• Running

    You can learn a lot about how people approach their careers by looking at how they approach their hobbies. Running is such an important part of my life that I have created a separate blog for it, Predawn Runner. Whether you are recreational or competitive, I welcome you to join me there in discussing how we fit running into an already-full life.

Successfully Selling Through a Price Increase

By Greg | Published: July 14, 2010

With the economy on the mend (maybe), the potential for raw material price inflation due to increasing demand is rearing its ugly head.  In fact, with metals, energy, and agricultural inputs well above their lows from early 2009, inflation may already be a fact for many manufacturers.  Therefore, it is time to consider recouping some of this lost margin through price increase actions.  I’m not talking about the “wink-wind, nod-nod” type of price increase where your major customers know that a greater discount off of “list” will offset the list price increase.  I’m talking about increases where you expect to see rising margins (or, at least margins that fall less quickly), and thus you have to implement the price change at a vast majority of your accounts.

Having had the experience of selling through price increases, there are several tips I’d offer as to how to be effective at getting your customers to understand the need and accept the realities of the situation.  As in all business dealings, the right degree of openness and communication is key to successful negotiations.

  1. Try to avoid the appearance of a “regular” price increase schedule. If you pursue price increases at the same time every year, for example, you lose any credibility on efforts to tie the increase to specific inflationary pressures.  Also, your customers become immune to the increases as such a procedure is typically associated with the practice of increasing list prices while maintaining prices for existing accounts.
  2. Provide the appropriate amount of notice. You should consult with legal counsel on what is appropriate for your business, as too much notice could be construed as “signaling”.  However, providing some notice (typically 30 or 60 days) provides a window in which to negotiate with customers before the increases take effect, so that renewed contracts and agreements are set in time for the increase.
  3. Prepare a good defense of the rationale for the increase. While you are certainly entitled to price your products in whichever manner you choose (ideally, what the market will bear), it can be useful to help customers understand why you need to take the price actions you are implementing.  This can take the form of a presentation showing (in a generic, indexed form) the impact of material cost inflation on your business, or the cost trends in critical raw materials.  You need to be careful not to reveal confidential information of course, and to show data that supplements your decision without either contradicting it or exaggerating the point.  Therefore, careful thought and preparation is required in preparing such a tool, but the impact can be significant.
  4. Consider in advance what tradeoffs are acceptable in negotiations. I don’t want to get into a significant discussion on negotiation best practices in this post, but suffice it to say that you should work out acceptable alternative scenarios (extending an existing contract with a guaranteed minimum volume, or delay an existing increase in return for more significant future ones, for example) prior to your discussions with customers.  In this way, you are able to use the price increase as leverage for achieving other objectives in relationships with key customers.
Examples of Price Increase Justification Data

The price increase process is tedious, but proper execution is absolutely critical to ensuring the ongoing profitability of your business – can you imagine a world in which you never increase prices?  Therefore, taking the time to invest in tools to support the increase and identifying negotiation approaches is well spent, and can help to improve the effectiveness of your pricing strategies.

Does anyone else have best practices they have used or experienced in regards to price increases?

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Innovation in Aftermarket Offerings for Industrial Marketers

By Greg | Published: June 25, 2010

Often the most profitable, yet most neglected, portion of an industrial equipment company’s portfolio is its range of aftermarket solutions, such as replacement parts and repair services.  Typically a captive market, aftermarket parts and services offer significant profit margin potential, yet the attitude most often in place at industrial equipment firms is that such sales “just happen” and there is not much that can be done to influence them.  This attitude overlooks the great improvement that even a small increase in aftermarket sales can provide to the bottom line.

You may wish to make your spare part kit a little better organized than this. Photo used under Creative Commons License: http://www.flickr.com/photos/coweater/ / CC BY-SA 2.0

Opportunities exist in both parts and services, but the challenges faced in recognizing these opportunities do differ.  Parts offer the potential for higher margins, but pressure on costs and inventories at manufacturers often limits their desire to hold spare parts.  The margins on services (like repair, inspection, installation, etc.) are often capped, as it is easier for a customer to understand and thus negotiate rates on labor, travel, and the per diem allowance.  Thus, the approaches to realize this untapped potential differ for parts and services.

