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Leading-edge Pricing:Harnessing the Power of the WaterfallBy Anthony Milani, Ray Florio, Tiago Salvador and Hyun Suk Oh
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Customers will always want more for less. In an effort to provide
the most compelling value proposition, companies in a wide range of
industriesconsumer packaged goods, resources, professional services,
hospitality, oilfield services, manufacturing and moreface continuouspressure to provide fresh offerings, extend existing services and find new
partners with which to collaborate. Recent economic turmoil has greatly
accelerated this process, as companies merge, consolidate and expand
to provide the best, most comprehensive deal to more ROI-focused
business-to-business customers.
Unfortunately, this had led to such diverse and multi-faceted offerings
that most companies cannot hope to peg the underlying costs of
deals to determine if they are pricing and negotiating profitably. More
importantly, these companies are limited in understanding whether they
are pricing and negotiating the right products to the right customers.
The processes and systems that identified and tracked their cost data,
designed for creating financial statements, were never intended toprovide sales organizations with the inputs required for sophisticated deal
and contract management.
While a fully allocated price and cost waterfall can address this
issue, many companies struggle in its creation, value realization and
industrializationa comprehensive approach that is necessary forsuccess. Fortunately, there are some key steps high performance
businesses can take to avoid the typical pitfalls.
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While businesses are locked in challenges
to enhance value propositions that attract
and retain customers, the recent economicturmoil has greatly accelerated the process.
Just think of all the mergers, acquisitions,
joint ventures and consolidation activity that
happened during the height of the recession
in 2009. Even as the recovery takes hold,
the trend appears to continue in 2013 based
upon a recent study that shows 76 percent
of respondents anticipated their company
would be involved in merger activities
this year.1
All of this activity has resulted in the
majority of companies expanding their
product and service catalogs, as well astheir cost base and resources much more
quickly. Moreover, once these new offerings
are available, they begin permeating
the majority of contracts, as sales
representatives look for any advantage over
the competition, with little visibility into
the true cost of that extra edge.
Employees and facilities that become idle
when services are underutilized also remain
an ongoing cost that are not typically
assigned or tracked. Unfortunately, if
Introduction: Doing more for lesscalculating the profitability of each deal,
customer or product was difficult five to 10
years ago, a true measure of profitability iseven more problematic today.
No one would advocate pricing solely
based on cost. For the vast majority of
companies, such a fundamental basis for
pricing became obsolete decades ago.
However, understanding true cost to serve
is a critical component of decision making,
and is a necessary first step to employing
more sophisticated pricing. Of course, for
many corporations, this key input is sorely
lacking.
2
1.Mergers and Acquisitions on the Rise for 2013, Proformative, Jan. 23, 2013,
http://www.proformative.com/news/1497051/mergers-acquisitions-rise-2013
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Fortunately, companies can gain the necessary insights and act upon them by developing a full price and cost waterfall for each deal.
This practice provides insight into true profitabilityafter all costs are taken into accountbeyond just cost of goods sold (COGS). The
waterfall might include customer-specific costs, such as specialized sales personnel or marketing events; nuisance costs like restocking
from returns; and even costs that may not be in the profit and loss statements, such as late payment costs (see Figure 1).
$0$K $20 $40 $60 $80 $100 $140$120
Pocket Margin
Basic Product/Service
Add-ons and Extras
List Price
Regional Adjustments
Regional Price
Contracted Discount
Contracted Price
Additional Negotiated Discount
Negotiated PriceAllowances/Returns
Rebates/Chargebacks
Promotions
Volume Discount
Payment Terms Discount
Surcharges
Expedited Freight
Pocket Price
Cost of Goods Sold
Freight
Third Party Charges
Other Variable Costs
Contribution Margin
Brokerage Fees/Commissions
Marketing and Advertising
Sales Compensation and Benefits
Proposal and Relationship Building
After-Sales Incentives
Product Development
Customer Service
Disputes
Bad Debt Expense
Inventory Carrying CostsStandard Terms
Non-Standard Terms
Cost of Late Payments
Technical Services
Dedicated Fixed Assets
Other Indirect Costs
Figure 1: Most companies look at contribution margin to determine profitability by deal; however,they should be looking at pocket margin
(Source: Example waterfall of cost s to take into account using figurative data.)
