Forecasting the Impact of Mass Price Changes on Profits

UNLOCK YOUR DATA • UNLEASH YOUR SALES FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS E-book FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 1 Contents How A Mass Price Change Could Backfire ........................................... Mass Price Change Advantages And Risks ........................................... How Organizations Forecast The Impact Of Mass Price Changes ........... Improving Your Forecasting Precision ................................................... Key Technologies For Managing Mass Price Changes ........................... Conclusion ....................................................................................... 2 3 5 7 10 12 FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 2 HOW A MASS PRICE CHANGE COULD BACKFIRE Your company is a leader in your B2B space, and sales have been good over the last year, so you announce a mass price increase. You’re confident that your competitors will see this move as an opportunity to raise their own prices, and follow your lead as they have in the past. You send out a press release announcing the mass price change to your market. Your press release indicates a 5 percent increase across the board, but that’s just a guideline. Your sales reps are still going to tailor the actual increase for each customer. Even without sophisticated pricing optimization tools, the sales organization decides on 1 to 8 percent increases for specific products or customers. But when the announcement goes out and you raise your prices, you realize you’ve made a mistake. None of your competitors follow suit. Perhaps your competitors knew about certain factors in the market you didn’t take into account. With their lower prices, they begin attracting some of your more price- sensitive customers. A few months in, the revenue and margin increases from the price change are far lower than what you forecasted. To remain competitive, you start slowly backing away from the higher prices you’d announced. That’s just one of the many ways a mass price change could backfire. SUMMARY Raising your prices and having none of your competitors follow suit is one of the many ways a mass price change could backfire. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 3 MASS PRICE CHANGE ADVANTAGES AND RISKS Mass price changes go by a variety of names: general price increase; annual price increase; catalog pricing; catalog refresh. It’s almost always a top-down tactic to produce a revenue uplift or margin uplift. An executive needs to secure a $5 million uplift in revenue, for example, and starts looking for options to achieve it. Some people differentiate between a general price increase for customers and a general list price change — these adjustments could take place separately or simultaneously. Whatever you choose to call it, many organizations announce these general price changes on an annual or quarterly basis. These general price changes affect a number of records across a geographical region, a product line or a segment. (In this context, “segment” could mean everything from a product and the additives it contains or manufacturer, supplier, geography, etc.) They differ from customer-specific price changes, which are more operational and take place throughout the year, rather than all at once. Trying to change prices in a single, annual event is expensive and difficult for many companies. The labor you need to manage pricing rises by as much as 80 percent during that annual event, which is a huge drain on your pricing team’s resources. Some companies try to get around it by adding staff to get through that annual event, but those analysts are then underutilized the rest of the year. But there’s still a strategic need for companies to perform and announce mass price changes. Here are a few strategic reasons for announcing a mass price change: SUMMARY It’s often expensive and difficult to try to change prices in a single, annual event. But there’s still a strategic need for companies to perform and announce mass price changes. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 4 1 Indicating your broad intentions within your sector: In most industries, there’s no legal reason why you can’t discuss what you’re doing with your business and pricing at a very high level. You’re also allowed to mention those kinds of details when you talk to Wall Street or publicly traded companies. While these broad announcements are allowable, you do have to be careful: Keeping your sector informed is one thing, but you don’t want to cross the line into price signaling. 2 Giving your customers advance notice to change their own prices: Your customers need time to adjust to your price change — especially when they are selling through distribution. They need time to update their price list and catalogue, flush out old inventory at one price level and get new inventory at the new price level. Due to this administrative burden, supplier contracts typically require 30 to 60 days’ notice before a price change. The need to announce a mass price change well in advance is one reason many organizations follow a once-a-year cycle. 