There are a couple of generalizations about industrial customers that should be understood before plotting an aftermarket strategy.  First, it is generally easier to add a small amount of funding to an existing project or appropriations request than to start a new one.  Second, many industrial companies believe they can do their own maintenance, yet have cut such staffing to the bone.  Finally, unplanned downtime creates urgency, recognition of what production time is really worth, and a temporary willingness to spend to get production re-started and avoid future issues.

The goal in driving aftermarket success is to accelerate the rate at which purchases are made (for example, by having the customer purchase parts before they are needed) or gain revenue through value-added services where the cost can be controlled.  There are numerous familiar examples that can be drawn from the consumer-marketing world, some of which apply directly to industrial products.  Such examples include:

  • Extended warranties – these play to the fact that it is easier to gain additional funding for existing projects, and are particularly appealing where the customer has limited experience with the type of equipment being provided (much as consumers are more willing to buy an extended warranty with their first plasma television).
  • Spare part kits – again, when provided as an option on the initial purchase, it is much easier to get funding for such kits approved.
  • Expediting fees – when a customer is down, it is reasonable and maybe even expected that you would offer rapid delivery at a higher (but not outrageous) fee.

Some of the examples are less obvious, but still value, and largely revolve around being able to plan and control your labor costs in providing services.  Some of these ideas include:

  • Service contracts – when you have a sufficient number of contracts in a given region, you can spread the often-overwhelming travel costs over a number of contracts, thus making the price and your margins reasonable.  The key is to be able to control the service or inspection schedule such that the travel costs can, in fact, be predicted and controlled, and to convince the customer that your “expert” staff can provide better results than their stretched in-house maintenance team.
  • Inspections – while you may only be able to charge a nominal amount for inspections, you can often make recommendations on repairs or spare parts that can make up for the slim margins on the inspection itself.  At a minimum, any service call should include an inspection with recommendations on spare part purchases or repairs.
  • Exchange programs – for standardized and portable equipment, offering an exchange program, whereby you replace a unit being repaired with a “like new” substitute, can provide both the urgent response the customer needs and good margins.  The exchanged units can be repaired at your leisure, and held for future exchanges.
  • Overhauls – often, if a unit is being repaired in the field or has been shipped to your facility, you can offer the customer a more thorough overhaul of the equipment (replacing wear components, tightening adjustments, etc.) at a reasonable incremental price.

Does anyone have experience with having developed better aftermarket approaches for industrial equipment or similar sectors?  Have you seen challenges applying the above approaches?

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From the Archives:
The Running Manifesto

By Greg | Published: December 10, 2009

The Running Manifesto has moved to a new home on the Predawn Runner blog; please be sure to stop by to view the manifesto and join the conversation on fitting running into an already-full life.

Should you find these thoughts motivating enough (as some apparently have), I’m happy to announce The Running Manifesto Shop on CafePress, offering shirts and prints of the manifesto.

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Book Review – Beating the Commodity Trap

By Greg | Published: May 26, 2010

Shortly after posting my recent write-up on the use of value equivalence lines (VELs) for strategic pricing, a new book by Richard D’Aveni called Beating the Commodity Trap: How to Maximize Your Competitive Position and Increase Your Pricing Power came to my attention via a review on strategy + business.  I eagerly purchased the book, and managed to read it over the course of a trip to San Diego.  This post highlights a few key points to the book, but suffice it to say that I highly recommend it to anyone involved in strategic pricing decisions, especially if you work in an industry facing commoditization pressures (which, at some point, is nearly every industry).

