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Taking Advantage of Tumultuous Times is a series rom Monitor ofering insights into critical issues organizations ace during this unprecedented period o
economic uncertainty, and how business leaders can use this time to seize opportunities or lasting change and growth.
As the global economy transitions through a period of unprecedented
volatility, the urge to wait out the economic storm is natural. But in
tumultuous times such as these—in which the recession coincides
with structural changes in global demographics, the spread of ubiq-
uitous connective technologies, the emergence of sustainability as a
key business issue and the blurring boundaries between commercial,
government and civic sectors which elevate expectations for corpo-
rate social responsibility—inaction is not an option. It is critically
important that commercial leaders resist the urge to hunker down and
Deending Proftability with Proactive Price ManagementBY TOM NAGLE, JOSEPH ZALE AND JOHN HOGAN
M A R G I N M A N A G E M E N T
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T
instead adopt a proactive stance that enables
them to protect and grow prots.
In this difcult economic period, customers are
considering lower-cost alternatives and reevalu-
ating their essential needs, and these shifts in
buying patterns are creating new winners and
losers. For example, sales of traditional PCs are
down dramatically in the recession. At the same
time, sales of lower cost (and lower functional-
ity) netbooks have jumped more than 160 per-
cent over the prior year. Importantly, many of
those customers are nding that they don’t miss
the incremental functionality of traditional PCs;
it’s fair to wonder if they will return to buying
PCs after the recession.
Just as the recession has changed customer
behaviors, it is changing the behaviors of sellers
as well by intensifying competition. For example,
Wal-Mart leveraged its cost advantage in gro-
ceries to launch a price
war in late January that
already has seen Bruno’s,
a regional chain in the
Southern United States,
le for bankruptcy.
Similarly, McDonald’s
has stepped up price-
related advertising in the
premium coffee sector to
take share from Starbucks at a time when cus-
tomers are questioning whether a latte is really
worth four dollars. As these examples illustrate,
the recession has created opportunities and
threats that companies ignore at their peril.
It would be imprudent to suggest that all com-
panies should take aggressive pricing actions
as McDonald’s and Wal-Mart have done.
Successfully navigating this recession, however,
does require a proactive approach to protect and
grow margins. In such uncertain times, business
leaders need to identify moves that generate cash
ow in the short term while also positioning their organizations for long-term prot growth.
This article will identify smart moves you can
make both internally and in the marketplace that
will help you take advantage of opportunities to
improve your competitive position—now and in
the future, so you will be in a stronger position
when the economy improves.
GROWING MARGINS
FROM THE INSIDE OUT
Even in the best of times, it is a given that com-
panies must continuously improve execution
of key business processes such as price setting,
negotiation and contract compliance. But tak-
ing control of a corporation’s pricing system is
even more urgent in an economic downturn.
While companies never operate in a vacuum,
tough times often make players more aggressive with pricing in an attempt to achieve sales goals
despite declining market demand. Recessions
increase the risk of price wars in which all sides
lose, and those conicts are often initiated by
companies executing tactical pricing moves with
no intent to spark broader price competition.
By more tightly controlling and improving the
process by which prices are set and managed,
managers can reduce the risk of inadvertent price wars, while also generating substantial
incremental prot. Our experience suggests that
focused efforts to improve price execution can
generate an incremental two to three percentage
points of operating income, even in a downturn.
These improvements come from shoring up the
SUCCESSFULLY NAVIGATING
THIS RECESSION REQUIRES A
PROACTIVE APPROACH TO PROTECT AND GROW MARGINS. IN SUCH
UNCERTAIN TIMES, BUSINESS
LEADERS NEED TO IDENTIFY MOVES
WHICH GENERATE PROFIT MARGINS
IN THE SHORT TERM WHILE ALSO
POSITIONING THEIR ORGANIZATIONS
FOR LONG-TERM GROWTH.
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leaks in your pricing system to capture revenues
that would otherwise be lost in excess discounts,
unenforced agreements and inconsistent applica-
tion of pricing policies.
The key to improving price execution is to
diagnose the sources of prot leaks in your com-
mercial system and build the business case for
change. Managers often underestimate the com-
plexity of their pricing processes and as a result
don’t fully understand the drivers of undesirable
pricing behaviors and the barriers to better ones.
