Think Twice Before You Re-Price

Many times companies try to change prices to stabilize or increase revenues. The results, unfortunately, are often disastrous.

In the low end of the PC business, for example, several companies have tried cutting prices by more than 50% and found their customer base has expanded by 10% or less. Revenues drop off a cliff and the person responsible for the price cut often follows.

Although price is an obvious variable in the business equation, it should not be the first thing to change. When companies feel the need for new prices, they are responding to various economic forces.

In this article we suggest focusing on how to increase cashflow and profitability before making a price change. People involved in pricing complex, differentiated products like software or engineered products can use the cashflow approach to identify other non-price methods for increasing cashflow. In addition, cashflow can be used to unify the activities in several departments thereby taking some of the heat off the role of pricing alone.

There are many tricks for increasing cashflow. Below is a series of ideas companies have used to improve their operations and thereby increase profitability.

Look for Improvements Systematically

If you want to improve your company's operations without being overwhelmed by the options, there are two keys to success. First, search systematically for improvements to find the most effective ones. Then second, select a few of the most promising ideas, implement them carefully and apply them consistently. Good management is 1% inspiration and 99% execution.

One of the major reasons for searching systematically for improvements is simple: People are involved and people do not like to change without understanding why. If changes are imposed on people without their involvement, their resistance to change goes up as the number of available options goes down.

By systematically looking for ways to improve a company's operations, people have a chance to make contributions and adapt to change. Often one of the smarter (or more often outspoken) members of a team will have an "Ah-ha!" experience about how to improve profitability. If the team locks onto a "the solution" prematurely, regardless of whether the idea is good or bad, other people cannot easily accept or internalize the idea. Even if the new idea is a good idea, people will reject it outright, drag their feet, or give it little support.

However, by looking for improvements systematically, more people can participate in the process. As people participate in the search for improved cashflow, people have time to adjust to potential changes and feel a part of the process. Furthermore, there will be more "Ah-ha's" working from which management can choose the best.

But of course, systematic examination does not lead to improved (or any) cashflow. Action does.

What is the best way to proceed?

First, recognize that improvements take time and constant effort. For improvements to have the greatest long-term impact, they must be part of an ongoing process. Home run solutions are possible but most ball games are won on singles and doubles (and making fewer errors than your competition).

Here's an example. Suppose a company wants to increase customer loyalty which leads to predictable cashflow. One way to achieve this is increasing customer satisfaction among new customers and their existing base of customers. If the company has a base of five thousand customers and works 500 existing customers per month, it will take 10 months to work through the existing customer base -- in addition to the efforts spent on satisfying new customers.

Maybe the process can be accelerated but it will still take a while. Be patient.

Look for Cashflow Improvements

In these days of complex financial transactions and less-than-straightforwad accounting practices, the best way to ensure business success is to watch cashflow. If you understand the "cash cycle" (production, delivery collection and disbursement) and cashflow needs of the business, the business will never get out of hand. The "fishbone chart" below shows some of the components of cashflow.



First you'll notice overall profitability and timing of payments to your company or others will affect cash flow. Even if your sales bookings are strong with good margins and profitability, companies can still go broke if the collections are slow. If revenue levels are high enough but there isn't enough cash to pay current expenses, then get paid sooner (customer advances) or stretch out your payables (pay in installments).

One of the favorite bootstrapping tricks of entrepreneurs is to use this month's collections to pay some of this month's expenses and make product for next month. But beware: This balancing act will catch up to a company that is unprofitable.

Although the credit department will set credit terms, the person responsible for pricing can affect the timing and predictability of cashflow by encouraging the equivalent of layaway plans -- especially in industries with seasonal or cyclical demand.

A wonderfully practical book had a title that captured the essence of all cashflow improvement techniques: "Buy Low, Sell High, Collect Early and Pay Late".