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One of the first reactions to a waterfall
is the ever common, We dont keep
track of all those costs at a deal level.Typically, companies do not. Instead they
build their financial tracking systems and
processes for the purposes of generating
financial reports. In fact, for some complex
businesses, fully tracking all of these
components could seem insurmountable,
but some simple logic can quickly and fairly
accurately assign the appropriate costs to
each deal. If done properly, it will provide
actionable information that is a close
approximation to reality. The tradeoff in
precision will be worthwhile.
Some executives in the organization may
still hesitate because they do not see the
benefits of this level of information, or
they believe COGS and other direct costs
is enough information for decision making.
Despite this common belief, companies
that do develop a waterfall often find the
decisions based on direct costs alone were
not right. As a matter of fact, customers
previously considered to be highly
profitable may actually have large indirectcosts, leading to losses on most sales.
Understanding true profitability will
impact far more than pricing decisions.
Incorporating this information into
customer, product and sales strategies can
make a difference for companies. Imagine
being able to direct the right products to
the customers who will actually provide the
highest bottom line profits for the company,
instead of those who will simply pay the
most.On top of that, consider the benefit in
negotiations if the sales organization can
leverage past information to quantify the
impact on margin for each individual add-
on service or contract term on margin, and
make the appropriate tradeoffs. If that is
not compelling enough, think how much
As an example, meatpackers or other food and beverage companies have
often found that some of their large distributors actually eroded profits due
to strict packaging requirements. These requirements demanded more labor
and equipment in facilities than were needed to service other customers.
In addition, frequent returns necessitated extra sales and support staff,along with associated costs for restocking and waste. Looking only at direct
costs, these types of customers previously may have been considered the
first choice for any sales; however bringing all factors into view provides a
different perspective for the customer strategy.
better cost-cutting decisions will be now
knowing how much the company leverages
a particular resource and the value it
adds, along with understanding the degree
necessary to cut costs in order to maintainproper margins on market-relevant prices.
In reality, though there can be major
benefits, most companies quickly realize
that achieving full visibility into the
true profitability of each and every deal,
and then getting the benefits from that
knowledge, is neither a simple nor a short
process. Many companies attempt it
numerous times before f inally achieving
success. Fortunately, the pitfalls they
encounter tend to be the same. The
companies that understand the key barrierscan greatly simplify the process and
shorten the time to realizing the benefits,
and eventually adopt this new way of doing
business throughout their organization.
But were not structured to do that
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Guiding principles for the journeyThe journey towards understanding and leveraging true profitability in a companys decision making can be broken down into three
distinct phases: waterfall creation or model building, value realization or acting upon newfound opportunities, and industrialization or
making the entire process sustainable in the organization (see Figure 2).
Figure 2: The three-phase journey to achieving visibility into true profitability
Waterfall Creation Value Realization Industrialization
Before delving into the details, there are a
few guiding principles to keep in mind:
Have the right sponsorSince the journey affects so many areas
across the company, the appropriate
sponsor should be a well-respected
influencer at a high enough level to bring
together the necessary stakeholders. By
being engaged throughout the journey, thesponsor will actively serve as an advisor
providing guidance and ensuring
forward progression.
Make it an ongoing journeyThis is not a one-time effort to achieve short-
term goals. The true advantages from a deal-
level profitability effort come from ongoing
benefits realization year over year. Putting in
place a waterfall is a cultural shift; getting
the most out of it requires that it become
part of day-to-day life in the company. If
the initiative is viewed only for short-term
margin gains, the company will get only asmall share of the potential benefits.
Let the business leadDo not make this a finance or IT initiative. All
of the decisions, outcomes and success relies
on the entire business. A waterfall approach
needs the business to fully embrace and drive
it from the beginning. Sales, operations and
leadership need to understand and accept
responsibility for the quality of the outputs
and improvements. Getting these functionsonboard and engaged at the onset will more
likely lead to success.