For example, a life sciences company had been
experiencing relatively at margin growth of one
to two percent for nearly 18 months despite the
fact the sales had been increasing at a healthy
ve percent clip during the same period.
A simple discount analysis discovered that
on and off-invoice discounts for key products
ranged from two to 75 percent with almost no
correlation with volume. Moreover, the dis-
count spread had increased substantially over the very same period that margin growth had
stalled. Subsequent investigation revealed two
root causes for the problem. First, key market-
ing managers were heavily focused on growing
market share and had essentially been buying
that share with aggressive price discounts. The
discounts were not highly visible because of the
loose, poorly controlled process for discounting,
rebating and waiving charges.
The second root cause of the disappointing pric-
ing performance was found in the sales organiza-
The management team at Tech Co., a Fortune 200 technology
manufacturer, recognized a coming recession and made aggressive
moves to use it to their company’s advantage. Historically, the man-
agement team responded to downturns with aggressive cost cutting.In this instance, however, cost cutting was il l-advised because the
company needed to aggressively support a pipeline of promising
new products when the business cycle turned. The question the
team addressed: How could the company generate incremental
operating profts to avoid critical headcount reductions that would
endanger future growth?
Tech Co. attacked the problem by focusing on price execution
improvements to identify opportunities to deliver bottom line results
by the end of its scal year. The project leaders focused on three
critical areas:
THEY PERFORMED A FAST-CYCLE DIAGNOSTIC to identify
the best opportunities to realize short term improvements. The
diagnostic mined the transaction data base and mapped key
pricing processes to identify “prot leaks” where prices were not
implemented according to policy. By analyzing transaction prices,
for example, Tech Co. was able to identify many customers that
were purchasing key products at very low prices—often resulting in
negative prot margins. This was just one of 25 potential opportuni-
ties the company uncovered in the global diagnostic.
THEY FOCUSED ON EXECUTING those opportunities with the
biggest impact and fewest barriers to implementation. Tech Co.
acted quickly to enforce pricing oors for low-margin accounts and
reducing the variability of its pricing of key products. The companyoffered a price discount for online orders, restructured contracts to
minimize special price breaks, and established rates for premium
service delivery and the charge for a minimum product order. Tech
Co. gave customers three months to transition to the new pricing
model, to minimize the loss of customers to rivals.
THEY IDENTIFIED CRITICAL ENABLERS to ensure the changes
created lasting impact. The management team wanted to ensure
that any changes in their pricing processes would be long lasting
and form a solid foundation to support the company’s upcoming
product launches. They ensured that every improvement was
embedded in the organization by ensuring that the necessary data,systems, incentives and processes were in place so that pricing
decisions would be made consistently throughout the organization.
Through these efforts, Tech. Co. identied millions of dollars in addi-
tional operating income by focusing on internal improvements to their
pricing process. Moreover, the effort created awareness of pricing as
a strategic growth lever.
TECH CO. MOVES FAST TO IMPROVE PROFITABILITY
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tion. The long-time sales strategy was to build
deep relationships with customers to become
a trusted provider of solutions to their most
pressing technical challenges. The goal was to
make price less important in the selling process
to enable higher prices and volume. The reality
was that over time, sales people developed close
personal relationships with their customers and
often felt obligated to provide their closest cus-
tomers with the best prices. Thus, as marketing
gave deeper discounts to win new customers, the
sales organization responded by ensuring that
their relationship accounts got even better dis-
counts to protect their preferred status.
This example is but one of the opportunities that
the life sciences rm discovered as it began to
identify and seal the leaks in its pricing execution
process. A detailed analysis of the company’s
pricing discount practices, combined with an
analysis of its sales organization to identify root
causes for its poor pricing performance, enabled
the company’s leaders to build a robust business
case for the size of the opportunity. In the end, the rm was able to reverse the margin declines
while maintaining its sales volume growth.
