Should Sales People Know The Costs Of Their Products?

We often find ourselves discussing an interesting decision that businesses are faced with: whether or not to inform salespeople of just what costs go into the products they sell. Two of the main arguments can be summed as follows:  
  1. Don’t give access to cost information to sales people as they then tend to lower the price as long as the margin is positive and focus on cost arguments with regard to the customer – instead of producing value arguments and getting customers to pay more. 
  2. Do give access to costs (and thus margin) as sales people cannot optimise profits (“price” minus “costs”) without knowing the costs. 
As an aside, it is important to understand what actually constitutes “costs”, as incorrect cost information could lead to poor pricing.
 
Many companies debate this question. There is generally a reluctance to share confidential information with more people than absolutely necessary, however, the key question must be: what is the outcome if the sales team does or doesn’t know the costs? 
 
Take the following example of a sales person selling two products:  
 
Product A has a price of 100, and marginal costs are 50; fixed costs are allocated to this product at 30 per unit, so the variable margin is 50 and margin against full costs is 20. Product B meanwhile, is priced at 120 and the marginal costs are 51. Fixed costs are allocated the same way as product A, i.e. 30 per unit. The demand for the two products is the same at their current price points. We will furthermore assume that both prices are value-based prices, i.e. the price is what the customers are willing to pay.
 
Even if they were not optimised value prices, there is nothing to indicate that any issue of lack of value arguments would be worse for product A or product B.
 
On the other hand, the bonus scheme of the sales force can play an important role in the outcome. 
 
 
Knows Costs
Doesn’t Know Costs
Bonus on Sales
Confusion, but tendency to sell more of Product A if it is cheaper and thus easier to sell.
 
Sell Product A as it is cheaper
Bonus on Profits
Push Product B as it is more profitable
 
Confusion/Unknown.
 
Pushing product B is the best option for the company, as it delivers most profit (remember, demand/market size is identical for the two). Selling product A leads to lower overall profits.
Therefore the best outcome is achieved if the sales force knows the costs AND is bonused on profits, not sales. 
 
Companies should always deliver value-based communication arguments to their sales people – as this will drive prices higher. However, when companies sell more than one product (as most do), using only this approach can lead to incorrect behaviours if sales people are not informed about pricing and are bonused only on sales.  
 
Coming up with a good profitability measure is then secondary, and can be achieved either by “true” costs or using a proxy, such as marginal cost plus an allocation. Activity-based costing (ABC) can often be used with success for allocating fixed costs.
 
First and foremost pricing is about optimising profits, not just sales. Pricing people must help sales by helping on the pricing side, but should not seek to prevent sales people from doing what is best for the company by barring them access to cost data. In fact, an argument could be made that it is the pricing people who should be kept away from cost data – as this will force them to push value-based pricing strategies rather than thinking about costs when coming up with internal pricing policies.
 
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Stratinis has a range of functionality to help ensure your pricing and sales people have the information they need to deliver the best prices. Please visit us here to learn how our software solution can help increase your profits.
 

Pricing in Mergers & Acquisitions

During mergers and acquisitions, there are many things to take into consideration for the integration of the two organizations. Pricing is, or should be, one of the key focus areas as a solid implementation of the new organization’s pricing, terms & conditions can deliver significant synergies and benefits – whereas a failed M&A pricing implementation will expose considerable risks and often loss of combined profits.

Imagine some examples of challenges when dealing with pricing in M&A:
  • If prices/terms/discounts are different between the two merging companies for roughly the same product/service – i.e. Company A charges 10 and Company B charges 12 today. In NewCo one would hope for a new price of at least 11, ideally 12, but if not managed well you could end up with 10 as the customer(s) exploit the situation.
  • Different discount or surcharge schemes exist (similar to price example above): customer ends up getting lowest common denominator – to the detriment of NewCo’s profits
  • Sales people give too many discounts/price concessions to secure their job in the NewCo (“look, I closed all my deals, so keep me”)
  • Customers refusing to recognise NewCo as new supplier unless they get some additional concessions – knowing that often senior management has something at stake with the acquisition and therefore they can pressurize sales teams into giving concessions.
  • Pricing/Sales teams don’t understand the value pricing of their new colleagues: Company A has a different value pricing approach than Company B and the sales people in NewCo that used to work for Company A are not able to properly value-sell Company B products, or vice-versa.
  • Pricing synergies (often being bigger and with more market power, within legal limits) are not materializing, as sales people don’t understand how to negotiate in the new environment – at least not for 1-2 years, meaning 1-2 years of synergies are lost.
A good M&A pricing implementation program takes into consideration a number of factors, including:
  • Modelling: understanding current pricing as well as NewCo pricing options. Build models for allowing simulations of new NewCo pricing approaches. A tool like Stratinis Pricing can help support this process.
  • Internal strategy and people alignment
  • Internal materials to provide to pricing management but especially also sales people so they negotiate and achieve the best possible prices for NewCo
  • Internal communication
  • Internal training of sales team in new pricing model for NewCo
  • External materials to be shared with customers during communication and negotiation of new prices/discounts/terms
  • External Communication
  • Negotiation – support, follow-up, and crisis handling for larger key accounts 

Finn Hansen is the founder and CEO of Stratinis and has strong personal experience in this field from working with several multinational companies in implementing a strong pricing approach for merged organizations. In one global example the estimated benefits in operating income from this programme was USD 40 million annually. In another global business, the improvement in prices over 12 months after the acquisition concluded was EUR 24 million on combined sales of app 700 million.

Head over to Stratinis’ website and learn about how their Pricing Software can help manage and simulate AS-IS and TO-BE prices/discounts/terms and conditions.