D’Aveni defines three types of commoditization situations that are most typically faced:

  • Deterioration – the rise of low cost / low benefit options that appeal to a significant segment of the market (in other words, the lower left of the VEL or price-benefit line).
  • Proliferation – the segmentation of the market into ever-finer niches through rapid new product introduction around your established price/benefit position.
  • Escalation – the introduction of breakthrough innovations simultaneously offering ever-higher benefits at lower costs (in other words, shifting the VEL or price-benefit line downwards and to the right)

D’Aveni also defines three types of responses to these pressures:

  • Escape the trap – by moving your position along the price-benefit line or shifting channels, focusing on the most immediate threats, or re-seizing the momentum (through innovative new business models, for example), you can avoid the most threatening competitor.
  • Destroy the trap – through redefining price or benefits in the industry, overwhelming the competitor by out-proliferating them, or taking blocking actions (such as locking up long-term supply agreements), you can nullify the advantages that the competitor has gained.
  • Turn the trap to your advantage – by proliferating around your competitor to trap them in the low end, finding white space in the price-benefit line, or building your own innovation momentum, you can in essence confine your competition to a limited portion of the market.

D’Aveni presents a several tactics appropriate to each threat / response combination (though, in some cases, only one possible tactic is discussed). The book is full of examples of companies facing and responding to these threats, many of which will be familiar (such as the proliferation of hotel brands in the 90’s, and responses to the entry of Zara as the low-end fashion retailer in Europe).  There are one or two examples that may not be as familiar and this does rob them of some of their educational value.

At times, the fit of the “tactics” to the “threat / response” schema seems a bit forced, and as always it is clear that implementing such tactics in your own business can be a challenge.  And the author clearly emphasizes that even recognizing you are facing a commoditization trap early enough to take action can often be difficult.  The greatest strength of the book is the use of the VEL (price-benefit lines) to illustrate the examples.  Just becoming more familiar with this powerful pricing and product planning tool makes the book worth the price and, at just 224 pages, it is a fast read and valuable reference source.

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Seven Leadership Lessons from the Marathon

By Greg | Published: May 20, 2010

One’s approach to their personal hobbies says a lot about their approach to professional pursuits (so long as they are passionate about what they do).  Successfully reaching a personal goal provides lessons that apply to professional endeavors.  Having recently reached my own goal of qualifying for the Boston Marathon, this is a good opportunity to reflect on the approach that got me there, and what lessons apply to one of my professional passions – leadership development.

Set Specific Goals

It may seem intuitive, but to reach a goal, you first have to set one.  All too often, actions are taken without a specific goal in mind because they seem like “the right thing to do.”  I spent much of 2009 just running with the general goal of losing weight, but not committing to a specific target.  While exercise is certainly noble, without combining it with a better diet and monitoring calories, there may be little weight loss.  When I got specific on my goal to qualify for Boston, I determined losing 20 pounds by May would be a key objective along the path, and it became easier to control my diet in addition to increasing my calorie burn.

Commit Yourself Publicly

If you don’t make your goal clear and visible, you lose a valuable source of incentive to reach it – your pride and the encouragement of friends, colleagues, or employees.  How can anyone offer you support if they don’t know what you are working towards?  In the case of qualifying for Boston, I first committed to my wife that I would get there (and she developed an enthusiasm about going to Boston next year), and then to my friends on Dailymile, who offered further support and encouragement for reaching the goal. The fear of failing to reach a publicly-committed goal can be a powerful motivator; this is why CEOs of companies like P&G and GE publicly state goals such as achieving a certain amount of organic growth.

Get Buy-in from Other Stakeholders

If you need the support of others to reach your goal, they must not only be “informed” of it, but actively understand and agree with it.  If your goal doesn’t inspire others, support will be lacking. If my wife viewed my goal of reaching Boston as purely selfish or perhaps even unachievable, then she would resent my early morning or late evening runs that interrupt her sleep or take away our time together.  Of course, the fact that I also recognized the other commitments I have as a father and professional makes it easier to gain support for my goals, by making it clear that the family and work roles come first. In business, if your customers, suppliers, partners, and, most importantly, employees don’t accept your goals, they will not have the motivation to provide the support needed to achieve them.