GROWING MARGINS IN
UNFRIENDLY MARKETS
The economic downturn has led buyers, both
end consumers and business customers, to
change their purchasing behaviors in notable
ways. Customers are more price-sensitive and willing to shop in new channels for the goods
and services they need. They are willing to do
more to secure better deals while taking a hard
look at their needs and wants. These shifts in
customer behavior, combined with an analysis of
what your competitors are doing (or not doing),
present opportunities to gain share and margin.
Here are three strategies that will help you nd
market openings in a recession:
1. Increase Category Spend through
Precision Discounting
Recently, select Hyatt hotels implemented a new
discount program targeted at local residents,
offering substantial discounts for dinners in their
underused restaurants. While hotel guests con-
tinued to pay regular rates, the hotel was able to
bring in more customers to dine, thus covering
xed operating costs and building brand recog-
nition in the local community.
The power in Hyatt’s approach is that it
accounted for the fact that, even in a downturn,
not all customers are highly price sensitive. The
management team could simply have dropped
prices in their restaurants, but that would have
cut prots for the business travelers staying in
the hotel who are less concerned about prices.
Instead, Hyatt used a laser-like focus to identify
a growing segment of price sensitive custom-
ers and then designed a discount program to
ensure only those customers got lower prices.
By analyzing price change and sales volume
data, a pricing organization can determine which
customers deserve discounts and which should
be paying the same or more. The key mistake
to avoid is to assume that all customers will
respond to price cuts in similar ways. Instead,
take a segmented approach that accounts for
changes in price sensitivity as well as changes in
desired value.
2. Leverage Competitive Advantagesto Take Share
McDonalds entered the premium coffee cat-
egory in late 2006 with the belief that it could
take share from coffee powerhouses such as
Starbucks and Dunkin’ Donuts. McDonald’s fol-
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lowed a seemingly infallible approach of improv-
ing its product quality at signicantly lower
prices than Starbucks. Surprisingly, McDonald’s
coffee sales were disappointing through 2007
and into 2008 despite heavy investments in
advertising to support the effort. That changed
in the fourth quarter of 2008 when sales surged
as increasingly price sensitive customers recon-
sidered the price-value ratio of their morning
brew. As Starbucks is slated to close 600 stores
in the United States in 2009, McDonald’s is
accelerating the global launch of lattes to lever-
age the emerging opportunity.
It would be easy to dismiss McDonald’s aggres-
sive price moves as simply being in the right
place at the right time. But that perspective
would overlook McDonald’s inherent advan-
tages that ensured it would succeed in its share
grab. First, McDonalds was able to leverage
its position as a small market-share competitor.
When it cut prices on a high margin product like
coffee, McDonald’s knew that it only needed
to capture a few percentage points of share in
order to increase prots. In contrast, Starbucks
position as a market leader placed it at a dis-
advantage because it would have to cut prices
across nearly 50 percent of the market in order
to respond to McDonald’s moves.
A second advantage that McDonalds lever-
aged was related to brand equity. Starbucks has
invested heavily to build its brand around deliv-
ering high quality coffee in a relaxing environ-
ment. Much of that investment would be lost if
Starbucks chose to compete on price instead of
value. Combined, these advantages are enabling
McDonalds to take share from Starbucks with-
out signicant risk of retaliation. Although not
all aggressive price moves are winners, the struc-
tural changes caused by recession can uncover
opportunities to improve your market position
if you are able to spot them and leverage your
advantages to press the attack.
3. Strategically Unbundle to DefendAgainst Aggressive Pricing
In the 2001 recession, Distributor Co., a lead-
ing technology distributor in the U.S., found
itself losing share to a small competitor that was
competing largely on price. As the economy
worsened, the share losses mounted and spurred
an internal debate within the company about the
best response. Many senior managers advocated
for a broad and aggressive response that would
leverage Distributor Co.’s signicant economies
of scale to compete aggressively on price. Others
argued for a more measured response that could
deect the attacks without broadly undercutting
margins across the board.
To resolve the debate, Distributor Co. conducted
a careful analysis of customer business models
and value to better understand what custom-
ers valued and were willing to pay for if asked.
The results of the study were compelling. The
management team learned that most of the sales
losses came from a growing price-sensitive
segment whose business model relied primar-
ily on efcient logistics and breadth of supply.
