May 29, 2012
This is the fifth entry in a six-part series focused on exploring five of the key areas of opportunity for better pricing in the chemicals industry.
For process-based manufacturers in general, and chemicals manufacturers in particular, executing well on price increases is crucial to maintaining or improving margins. Yet, we often hear that chemicals manufacturers struggle to realize a projected price increase, and many actually have trouble measuring where a price increase was achieved it and where it was not.
Improving the price increase execution process, particularly for commodity products with volatile prices, can be critical to maintaining margins in these markets.
First of all, it’s important to consider that there is more one type of price increase. The three primary types of price increases are:
1) List / Reference Price Increases – While list or reference prices are not always used in commodity chemicals, they are a best practice, and are used with many specialty materials and end-use products with less price volatility.
These increases are designed to move all customers up an equal amount, or by a target amount within a region or segment
Due to its nature, a list price increase is often used for communicating a change to the entire market (customers and competitors at the same time).
It may signal a shift in underlying costs, or perhaps a change in market value.
It can also be used for communicating product positioning and product ladder values (e.g. good, better, best).
2) Customer Invoice Price Increases (or Discount Reductions) – Changes to specific customers’ invoice price(s) are designed to move targeted customers up or down by different amounts.
This may be done in cases when the market won’t support or you do not wish to signal a broad “list price” increase, however increases are supported within specific end-use segments.
It’s useful in rebalancing price levels within your customer portfolio, effectively reducing unwarranted price variation after a period where discounts or prices have diverged. This often is the case after a prolonged period of downward pricing pressure or periods of high supply.
There is also a version of this type of increase that occurs automatically, if the pricing is tied to a raw materials index or pricing formula.
3) Charges & Surcharges Increases – When it comes to managing “pricing” in the chemical industry, it’s not always about the “price” on the invoice, per se. Effectively managing (and increasing when possible) value-added charges & surcharges can be just as important as managing the price per unit – especially in base or intermediate chemicals where prices are largely tied to indexes.
Charges & surcharges are typically designed to recover or pass on variable (and sometimes volatile) costs such as logistics & transportation, fuel costs, technical services, special fees or other costs of doing business.
These costs-to-serve are valued differently by customers and can be used to differentiate what you charge one customer who has low costs-to-serve from another customer who has a much higher cost-to-serve, even though they may be buying the same material at the same contracted price.
Surcharges can also be triggered based on the order processes. For instance, if you pre-negotiate the surcharges for rush shipments, partial loads, or even a surcharge for each shipment and invoice, then you can maintain a common competitive material price while capturing more value from the customer based on their ordering behavior. Surcharges should create incentives for more profitable customer behavior – they can change their behavior to avoid the surcharges, or gladly pay them when they value the extra services. Minimum order quantities work in a similar way.
Separating out costs-to-serve fees and surcharges is important to be able to have clear visibility to comparable customer prices. Even if you roll in surcharges to the invoice price, these should be separated internally in your price waterfall data, to be able to compare customers on an apples-to-apples basis.
Here are some best practices in price increase realization to consider:
Organize for Success: separate the strategic price increase decisions (setting the targets) from the tactical decisions (carrying out the increases).
Set clear goals for the price increase when planning the increase. Simulate the impact of the increase, using realistic assumptions around realization/capture rates. Use past price increase realization rates as a guideline.
Differentiate the price increase application by customer. Understand which customers are more valuable to you and which ones are less valuable using a customer classification scheme (see illustration). Consider taking up price for “D” customers by more than the overall target because of their lower profitability and lower risk to your business if they defect, while taking up “A” customers by just a small amount to preserve your market position with these more valuable customers.
Consider your supply chain costs to see where there may be cost-to-serve related surcharges available to you. Some examples: Freight or Diesel Surcharge, Wait-time Surcharge, Exchange Rate Indexing, Hazmat or Environmental Charge Recovery, Small Order Surcharge, Rush Freight Surcharge.
For surcharges, consider introducing the surcharge with a value of $0.00 at first. This begins to communicate that there is something of potential value here, and allows you to test customer response. Everyone likes something for free, and it makes the customer feel good because it is included at no cost (for now).
Plan your internal and external communications ahead of time, anticipating the questions and pushback you’ll receive both internally and externally. Communicate to your field sales force well in advance, and provide them with a FAQ document when the program is implemented.
Be clear and consistent in your communications. Generally is is better to have less emphasis on costs and more on the general market conditions, supply, demand, etc.
Prepare your sales teams with supporting data and talking points so they are not left doing the “shoe-shine stare” when getting pushback on the proposed increases. Stiffen their spines with data.
Measure and monitor price increase realization. You need to have a plan in place to measure how much of the price increase was achieved, and use the lessons learned to improve future price moves. With a tool like Vendavo, you can set up a tracking program to monitor exactly where you achieved what percent of your expected price increase target… by market, customer, product, sales rep, etc. versus your plan. Price Increase Effectiveness is a great metric to use to compare different price increase programs on a common basis. This will greatly help with your internal communications about the value returned from pricing.
Vendavo customers have seen huge amounts of value added to the bottom line by employing best practices like the ones above to improve their price change processes. What have you seen in the area of best practices in price increase effectiveness?
– Jared Hansen