Look for Profitability Improvements

Moving up the fishbone, there are two ways to increase profitability: Increase contribution (a.k.a. Gross Profit) or decrease costs. While there are many cost centers, start with the major overhead cost areas. For example in high tech companies, sales and marketing is the major cost element. Although most marketing and sales departments know how to increase their effectiveness, these adjustments take time -- a scarce commodity in fast moving markets especially. This is one of the reasons companies change prices instead of marketing and sales processes.

Here are some examples where sales and marketing changes alone can affect total contribution without changing prices. Note that these changes can take from six months to two years before the effect is felt.

• Find more effective promotional methods or more cost effective sales methods.
• Substitute a telemarketing and telesales front-end for expensive direct sales.
• Use sales reps instead of salaried sales people;
• Change sales compensation programs to increase rewards when higher sales and profit levels are achieved.

To be sure, these areas and programs are hard to change (and may be expensive). However, it may be possible to time these changes to coincide with a series of time-limited price deals whose increased revenues can offset the higher initial costs/lower initial sales of these programs.

Another alternative to a price change is to look at where money is being spent in the sales and marketing process. If it is in lead generation, find more effective methods of generating leads to less price sensitive customers. Often different mail lists, advertising copy, choice of trade show, or introductory offers will have the desired effect.

If sales are slowing down and closing deals are getting harder or happening later, find out why. Perhaps collaterals can be just as effective as a personal sales call in educating a customer about the value of high value added services? Maybe a sales training course or providing materials about handling price objections or creating a value proposition are in order...

For some time I have been a fan of "cycle time reduction" which is used to reduce time to market, expenses, etc. One of the premises of this method is the less time you spend in doing something, the less time (and hence expenses) can get burdened on the activity. This suggests looking more carefully at where in the sales and marketing process the sales organization spends most of its time. Saving time in the sales cycle, will save a company money.

Sales and marketing is but one area to look for profitability improvements. It goes without saying that there are ways to trim "G&A" (General and Administrative). Shift receptionists to telesales and use voice mail. Use part-time help instead of full-timers. Look at using a payroll or bookkeeping service. See if high cost credit lines can be replaced with low cost ones.

Look for changes anywhere monies are being spent -- even in the pricing process. One major area to save costs in the pricing process is to have fewer meetings and make the meetings more effective.

Look for Improvements in Total Contribution

While it is always useful to look at ways to increase efficiency/effectiveness, remember the objective is to increase cashflow. The best way to do this is generate more contribution (gross profits) to overhead. Since total contribution is average unit margin multiplied by total unit volume across all sales, there are two more variables with which to work .

One obvious way to increase product volumes is to appeal to higher volume customers. If high volume customers want service, give them service (at a reasonable price). If they want lower cost distribution, do that (and pass some of the cost savings along). The point is to make sure products and associated services appeal to important customers segments. As markets become more competitive, the traditional approach -- volume discount schedules -- are becoming less effective in attracting the "heavy user" segment in a market or in the existing customer base. These days it is essential to look for creative alternatives.

Here is another alternative to increased product volume: increased customer loyalty. More loyalty means customers will buy more product over a longer period of time. In the software business we are finding customers that buy 3-4 product upgrades and an initial support contract often generate more revenues than the initial purchase of the product (net of discounts given to the sales channel).

What can you do to increase product loyalty? Suppose your company makes business products that appeal to the home office user (e.g. the "SOHO" market -- small office, home office), lowering prices won't generate loyal customers as much as effectively using cross promotions with other companies with products that complement yours. Maybe a newsletter or some other direct contact piece will obtain the same "share of mind" as a favorable price. Some office product companies have been known to use dealer seminars, small local/regional trade shows and free factory consultations to increase customer loyalty.

The Internet and the World Wide Web offer new opportunities for lowering the cost of information delivery. In some markets, direct e-mail may be as useful as fax support and on-line bulletin boards for increasing loyalty.

As an aside, if you want to increase customer loyalty, you'd better start measuring it just as you would measure volume changes per transaction from price changes. Don't forget rough measures are better than no measures at all. Roughly right is better than precisely wrong -- or late.