Distributor Co.’s unsurpassed customer service
and technical support were not valued by this
segment and, not surprisingly, they were not
willing to pay a premium for it.
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The solution was straightforward once the
problem was clearly dened. Distributor Co.
unbundled its high value solution to create a
lower price, lower value offer for the price-
sensitive segment (see table above). This
approach enabled them to compete aggressively
on price against the smaller competitor and do
so protably because of the lower cost of the
unbundled offering. The power in the approach,
however, stemmed from the fact that the aggres-
sive pricing was not attractive to Distributor
Co.’s other customers whose business models
relied on quality technical support. For these
customers the added value of the technical sup-
port far outweighed the incremental price they
had to pay.
A STRATEGIC APPROACH
TO PRICING PAYS OFF
From our experience, it’s clear that a stra-
tegic approach to pricing can generate sig-
nicant returns, even in a recession. Those
returns may take many forms including higher
prices, lower discounts and increased volume.
Success requires organizational commitment
and thoughtful leadership to see an enterprise
through tumultuous times. And those that make
it through the downturn will have strengthened
their position when the recession ends.
SUCCESS FOR DISTRIBUTOR CO.: A REDESIGNED OFFER AND POLICIES THAT ENFORCE VALUE-PRICE ALIGNMENT
Discount Option Standard Option FullService Option
Pricing > Lowest Price Competitive Price Premium Price
Ordering > Must order onli ne Can use any method o ordering Ca n use any method o ordering
Fulfllment > Within two business days Within one business day Same day
Handling Fee > For orders le ss than $1000 For orders less than $500 For orders les s than $100
Freight > All reight expenses chargedFree reight or ordersmore than $2000
Free reight or ordersmore than $1500
Presales
Tech Support> Not included
Requires minimum purchaseo $50K per quarter
Requires minimum purchaseo $30K per quarter
Postsales
Tech Support> Not included Not included
Requires minimum purchaseo $30K per quarter
Financing > At order 30-day net terms 30-day net terms
Sales Support >Available or complexorders only
Available or placement pricing,availability, and order verifcation
Available or placement pricing, availabil-ity, and order verifcation
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Copyright © 2009 Monitor Company Group Limited Partnership.
All rights reserved. Reproduction in whole or part is prohibited
without permission.
www.monitor.com
About Monitor works with the world’s leading corporations, governments and social sec-
tor organizations to drive growth in ways that are most important to them. The
frm oers a range o services—advisory, capability-building and capital services—
designed to unlock the challenges o achieving sustained growth.
About TOM NAGLE
About JOSEPH ZALE
About JOHN HOGAN
Tom Nagle is a partner at Monitor and founder of the Strategic Pricing Group, Monitor’s com-
pany focused on pricing and value capture strategies. Dr. Nagle is a frequent keynote speaker
and former professor of marketing and strategy at the University of Chicago and Boston
University. He is the author of the bestselling book The Strategy and Tactics of Pricing, and
has published in MIT Sloan Management Review and Harvard Business Review . E-mail him
at [email protected] .
Joseph Zale is a Partner and Global Account Manager in Monitor Group, where he leads
the pricing strategy practice. Prior to joining Monitor Group, Joe was a Vice President and
Managing Director at Strategic Pricing Group (SPG), which was acquired by Monitor Group
in 2005. Joe has worked across multiple projects in a diverse set of industries including
medical products, data services, basic materials, capital equipment, publishing and print-
ing, and semiconductors. E-mail him at [email protected] .
John Hogan, co-author of The Strategy and Tactics of Pricing 4th ed., is a recognized
thought leader on the topic of strategic pricing and building pricing capabilities within the
firm. As a partner at Monitor Group and leader in the strategic pricing practice, John has
worked with clients to develop more effective pricing strategies in technology, software,
distribution, manufacturing, financial and professional services, and pharmaceutical sectors.
Taking Advantage of Tumultuous Times is a series o articles rom Monitor oering
insights into critical issues organizations ace during this unprecedented period.
Today’s economic uncertainties, combined with multiple, signifcant and disruptive
orces, change the nature o industries and competition across the globe. The articles
explain how business leaders can seize opportunities during these times or lasting
change and growth. Read more at www.monitor.com/tumultuoustimes.