3 Letting end consumers know what the manufacturer is doing: Good distributor partners love mass price change announcements, because they give them permission to raise prices potentially even more. When having price increase conversations with end consumers, distributors are able to blame the increase on the manufacturer. Announcements may also help drive up orders, artificially increasing demand. Those are a few of the advantages. But don’t forget about the risks. For example, if the executives behind the price change didn’t have a well thought- out plan for execution, some of their forecasts may be unrealistic. That leaves the sales organization in a situation where you’re likely to miss revenue and margin targets. A mass price increase could also have unintended consequences for your product mix. If you’re doing a smooth price increase across the board, you may force your customers to switch from your best offering to a good-enough offering. In this case, the volume may still be there, but it may be driving customers to less-profitable products. In most industries, there’s no legal reason why you can’t discuss what you’re doing with your business and pricing at a very high level. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 5 In the worst-case scenario, you announce a price change and your competitors don’t follow, resulting in loss of volume and margin as your customers look elsewhere. This resets the market, and now you have to be even more aggressive to win those customers back. For example, a company may have been a nice, profitable customer for you in the past until your pricing forced them to go with a competitor. Now, you’ll need to offer an even lower price than they had before to regain their business. For a successful mass price change, you need a way to mitigate these risks while making the most of the advantages. How different organizations manage this price increase varies considerably, depending on their maturity. HOW ORGANIZATIONS FORECAST THE IMPACT OF MASS PRICE CHANGES A mass price change is a broad, general increase at a global level. What little segmentation occurs tends to happen at only the highest levels, such as different prices for North America and Europe, for example. These general, high-level changes are especially common in immature organizations. The basic process starts as a top-down, high-level strategy that looks at a variety of global factors, such as commodities and industry-wide trends, and compares them against your product offerings, market presence and profit trends. A price change might be a way to capture increased commodities costs, for example. Starting at this high level ultimately helps you forecast the impact of the mass price change. But your segmentation doesn’t have to be this blunt in a mass price change. More mature organizations use a variety of targeted strategies for more precise forecasts. You could use the tradition and expectations of the mass increase to announce the change, but then use a finer, more segmented approach when implementing the changes for individual customers, analyzing buying characteristics, order frequency and other factors. SUMMARY Mature organizations use a variety of targeted strategies to develop more precise forecasts. They put significant effort into understanding the bottom-up impact. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 6 Mature organizations put significant effort into understanding the bottom-up impact and connecting it to these high-level trends. This allows them to better forecast any margin erosion between what’s announced and what’s actually realized. These bottom-up considerations examine product lines, specific SKUs and individual customers to forecast how much a price change is actually going to transfer to specific customers. Rolling all of that data up gives you a more accurate forecast than high-level trends alone. The ultimate price increase forecasting goal — which very few companies are currently capable of pursuing — is the ability to overlay increases with contract terms and conditions. If a customer’s contract is about to expire or roll over into the next period, for example, the price increase should be carefully timed so that it doesn’t have an impact on the contract renewal. In this kind of situation, you might want to wait until the contract rolls over before you execute the price increase. To truly understand the best opportunities and potential pitfalls in a price change, you need a sophisticated pricing optimization system. This type of system enables you to analyze the top-down and bottom-up factors, then overlay them with individual customers’ contract terms and conditions, such as price protection clauses, cancellation periods and so on. To truly understand the best opportunities and potential pitfalls in a price change, you need a sophisticated pricing optimization system. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 7 IMPROVING YOUR FORECASTING PRECISION When you’re looking for ways to accurately forecast the impact of a mass price change, the key is precision in your data and analysis, strategy and process. Your organization’s capacity for this precision depends on your pricing sophistication. On one end of the spectrum, you have the most basic forecasting methods; on the other end, you’re applying segmentation that offers greater granularity and precision. In between these extremes, there’s a continuum of increasingly sophisticated forecasting techniques. For example, if it makes sense for your business, you may choose to run all sorts of price elasticity analyses. If you have market share data, you might want to know how much your price changes are going to affect your share of the market. If you have a good handle on industry-wide trends and believe the market is going to grow by 4 percent, you want your growth to exceed that. All of those techniques could be used in conjunction with a price increase to try to predict the outcome. But you’re only able to use the techniques supported by your current system. Here are three levels of forecasting, from one available to the least mature organizations to those only accessible to the most sophisticated: 1 Macro-level forecast: When you announce a 3 percent price increase across the board, you’re forecasting a simple uplift to business. You’re saying that profitability is 18 percent today, and tomorrow it will be 21 percent, due to this 3 percent increase in revenue. This is the most basic approach, and it’s available to organizations that don’t have a pricing team. It’s relatively easy, so the sales or marketing teams don’t require a pricing analyst. SUMMARY Accurately forecasting the impact of a mass price change requires precision in your data and analysis, strategy and process. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 8 All you need to come up with a high-level estimate are a few lines in a spreadsheet with some gross assumptions. But there are several ways to add nuance to this approach. For example, if your procurement or supply chain organization is putting together cost increase estimates for the next year, you could layer that into your forecast. Even the broadest segmentation improves the precision of your forecast. If you have different prices for the U.S. and Europe, for instance, you could factor in a weighted average based on the amount of revenue you’re expecting in those regions. Unfortunately, this type of forecasting doesn’t give you a good idea of what to expect when you implement a general price change. It’s only useful for companies that aren’t yet ready to apply full segmentation, full precision and timing elasticity. 2 More targeted, precise calculations: To improve your forecasting, include analysis of your market, customer behavior, company objectives, and contract terms and conditions. Companies that are midway between immature and fully mature tend to employ one, two or three of these techniques, but not all four. These factors improve the accuracy of forecasting because they take your high- level estimate and refine it in whatever dimensions make sense for your business. Companies may want to use all those factors to make precise estimates, but lack the necessary technology, data and overall sophistication. They may have a great idea for forecasting, but don’t have the capacity to bring all of those factors into consideration. With a mass price change, a macro forecast that estimates a 3 percent increase across the board probably isn’t realistic. To get a more realistic, precise and granular estimate, you apply all the information you have about the market, contracts, internal company goals and customer behavior. These techniques allow you to estimate the impact of the change on actual price, volume and mix. Combining these estimates gives you a better predictive forecast. To improve your forecasting, include analysis of your market, customer behavior, company objectives, and contract terms and conditions. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 9 If you’re at the low end of the maturity scale, you’re less likely to hit the targets that you set. When measuring the effectiveness of forecasting, you’re comparing baseline, expected and actual revenue, and measuring the delta. Maturity also plays a role in your ability to quickly correct course. Everyone’s forecasting is off sometimes, but mature companies know when, why and how to fix it. Less mature companies are effectively averaging, and the impact of averaging all those results to do your assessments means that it’s very hard to tease apart what the root cause is, and takes longer to react. Having more granular analysis is important because it allows you to find deviations from your forecast and react more quickly. 3 Bringing your own company’s needs into the forecast: At the highest level of maturity, your forecasting takes into consideration your own company’s needs, as well as the market conditions, contract terms and conditions, future growth potential or limiting factors. Your organization’s maturity is the sum of where you are across all of those different areas. While technology is one of the key elements, maturity means a balance of the right people and processes, tools and strategy. If you put in a pricing optimization tool without the supporting elements, it’s just a wasted investment. On the people front, you need strategic people capable of defining and setting strategies, as well as pricing analysts capable of building models and leveraging tools and data to get results and make any necessary course corrections. You also need collaborative people in your organization (especially in your sales team) capable of using direction from the strategy and pricing team to execute in the marketplace, and provide meaningful input on the process. To understand your company’s needs and build them into a mass price change, you need internal negotiations between pricing and sales. These two teams should review individual accounts as part of planning the mass price change, determining what increases to announce and how they apply to each region, as well as identifying any contracts that would prevent you from applying the changes. These three levels outline the two extremes and midpoint along the maturity spectrum. If you’re at the first level, don’t expect to jump to full maturity at once; organizations normally follow a stair step approach as they improve their forecasting capabilities. Everyone’s forecasting is off sometimes, but mature companies know when, why and how to fix it. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 10 KEY TECHNOLOGIES FOR MANAGING MASS PRICE CHANGES When it comes to planning and implementing mass price changes, it’s essential to have the right technology infrastructure in place. As much as companies acknowledge that they’d be better off doing forecasting at the transactional level, they often lack the data structures and technology to achieve those benefits. Where you are on the maturity continuum has a lot to do with your ability to bring transaction-level data into your analysis and forecasting estimates. Companies should typically start by investing in core process enablement, such as enterprise resource planning (ERP) systems. ERP focuses on the core processes to enable their supply chain and manage transactions with other financial systems. The next step is to add a customer relationship management (CRM) system with price management tools. When you’ve already implemented an ERP system to manage your supply chain, you’ve done much of the heavy lifting in terms of organizing and consolidating your data. This sets the stage for taking further advantage of that enterprise-wide investment by developing a mass price change process. If you have your CRM and ERP systems working together, it saves you from over- engineering your ERP system to handle functions that would be more appropriate for your pricing software to handle. There’s a huge upside to that integration in terms of getting greater value from your business data. Many organizations have used an ERP system for 10 to 20 years and are looking for additional applications that would help them get more value from it. Much like an ERP system, pricing software really affects all of the organizations within an enterprise. That may make pricing more difficult than implementing something like a CRM system, which typically only affects sales, but the ultimate benefits of pricing software have a far-reaching impact. SUMMARY You need the right technology infrastructure in place to plan and implement mass price changes. Start by ensuring your CRM and ERP systems work together. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 11 Effective price change techniques require data and transaction-level detail. If you have disparate systems that make it difficult to access and use that transaction data, your potential upside is much smaller. Again, it’s important to balance technology investments with improvements in your workforce and processes. This is often an iterative improvement. You don’t want to map your processes, only to realize they don’t make sense when you buy a new CRM platform. Your original process may have included elements based on the limitations inherent in your previous tools, and you don’t want to build a whole process around those limitations. For example, your current process may indicate that you need four days to run the forecast model, while it only takes two hours with the new technology. To keep your people, process and tools in balance, try to map your processes to a certain level and stop. Put in the technology and get it working for you, and then continue the process mapping where necessary. That way, you’re not over- engineering your process or your technology. You make incremental improvements as you implement the technology. Even if you’re immature, you’ll gain something by taking technology into your planning. If you’re at a medium level, you still gain by leveraging technology. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 12 THINK OTHERS MAY BE INTERESTED? SHARE THIS E-BOOK: CONCLUSION Even with the latest pricing optimization software, there’s still a strategic need for companies to perform and announce mass price changes. But rather than making these changes in one fell swoop, it’s best to take a more tactical approach, updating pricing at different times of the year across different customer segments. While it’s unlikely that customer contracts will change to allow price updates more than once a year, moving away from an annual mass price change event allows you to spread these changes out. In January, you’d update the price for one set of customers, then for another set in February and so on. It’s largely a question of having the right tools. For companies in the early stages, analytics and visibility are a tremendous help in managing mass price changes and forecasting their impact. As your organization matures, you’re able to use more execution-oriented technology, eventually followed by full-on price optimization. There’s not a magic point in the process where technology suddenly becomes relevant. You need to think about it in a more agile format. Making smaller investments in technology gets you to the next level, where you plateau again, make another investment and so on. As price optimization technology becomes more prevalent, industries that used to change prices once per year are seeing the advantages of more frequent, nuanced approaches to price management. Once they get past the hurdle of changing expectations with customers, competitors and supply channels, whole industries will move past these annual events. Are you ready to learn more about how pricing strategy and data science could help your organization in managing price changes and driving revenue? Visit the PROS Pricing Effectiveness Blog for expert insights and guidance. FORECASTING THE IMPACT OF MASS PRICE CHANGES ON PROFITS 13 About PROS PROS Holdings, Inc. (NYSE: PRO) is a big data software company that helps customers outperform in their markets by using big data to sell more effectively. We apply years of data science experience to unlock buying patterns and preferences within transaction data to reveal which opportunities are most likely to close, which offers are most likely to sell and which prices are most likely to win. PROS offers big data solutions to optimize sales, pricing, quoting, rebates and revenue management across more than 40 industries. PROS has completed over 800 implementations of its solutions in more than 55 countries. The PROS team comprises more than 1,000 professionals around the world. To learn more, visit pros.com. Copyright © 2015, PROS Inc. All rights reserved. This document is provided for information purposes only and the contents hereof are subject to change without notice. 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