A Special Series from North American Wholesale Lumber Association
By Anthony Muck and Andrew Ryba, DMSi Software
There are many aspects involved in developing a strong pricing strategy. In addition to considering the cost to serve your customers, you have to determine which products you’re going to sell, who will purchase those products and how to gain more customers — all while remaining profitable at the same time.
Here is where pricing optimization can come in. Price optimization is mathematical analysis that calculates how demand varies at different price levels, then combines that data with information on costs and inventory levels to recommend prices that will improve profits, according to management consulting firm Bain & Company.
Companies in the building materials industry should use a pricing optimization model because it is important to identify unnecessary overhead costs, maximize margins based on relationships between item and customer, and evaluate your current processes. In order to achieve your highest level of profitability, understanding how all aspects of your business impact profitability is important, and a pricing optimization engagement can help achieve this. Even though the end goal is to provide a specific item price to a specific customer, simply going through the exercise of pricing optimization will help to clear the fog around existing practices.
But where do you start?
One of the strategic factors to consider is the “cost to serve” specific to your customers. According to Logistics Management, cost to serve is the analysis and quantification of all the activities and costs incurred to fulfill customer demand for a product through the end-to-end supply chain. Understanding what it takes to service a customer and being able to compare that to your business model and other comparable customers can provide a lot of insight for your business. By completing this analysis, you learn more about your key accounts and your overall business value. It also helps you make decisions based on data — decisions that could assist in identifying potential areas to improve profitability for a certain customer or even learn where you can right-size others.
Once you identify the cost to serve, think about what can be done internally to reduce it. This will allow you to beat competition during the quote process, while still maintaining your margins. When you think about pricing decisions, costs should not be excluded. This is an area business owners may not always consider when developing a pricing strategy, but it is important in pinpointing possible cost-savings, especially in parts of the business such as operations.
Aside from the cost to serve, another factor to consider is the customer and item relationship. It is important to know which products are important to your customers. Too often, customers are lumped into a “level” price for all items. In order to achieve an optimized price, you should look at charging more for that customer’s “D” items and staying competitive on the “A” items.
Customer stratification can help you determine exactly this. It helps answer the crucial questions that give you a more in-depth understanding of your customers. According to NAW Institute, customer stratification not only measures the cost to serve a customer, but it also details how much business a customer does with a company (sales), how profitable that customer is and how loyal they are. Research study Customer Stratification: Best Practices for Boosting Profitability focuses on these four key dimensions of customer stratification as best practices for wholesaler-distributors:
- Buying power
- Customer loyalty
- Cost to serve
While pricing optimization and stratification as a topic isn’t all that new (Texas A&M has been researching this for many years in its Industrial Distribution Program), it is relatively new to this industry. Being in the building products industry, cutting-edge technology and analytics that come along with it aren’t adopted as quickly as other industries. While this is true, I have seen an increase in interest and discussion in this area. Our customers are looking to see how this practice could help them improve their business.
At the end of the day, the best way to develop a pricing strategy is to start with an open mind. Be open to new ideas and approaches — after all you are going through this exercise for a reason! Initially, this should not be a “set up and pull the trigger” approach to pricing. Start this process knowing that discussions and revisions will need to be made.
I have seen people suggest that optimization systems can give you prices automatically with little effort and input. A software application can certainly take a variety of formulas and factors, chew on some data and spit out a price. However, I don’t think this is the best way to tackle the pricing strategy discussion. This should be a process or exercise in evaluating the relationships, processes and factors that are important to your business. Then setting a framework around those factors and implementing based on the framework is how you define a pricing strategy.
- “Pricing Optimization: Striking the Right Balance for Margin Advantage” by Pradip Krishnadevarajan, Senthil Gunasekaran, F. Barry Lawrence, Ph.D., Brijesh Rao
- “Customer Stratification: Best Practices for Boosting Profitability” by F. Barry Lawrence, Ph.D., Pradip Krishnadevarajan, Senthil Gunasekaran
- “Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line” by F. Barry Lawrence, Ph.D., Senthil Gunasekaran, Pradip Krishnadevarajan