Plan the Work, but Know When to Be Flexible

Training for a marathon, just like executing a business initiative, requires establishing and following a plan.  You can’t simply go out and run a random distance at a random pace and expect to achieve your goal. Each day has a purpose, be it working on your pace, improving your stamina, or resting and recovering.  However, circumstances like weather, work conflicts, injury, or family commitments will interfere with the plan, in which case you need to have an open mind to making adjustments within the context of still achieving the training you need (such as running at a different time, shifting days in the schedule around, or lengthening or shortening a workout).  It’s even better if you can have coping mechanisms identified in advance, so you can react quickly, with minimal stress, to these disturbances. The same is true for business – you have to start with a plan, but have the right processes in place to identify when changes are needed and make the changes as necessary.

Establish Appropriate Metrics and Use the Right Technology

In running, there are two or three metrics that matter – time, distance, and (if you follow this method) heart rate.  If you cannot accurately measure these, then you will be unable to track your progress.  Investing in the right technology, such as a GPS-enabled watch, is important, if not essential.  In addition, it is helpful to test your progress towards your goal occasionally; in running this is done through specific workouts designed to test your ability o hold a desired pace over a specified distance.  In business, of course, similar principals apply – you can’t control what you can’t measure, and you can’t wait until the end to begin measuring – you need milestones to track your progress towards a goal.

Stay Focused on the Goal and Ignore Distractions

Working towards a goal means that you have to forego other opportunities.  In running, it might be a very tempting race, or it might be a night out with friends before a big run.  In business, it may be a request for a new product, or a project offered by a customer.  While you may occasionally have the capacity to take advantage of such an opportunity, this must be weighed against the risk of losing progress towards your ultimate goal. In many cases, it is better to pass on the short-term gains to keep the focus on the big picture priorities.

Proceed with Confidence

If you doubt your ability to reach a goal, your probability of doing so drops dramatically.  You can find countless references to the benefits if “acting as if” you have already achieved your goal.  While this can certainly bleed over into overconfidence, there is a lot of value in pursuing your training aggressively, with the belief that you are already at the level you need to be to succeed.  In my case, I certainly didn’t go so far as to book a trip to Boston, but I did explore the timing of the race next year and the process for registering.  And, I confess, I wrote this blog post two weeks before the race.  In business, if you act as a non-serious participant in a new market, you will be taken exactly as you act – not seriously.

The above steps are essential in establishing yourself as a leader, whether it is as a runner or a business manager.  If you don’t set and communicate goals, energize others towards achieving them, set a plan with appropriate metrics, stay focused, and act with confidence, the probabilities of success in any endeavor suffer grievously.

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Strategic Pricing Using Value Equivalence Lines

By Greg | Published: April 15, 2010

The number one variable that can impact your profitability is pricing.  Yet it is amazing how little many marketing and product managers really understand about pricing strategies, and therefore use poor decision-making processes to set price plans.  McKinsey consultants Michael Marn, Eric Roegner, and Craig Zawada have produced an excellent work on pricing approaches called The Price Advantage in which they discuss pricing at three levels:

  • Industry – set by supply and demand conditions, input prices, and overall competition,
  • Strategic – product / market level pricing set by comparing and positioning solutions within a given segment of the market, and
  • Transactional – executing pricing on a day-to-day basis, establishing “on-invoice” and “off-invoice” mechanisms and channel- and customer-specific agreements.

The product or marketing manager generally owns strategic pricing for their product or market.  Unfortunately, it is all too easy to rely on simple pricing methods such as “cost-plus” models to establish pricing guidelines.  There are three major issues with “cost-plus” pricing.  The first two are the cost competitiveness of your offering and your margin expectations compared to competition.  These are generally sorted out over time – you either improve your cost to get more competitive or adjust (most typically lower) your margin expectations.

The third issue is more significant and gets at the heart of poor pricing strategies.  This is the fact that your cost typically has very little to do with the value that your solution brings to customers.  It is conceivable, for example, that something that costs you $10 may bring $500 of benefit to a customer.  Your cost-plus approach might price it at $15 when in reality you could command far more.  Since you do need to “share” the benefit of your solution with your customer to encourage them to purchase, you wouldn’t be able to charge the full $500, but perhaps $100, or a 90% gross margin vs. the 33% or so you might realize under a cost plus strategy.

