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The Price Is (More) Right

Improved technology – and leadership from finance – may help companies optimize their margins.

Helping drive that market is the cash buyers have plowed into procurement software, making price optimization something of a defensive move for sellers. “McKinsey did a study last year indicating that B2B companies spent $3.2 billion on procurement software to get an edge on sellers,” says Zawada. “If sellers haven’t invested in price optimization, it’s like bringing a knife to a gunfight.”

Dispatches from the Pricing Front

The average price PROS charges for enterprises with more than $500 million in annual revenues is a hefty $2 million, which includes the license, maintenance, and service. (PROS recently announced that it will offer the midmarket a cloud-based solution with a smaller price tag.) Zilliant and Vendavo, two other major players in this market, also offer solutions for large and midmarket clients.

Some organizations like McKesson Medical-Surgical didn’t blanch at the cost. Three years ago, the medical-supplies and -equipment distribution unit of McKesson Corp. invested in PROS price-optimization software. “We had some margin pressures that weren’t evident, and I wanted to know why it was happening,” says Britt Vitalone, CFO of the unit. “We stepped back as a finance team to determine what tools the sales force needed to make better pricing decisions on a day-to-day basis, segmenting customers to drive pricing for different customer groupings.”

Previously, McKesson salespeople based pricing on historical interactions with their customers. “When a new sales rep joined the force, he or she was told by veteran reps to charge x, because that’s the way they’d been doing things for the past 25 years,” Vitalone explains. “A ceiling mentality of what could be charged for different products took hold. We were passing on cost savings to customers that we should have retained as profit.”

The company now uses PROS to segment customers and deliver recommended pricing. “For a particular customer or product, we will recommend a target price, a premium price, and a floor price,” says Vitalone. “If it’s a product we’ve never sold before, [the salespeople] at least have a price band that won’t embarrass them. We still give sales the leeway to make the final decision. They know the competitive situation better than anyone else here.”

While Vitalone won’t disclose metrics on margin improvement, he says they have been “meaningful, going from a situation of declining and volatile margins to consistent margin expansion.” As for the return on the investment, he says the payback was “very fast.”

Despite the assertion of Gartner’s Dunne that customers often need to retain an outside consultant to interpret the software’s output, McKesson’s beefed-up pricing department took on that role itself. “We have 12 people in the pricing department, up from 3 before we implemented the software,” Vitalone says. “They work closely with the category management teams that provide data on product costs and their impact on pricing.”

Westcon Group took a different approach. The network-technology distributor solicited outside guidance from consultancy AlixPartners, which taps its own software to assist clients with pricing and profitability. “Most of our pricing is driven by our key suppliers like Cisco, in terms of price lists they establish,” says Chuck Thropp, Westcon’s CFO of the Americas. “We then negotiated a discount with the customer off that price list. But we wanted a more refined way for determining the discount in order to maximize profitability.”

AlixPartners segmented Westcon’s customers primarily by individual customer profitability and what it cost Westcon to serve each customer. This allowed the company to better analyze pricing and its costs to serve and support those customers. While this may sound like an activity-based costing exercise, Thropp says the difference is that each customer was analyzed based on its unique level of cost to serve and specific value to the organization. “There were four or five products that really mattered from a margin standpoint, and many others that really didn’t,” the CFO explains.

As the software becomes mainstream, early adopters will lose their lead. “In 5 or 10 years, it will be a zero-sum game,” predicts Simonetto. But today there is a window of opportunity for companies to not simply blunder their way toward a minimally adequate pricing system, but to develop a strategy that provides a true advantage.

Russ Banham is a contributing editor of CFO.

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