Start smallTrying to implement deal-level profitability
across the entire business all at once is
daunting. Some functions will be less open
to this change until its value is proven, and
there will be a large number of differences
in the cost base across business lines and
geographies. Begin with a segment of the
business that is receptive, demonstrate
success and then expand from there.
Focus on outcomesA good profitability model is extremely
helpful, but it is how an organization
leverages it that counts. The entire effort
is only worthwhile if it results in tangible
benefits for the business, and those benefits
need to cover the spectrumfrom simply
plugging data gaps to make way for future
improvements to the model, to identifying
major profit opportunities for the company
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A detailed look at the three phasesAs companies embark on the journey
depicted in Figure 2, there are important
details for each phase, as well as methodsto avoid typical pitfalls during each:
Waterfall creationThe first step to gaining and acting on a full
understanding of deal-level profitability is
to calculate that profitability. The resulting
waterfall model will serve as the basis for
the remainder of the effort . Unfortunately,
many companies find themselves halted by
barriers at this early stage, trying numerous
methods to develop a waterfall butfalling short.
Companies can use this situation to their
advantage, though. Analyze previous
attempts and understand why they failed.
Was the model growing too complex?
Did it require too much effort to sustain?
Did it grow outdated too quickly? Did the
necessary stakeholders not understand
it? Whatever the cause, the learning
experience helps to avoid making the same
mistake again.After identifying what caused the company
to stall, or if attempting this for the first
time, begin with the philosophy that the
end product is not a financial report or an
accounting tool. It is a decision-making aid
meaning if it is off by $57 dollars on $3
billion in revenues, it is unlikely that the
resulting actions will change significantly.
Efforts to reconcile small discrepancies
across multiple financial systems usually
do not add much value, so avoid tracking
every penny. Provided that the results alignreasonably well with a widely accepted
external standard, such as the companys
profit and loss statement, then the results
are close to accurate for decision making
and will build confidence in the underlying
numbers.
Allocating costs down to individual deals is
likely to be the next sticking point, and one
that generally generates debate over how
to properly assign costs. Take an approach
that balances thoughtful vs. thorough in
the methods. It is likely that each business
line and geography has only a small number
of significant costs. Rather than attempting
complex allocations or even developing
difficult-to-maintain activity rates for all
costs, focus where it really matters.
Spend time with a broad group ofinfluential stakeholders to find acceptable,
more sophisticated methods to allocate
costs as accurately as possible. The less
substantial costs can rely on simple logic.
It will be far easier to gain stakeholder
agreement through this approach, and it
will prove an effective means of balancing
collaboration with top-down direction.
Most stakeholders will appreciate inclusion
and will feel valued by bringing their
insights into the process. As a result, the
waterfall will not be seen as complexcalculations and they are more likely to
champion the initiative, leading it towards
success.
Once the company has the numbers, begin
an iterative process of validating them with
the stakeholder group. Not only will they
help identify potential flaws in allocation
logic, but also they can pinpoint some
underlying inconsistencies in billing or
invoicing processes that result in inaccurate
inputs into the models. These inconsistencies
will either need to be addressed or worked
around to ensure the model represents the
true state of the business.
A critical element to the waterfall is ensuring the base list price is current and
market relevant.
Get Ready: Address issues in the base list price.
Get Set: A base list price aligned to strategies and segment goals enables the
discount analysis required by the sales force to effectively negotiate with
customers and it minimizes risk for erroneous conclusions when comparing
the discount bar of the waterfall.
Now Go: Begin the journey of true profitability through Waterfall Creation
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A leading oilfield services provider recently put this approach into practice
for their final and successful attempt at developing a waterfall. From
previous attempts, the company learned that overly complex or manually
intensive cost allocations eventually met with failure. By adapting the
approach to use simplified assumptions as the basis for the logic, their
waterfall effort then allowed them to effectively focus on getting the
more significant costs correct as well as the ability to turn their insights
into actions. Working with key representatives from sales, operations andfinance, the provider was able to develop reasonable, understandable cost
allocation methods that everyone could support.