One tool to analyze and set pricing strategies described in The Price Advantage is the value equivalence line, or VEL.  The VEL identifies the perceived benefits vs. perceived price tradeoff that various customers are willing to accept within a given market, as shown below. In this graph, offerings that are to the right and / or below the VEL are perceived to be of greater value / benefit for a given price. While obviously a simplification (and in particular, this approach does not work well in categories subject to frequent disruptions due to innovation, new entrants, etc.), there are several powerful insights you can be gain from the process and result of creating a VEL for your solution space.  Most specifically, you can identify how your offering is positioned against competitive solutions and how adjusting your value proposition or pricing may impact your sales and margins.

Value Equivalence Line for Strategic Pricing
Value Equivalence Line (click to expand)

The graph shows the positioning of several offerings (the ellipses labeled A, B, C, and D) in the same “market”.  Note that these solutions can be different in nature, not just different versions of the same concept; you could compare materials like steel, plastic, and aluminum in their ability to fit the need for a certain component, for example. It also shows the pockets of demand (the bars along the line) based on various customer segments (and in a prior post I discuss a market segmentation approach).  When positioning your offering, it is important to note that demand is not spread evenly along the VEL, and there may be no demand for a certain price/benefit combination.  The graph also represents that fact that understanding of the price and benefit tradeoff may be a little vague (represented by the dotted lines on either side of the VEL) and perceptions of a given solution may vary from customer to customer (thus the ellipse to represent the offering instead of a dot).  It is not critical to get the exact size of these bands or ellipses correct, but it is in general helpful to consider how broadly perceptions might vary, as narrowing these differences may be an effective strategy for better positioning you r solution.

Value Equivalence Line as used for pricing decisions
Using the Value Equivalence Line to Inform Pricing Decisions (click to enlarge)

As a theoretical example of using the VEL to inform pricing decisions, consider offering A, for which the provider desires to increase their market penetration.  There are three ways to do so, as shown in the accompanying picture:

  1. Change customer preferences: this is the hardest but has the least impact on the industry pricing structure; you can seek to move demand from one point on the curve to another through education, marketing, or other selling tools. Some customers may not be aware of the benefits that your solution offers that justify its price, so this approach can help for such a situation.
  2. Move your benefit-price ratio along the VEL to tap unmet demand.  It may be that there is latent demand that is unsatisfied by existing solutions and that by repositioning your solution, you can capture some of that demand (which is currently being filled by suboptimal solutions, if at all). This may be difficult as well depending on the work required to change your value proposition, but again it has minimal risk to the industry price structure.
  3. Move a new or existing offering off the VEL.  This could be accomplished through a new or upgraded offering at the same price, thus moving to the right, which would serve demand from E (who will be happy to find a cheaper solution that meets their needs) and A’s current customer base (who will be happy to get more benefit for the same price).  This could also be accomplished by cutting your price, moving down on the graph, and thus serving existing customers more cheaply plus potentially capturing demand from D by providing more benefit for the price.

Note that each of these approaches may (and probably will) provoke eventual competitive reaction.  The risk is greatest in scenario 3, as in fact the new offering from A will have shifted the VEL, and competitors are very likely to develop their own new higher-benefit solutions, reduce their prices, or both to re-establish their position on the VEL.  Some uncertainly is also added to the demand patterns, as some customers will choose to pay less for their existing level of benefits, and some will take the additional benefits at the same price, thus splitting existing demand pocket.

While clearly a simplified approach, with some challenges involved in collecting the data needed (or, in many cases, making meaningful assumptions and estimates), the VEL tool is a powerful approach to analyzing pricing situations and feeding decisions.  Like most good tools, much of the value is in developing and debating the data.  Should you wish to learn more about VELs (as it is impossible to give them sufficient treatment in a single blog post), I’d encourage you to read The Price Advantage.

Another good book recently published regarding the use of VELs (price-benefit lines) in assessing pricing situations, mostly from a crisis mode, is Beating the Commodity Trap by Richard D’Aveni, which I review in a subsequent post.

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