Loyal customers generate positive word-of-mouth references. And these are the references that sell products.

Look for Improvements in Unit Margins

Increased unit volumes won't increase cashflow if unit margins fall off a cliff. Therefore, look at ways to maintain margins (or at least minimize margin erosion.)

Maintaining current levels of cashflow is particularly tough as competitors cut prices in a scramble for revenues and as customers tighten their belts. About the only thing that can be done to keep unit margins high in a price competitive market is to make sure the cost to manufacture and develop product falls faster than prices erode.

People in manufacturing organizations tend to be pretty good at cost control. For example, they may be able to use less costly cardboard instead of plastic (and be more environmentally friendly). Perhaps some activities can be done in sheltered workshops -- this is a community service and there may even be some tax incentives to encourage this.

Don't forget to look to the product development group for help. Project schedules and product release dates can affect cashflow. Also, a surprising number of organizations do not use "design to cost" or "design to manufacture and assembly". These techniques can reduce product costs by 20-60% -- often by using standard sized anythings which are cheaper than custom sized anythings.

Prices -- Finally

There is one group to whom pricing is the most important product attribute: sales people. Countless surveys show customers that buy industrial or consumer products and services rank price third or fourth in importance. That is why we, too, have made pricing the last topic of this article.

On the price side, the best way to maintain prices is to offer customers high quality product and service bundles. But make sure the product value delivered lines up with the needs of customers and their willingness to pay.

Customers that have beer tastes and a beer budget won't pay for champagne so don't serve it.

As a rule it is always better to look for customers that are less price sensitive. Build in reliability. Provide premium support at premium prices. Don't be all things to all people. Focus on what you do well and get paid for it.

If customers won't pay for it, start stripping out features, services, updates, whatever you have to so your customer will pay less while getting less.

If your customers want lower prices, often they don't know what trade-offs they will have to make. Make sure the trade-offs are obvious but not undesirable. (For example, no one gives a $1000 discount on a car without tires). If customers want lower prices, they will have to order more. If they won't order more, they will have to pay for support. If they won't pay for support , help them contract with a third party for support if they won't pay you for doing that task.

If you want to keep your prices up there, make sure your product reeks of desirability. Tasteful collaterals, packaging, ads, sales people, voice mail.... Make it clear that you and your customers both belong to a very exclusive club with proven membership advantages like an active user community, stable account reps, easily accessible senior executives, widely quoted users.

Above all, make sure that any demands for price concessions are countered politely with a demand for a product or service concession. Remember most customers want a good deal which will not drive you out of business. Push back -- politely. Learn to negotiate.

But if you find a customer that doesn't care about your survival (i.e. won't give on price), give them a great deal on a older model. Another alternative if you are in the capital goods business is to help customers sell their old products to make way (and pay) for yours. GM takes Fords in trade why shouldn't you?

But ultimately if you find a customer that only cares about price and doesn't want to hear about anything else, let them go. Give the lead to a competitor. This will surely drive your competitor's sales rep crazy and, if you send enough of these customers their way, your competitor may even go broke.

Review, Re-do, Repeat

In the above sections I've suggested an approach and several examples of how to improve profitability and cashflow before changing prices.

To ease the culture shock, often the best way to improve cashflow and profitability comes from what you are now doing! Most companies are doing a number of things to increase profitability and increase cashflow. Often some of these activities are not as effective as they might be.

Therefore, let me close by suggesting you to look at everything that can be done a little better. It is very likely that a 10% improvement in three things you are now doing ineffectively will increase profitability and cashflow more than any one new idea a team might implement over a 12 month period.

Clearly, the operational changes having an impact on cash flow go well beyond pricing. In many companies pricing is an activity that cuts across many departments. Therefore, when it comes time to change prices, it may be a good idea to look for new approaches that can have the same impact on cashflow as price changes can have. You'd be surprised at how many useful and often elegant ideas are out there.