After reconciling to the overall profit and loss statements, an iterative review
process of the resulting models further enhanced the organizations comfort
levels with where costs were being pushed down, leaving the critical decision
makers open to acting upon the insights gained. In fact, many of those
involved early in the process became outspoken champions of the profitability
initiative as it deployed to other business lines and geographies.
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Value realizationA waterfall is useful only if it results in
actual improvements. The model may tell
where to focus attention, but once the
company knows that, it is time to act on
the most promising opportunities. Typicallythe common barriers to realizing the
benefits are lack of direction, doubts about
the ability to actually produce outcomes,
and a general lack of time to pursue new
opportunities.
However, some simple practices can help
companies achieve more significant and
sustainable benefits, and in a manner that
builds support for the new profitability view
across the business. Moreover, with these
best practices in place, companies canmake value realization a permanent feature
of doing business, one which everyone
actively takes accountability.
Rather than setting an ambiguous goal
of simply improving profitability, the first
step to generating benefits is establishing
firm, attainable improvement targets based
on both benchmarks and internal analysis
of potential opportunities. In addition,
these end-goals need to be well known
across the organization and incorporated
into the overall business agenda. It is
paramount that leadership engages in
regular communications on the progress
the company makes toward its goals, with
clear visibility to executive sponsors and
functional leads.
Building a value realization review into
monthly leadership meetings, or even
establishing specific value realization
touchpoints, can help the business keep
moving toward objectives. It is advised that
those objectives are continually reviewedand updated as the business improves and
the market changes. Without this attention
to goals, employees tend to fall into their
normal routines and may not reach for the
potential opportunities.
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The second step is to set up a team who is
responsible for achieving these goals. This
team will be much more successful if it has
in-depth knowledge and support from all
the major functional areas likely impacted
including marketing, sales, corporatestrategy, operations, logistics, supply chain,
finance and IT. This broad base of expertise
will not only foster a better understanding
of how to act on opportunities, but will
facilitate the identification of significantly
more.
If opportunities emerge that involve an
underrepresented or even unrepresented
business function, the team should
involve that function in the opportunity
identification process. Gaining this kind
of internal support removes potential
barriers to realizing value. Also, to support
making this effort an ongoing component
of the companys culture and operations,
as well as bringing in fresh perspectives,
companies should cycle new members from
the business into the value realization team
every few months.
As this team and the remainder of the
business are acclimating to the value
realization effort and overall changes in
how they view profitability, some pushbackwill naturally occur. At this critical adoption
point, initiatives that require extensive effort
or prolonged time-to-value are not going
to win support. On the other hand, if the
value realization team prioritizes quick wins
that achieve significant benefits rapidly,
stakeholders will be inclined to champion
profitability efforts earlier.
Likewise, prior to starting any initiatives, the
team must work with each functional area to
estimate the benefits for each area as well as
the efforts required. This approach will help
the team to best understand ways to build
support upfront, before delving into more
involved and longer-term efforts. This will also
help with broadening the overall profitability
effort to other areas of the business.
In recent years, several leading clients have followed these guidelines
to jumpstart adoption of, and benefits generation from, their waterfall.
Accenture has often helped drive this process, with leadership setting
the stage, being involved from the very beginning and setting up value
realization teams from all functional areas, including off-site plant
operations and sales offices. For a typical client, those selected for these
teams are expected to spend at least five to 10 hours a week focused on
value realization, and their normal responsibilities are adjusted accordingly.Once these teams identify a number of opportunities, the business leads help
select those with the best trade-off between benefit and effort, and then
shift implementation to the appropriate groups.
When putting this approach in action, the companies involved soon start
realizing benefits, but this tends to work best if the value realization teams
are suitably rewarded. Continuing the process, Accenture will help lay the
groundwork for our clients to cycle new team members at regular intervals.
In many cases, the clients we have guided along this journey not only met
but exceeded the initial goals they established. Some even exceeded initial
profit improvement targets by as much as 50 percent, building considerablesupport for the profitability initiative among key stakeholders.
