeal of the packaging, and claims that the product has had a life cycle that has already surpassed the industry average by a wide margin. Once again, this supplier has created strong champions in this customer organization as a result of its contribution to the firm’s success in its own end markets.

In a third example, a firm serving the commercial vehicles industry with a major drivetrain system developed some new technology that allowed better monitoring of the performance of the trucks on which it was installed, including helping to predict when maintenance was required to avoid a breakdown or a reduction in fuel economy. It brought this technology to the truck builders, with a recommendation that they offer it as an option to fleet buyers at a premium price for those that selected this option. That avoided the problem of forcing the truck builders to raise their base prices, while still giving the fleets the opportunity to benefit from this new technology. At first, take-up was modest, with only a few fleets selecting the option. But very quickly, these sharp-pencil buyers in the fleet organizations realized that the benefits from this technology dwarfed the cost of including it as an option. As that happened, the option became more and more positive, with the truck builders, the fleets, and the drivetrain supplier all coming out ahead from this new technology. This firm gained strong advocates all along the customer chain, both for the technology innovation and for the strategy of offering it as an option available to those fleets that felt it made business sense.

You can sometimes transform a bulls-eye into a favorable spotlight designed to focus applause from within the customer organization when you provide your customers with an important and visible “win”. You can do so by helping them take costs out and improve their bottom lines, by helping them to gain new sales and improve market share, and/or by helping them get to a more profitable price point through options and trade-ups. When you can create value in one of these ways, you have the opportunity to capture it for your own shareholders.

At the beginning of this article, I cited the Far Side™ cartoon’s caption “Bummer of a birthmark, Hal”. Like a birthmark, for many firms, sitting on the bulls-eye is something that can’t be avoided. It’s just a fact of life. But accepting the inevitability of the vicious cycle of pricing is wrong. It is not a fact of life.

There are things a firm sitting on the bulls-eye can do in order to sustain the success that got them there. This paper has outlined three strategies for managing life on the bulls-eye: (1) focusing on the real factors that drive purchase decisions, rather than assuming it is always about price; (2) understanding how strong pricing pressures are likely to be and taking proactive efforts to get ahead of price challenges; and (3) learning what creates a “win” for customers and transforming the bulls-eye into a spotlight on the firm deserving of applause. Those firms that learn and implement these lessons can join those that can just enjoy the humor associated with the Far Side™ cartoon rather than having to bemoan the analogy to their own sad situation

Author: George F. Brown, Jr.

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Insights

How Real Are Those Price Pressures

Decisions on pricing are among the toughest ones facing business executives. Customers and competitors alike put tremendous pressure on firms that raise prices. At the same time, ongoing increases in the costs of health care benefits, energy, raw materials, wages, and other factors of production cannot be easily overcome without price increases. The question most often asked in discussions about pricing is “How real are those price pressures?”

Four fundamental indicators can help to determine if price pressures are real or not. Each of these can be measured, and provides solid insights into the characteristics of a firm’s business environment that impact on pricing decisions. These indicators are useful in multiple ways. In addition to helping to identify price pressures that must be taken seriously, they are useful when monitored over time and when evaluated from one product line to another or from one market segment to another.

Monitoring these indicators over time can spotlight instances in which a product is evolving towards commodity status, with the obvious implications of such a migration in terms of future margins and the need to focus on ways of reducing the costs of such products. Evaluating these indicators across product lines and market segments can allow a firm to focus price increases appropriately, thereby avoiding a strategy that is on average right, but wrong for every product and market segment.

One executive commented that his sales team’s philosophy seems to be to respond to every price challenge that is encountered. That strategy might avoid an occasional loss of business to a competitor, but it has adverse long-term implications. In CoDestiny, we discuss the trap of falling unnecessarily into a vicious cycle of price-based competition. Firms that do so subsequently find themselves having to reduce investments in product development, high-value services, and other ways in which they respond to customer needs and differentiate their offering. As they do so, their products become more and more of a commodity, and price cuts become the only way in which they can win competitive battles.

The first indicator that defines the strength of pricing pressures is the capacity balance in the industry. Simply stated, the more excess capacity that exists in an industry relative to demand, the more real and intense pricing pressures will be. This indicator can change rapidly over time as demand moves with the business cycle. It can also change in a significant step-function way as firms build new plants or shutter older ones. To a significant extent, this indicator is one that is largely outside the control of the individual firm. It can make decisions on its own capacity, but except in a few unique industries, the overall capacity balance is determined by other industry participants. The capacity balance is a very significant indicator; in industries with a massive overhang of unused capacity, the pricing pressures will be incredibly intense, almost overshadowing any favorable implications that might be seen in the other three indicators.

The second indicator involves the degree of “protection” that exists for the business or product line being examined. Protection can be legal in the form of patents or copyrights, but it also can involve the degree of customization, engineering, design, or service embedded into the product. The evidence is strong that such value contributions place implicit barriers to competition and impose significant costs of change on customers that shift suppliers. The customers that elect to buy products which are customized or highly engineered do so because of the value they get from them; as a result, they are not likely to casually shift to another supplier with increased risk of disappointing results. In a common sense way, this indicator reflects the fact that when a supplier’s offering includes elements that are of high value to customers, that supplier should be able to capture some of that value in their pricing.

The third indicator focuses on the business environment into which the supplier is selling. In healthy business environments, pricing pressures are less intense. The measures of health involve not only the supplier’s direct customer, but even more so to those further along the customer chain. Every business has seen occasions when everyone is scrambling to keep up with demand. In those circumstances, price challenges are often the furthest thing from everyone’s mind. And every business has seen unhealthy markets, ones in which finding a customer is itself a challenge. In those situations, the tendency is to look back at the supply chain and battle for every dime. Pricing pressures travel along the customer chain. If a participant at any stage of the customer chain, from the lowest tier supplier to the final end customers that use the product, is facing a difficult business environment, the implications tend to ripple along the customer chain, another manifestation of the old saying that a chain is only as strong as its weakest link.

The fourth indicator focuses on the relationship between the supplier and the customer. There are two basic elements to this indicator. On the positive side, instances in which the parties consider each other a “strategic supplier” or a “strategic customer” are ones in which pricing pressures are likely to be less intense. This isn’t to suggest that buyers become soft in strategic relationships. Rather, the reality is that other elements to the relationship are far more important than price, and pricing rarely dominates the agenda of meetings between the two organizations. In strong relationships, the firms involved have largely solved the pricing issue, and can quickly reach agreement and move on to more important topics. On the negative side, our research indicates that the suppliers that rank among the customer’s largest, suppliers whose products are expensive, and suppliers whose products represent a significant portion of their customer’s product cost structure sit on the bulls-eye, attracting the attention of both purchasing managers and competitors.

In the context of various consulting projects, we’ve examined these indicators in many diverse industries and economic environments. Over and over, the result has shown significant variation from product line to product line and from one market segment to another. Such learning has allowed firms to make pricing decisions that were appropriate to the business environment in which they were operating, and to do so on a segment by segment basis. Occasionally, the process has spotlighted sharp shifts taking place from one time period to the next, allowing firms to make forward-looking pricing decisions. The process has also allowed firms to uncover quite a few surprises in the indicators and their implications—and these surprises have been in both directions, some positive ones where firms had inappropriately accepted pricing challenges as an ongoing reality and some negative ones in which firms had been unaware of the pressures that were sure to come.

A real strength of this approach is the rigor that it brings to discussions of pricing, allowing firms to get beyond the latest “war story” and to discuss pricing options from a factual base.

Author: George F. Brown, Jr.

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