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IndustrializationOnce the company has its models, and has
begun leveraging them to generate actual
benefits, many employees may wonder how
they can sustain the initiative. At the same
time, fears may be high that the entireprocess may need repeating every quarter
or month, depending on refresh needs. A
company also may have a list of changes
that stakeholders want to incorporate after
using the waterfall, or there may be new
data sources to enhance the allocation
logic. How can executives be sure that all
of this is incorporated without introducing
errors that may compromise confidence, or
result in a cumbersome update process?
Start with the basics. Throughout theentire process, maintain and update clear,
concise documentation. This will allow
the company to understand the goal and
function of each part of the model, and
provide for an easier transition to resources
who may take on responsibility for it.
Moreover, clear documentation will allow a
more streamlined and efficient validation
process, allowing the right resources to
easily confirm or find errors in the model
prior to its widespread dissemination.
Once documentation and validation are
established, a change management process
will prove necessary. Similar to the way
software developers address multiple
changes in a single patch, schedule and
prioritize alterations to the model, providing
ample time to fully test and prepare the
organization for the new or different
features. It is best to not reactively address
every change request as it comes up since
these actions may serve as an incubating
ground for introducing errors. Similarly,investigate new data sources thoroughly,
and resist incorporating if requirements
involve high manual maintenance, or
introduce a wide disparity of approaches
across business lines and geographies.
Often companies ask whether this type of
effort should result in a technology solution
for true sustainability. This will depend on
specific needs and the complexity of the
models. While a company may have begun
Recently a global beverage company embarked on creating a new and
consolidated waterfall following a large merger. While the waterfall was
able to address and support key initiatives for the company, the after
effects of the merger resulted in allocation logic having to bridge multiple
systems and account for a myriad of processes. In addition to sustainably
weaving together these varied data sources and inputs, the brand needed
help streamlining disparate pricing management, approval processes and
field communications, leading it to leverage a major packaged technologysolution for pricing.
Through this transition, the documentation the company provided allowed for
much faster speed-to-value, and limited the costs of the industrialized solution.
the journey with a proof-of-concept based
in a simple spreadsheet, as the model grows
to encompass more of the complexities of
the entire business, it is unlikely this will
remain sufficient. However, it may not
require the biggest and best solution outthere. Some companies even find success
outsourcing the process to a third party.
The key to making the right decision is to
embark on this path prior to selecting the
way forward. To find what works for the
company, assess the design with existing
tools and capabilities. Once the full scope
is understood, think about making a
technology investment. This will help the
company be better positioned to understandthe true value each solution provides.
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Conclusion
Companies across multiple industries are being driven to negotiate much more complex and
intricate deals, causing them to lose touch with the ability to quickly and easily measure
true profitability. Some companies have made numerous attempts to regain the appropriate
levels of visibility only to stumble into the typical barriers and pitfalls. The high performing
businesses that learn from these obstacles, establish broad support, validate the results
continuously, focus on objectives, support outcomes, and make intelligent choices to sustain
the process realize their achievements and overwhelming levels of success.
The benefits from reconnecting with this key metric are both broad and substantial,
spanning customer and product strategies, as well as pricing and cost reduction tactics.
Assigning the right resources to the right areas can prove a true competitive advantage
for the long run.
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Copyright 2013 Accenture
All rights reserved.
Accenture, its logo, and
High Performance Delivered are
trademarks of Accenture.
ContactsFor more information about applying a
waterfall pricing approach in your company,
please contact:
Anthony [email protected]
Ray Florio
Tiago Salvador
Hyun Suk Oh
About AccentureAccenture is a global management
consulting, technology services and
outsourcing company, with approximately
266,000 people serving clients in more
than 120 countries. Combining unparalleledexperience, comprehensive capabilities
across all industries and business functions,
and extensive research on the worlds
most successful companies, Accenture
collaborates with clients to help them
become high-performance businesses and
governments. The company generated net
revenues of US$27.9 billion for the fiscal
year ended Aug. 31, 2012. Its home page
is www.accenture.com.
About Sales & CustomerServices (CRM)Sales & Customer Services (CRM) helps
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more profitable customer relationships.
We offer a broad range of innovative
capabilities that address every aspect of
the customer experience, including pricing
strategy and profitability assessment,
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sales force execution, customer service,
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and retail/branch operations. We use
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