Tuesday, June 8, 2010

Guest Post: A Progressive Strategy for Trade Customer Pricing

This guest article was previously highlighted in the Professional Pricing Society Newsletter.

Title: A Progressive Strategy for Trade Customer Pricing
Author: Paul Andrew Smith, CPP

Effectively managing trade pricing has become an increasingly difficult conundrum for Consumer Products (CP) companies over the past decade, due to the growth of large international retailers with massive buying power. Faced with sophisticated purchasing departments and vigorous competition, many organisations have lost control of the discounts offered by their sales force in an effort to retain volume. With volatile costs overlaid on tight margins, the net impact of this lack of control on both short and long-term profits can be severe. More recently, recessionary pressures have also encouraged CP companies to re-examine one of the most important and challenging components of their go-to-market strategies – trade pricing.

As such, teams from Global Business Services practices have been working closely with a number of CP companies to transform their approach to pricing and trade terms. The bringing together of functional expertise in finance, supply chain logistics, pricing and customer management with deep industry experience has led to the development of a five-step approach for implementing a new pricing and trade terms framework.

What is a pricing and trade terms framework?
As illustrated in Figure 1, a pricing and trade terms framework is a structured set of prices and trade terms transparently available to all trade customers (i.e. to wholesalers and retailers acting as intermediaries between manufacturers and end customers). The best net price and pocket price achievable differs only with the ability and willingness of the trade customer to consistently exhibit desired behaviour patterns and performance levels.

Below the list price, the framework includes a range of commercial, operational and behavioural terms collectively referred to as “efficiency” terms. These terms reward beneficial behaviour in areas such as logistics, supply chain and payment terms with discounts or rebates, as well as providing for surcharges where appropriate. The framework also details how the manufacturer will support their trade customers through the financing of trade promotions and investment, ensuring that funding is directly aligned with the achievement of defined performance criteria. These terms (labelled “business building” terms in Figure 1) are successfully being used by leading companies to remove the practice of unconditional trade investments and rebates. The efficiency terms recognise the importance of costs-to-serve within the channel, while the business building terms recognise the opportunities for channel partners to add value.

The adoption of the new terms is encouraged through transparency, shared efficiency savings and an unbundling of costs and services that provides clear choices for the trade customer. Transparency and consistent application are key elements of the approach, because they demonstrate to customers that they are receiving equitable and defensible prices.

Why is it worth implementing?
The approach outlined here puts the CP company in control of its own commercial and financial destiny. It allows the manufacturer to reward trade customers for adopting behaviour patterns and operational practices favourable to the manufacturer’s own strategic, financial and operational goals. This planned approach to cooperative working still allows trade partners to leverage their buying power. In return, it ensures that manufacturers can drive operational efficiencies and better manage the apportioning of trade investment, resulting in significant gains for both the wholesaler/retailer and the manufacturer, and a stronger trading relationship.

Large international retailers have become proficient in using their buying power to exploit pricing differentials, negotiation weaknesses and a lack of preparation by manufacturers. A major benefit of a well-planned pricing and trade terms framework is the negotiating strength that it gives the manufacturer; A transparent framework incorporating comprehensive incentive options can help combat aggressive and unconditional demands for better prices from mega retail groups. Experience indicates that the top ten product lines often account for 50% of a CP company’s total revenue. Typically the prices achieved for these top lines may vary by up to 20% across the manufacturer’s customer portfolio. This can have a devastating impact on manufacturers’ profits as mega retailers, fresh from acquiring new businesses, have visibility of these pricing discrepancies and can aggressively cherry-pick the best prices and terms on such products.

Financial and operational benefits
• By structuring payment terms to reward rapid invoice settlement, CP companies have reduced average debtor days from 45 to just 14
• A leading food company achieved a 10% reduction in promotional costs and improved control over merchandising by funding trade promotions retrospectively in line with the volume and timing of trade orders received

Step 1 – Diagnostic assessment, and construction of the framework
The starting point for any engagement is the undertaking of a diagnostic assessment of the industry context, the manufacturer’s go-to-market strategy, and their current commercial and pricing practices. This assessment requires interaction with multiple areas of the organisation including sales, marketing, finance and operations, which is indicative of the breadth of stakeholders who must be aligned to ensure the successful introduction of the framework. The diagnostic ensures agreement on the broader company strategy, which helps prevent debate further down the line. The diagnostic also frequently identifies quick wins which can be implemented ahead of the main project timelines to help the project gain traction, and potentially fund the later stages of the project.

Once the broader context is understood, the terms to be included in the framework can be developed. Precise definition of the terms is essential, including the relevant behavioural eligibility criteria, the level of discount or surcharge to be offered, and whether they will be one-off or cumulative, on-invoice or retrospective. This level of clarity is necessary to ensure that theoretical cost-savings that have been identified are realised in reality, as well as enabling better internal and external communication. This step of the process again involves multi-departmental cooperation; the definition of the efficiency terms requires detailed financial knowledge of the cost-drivers in the supply chain coupled with the account teams’ knowledge of what trade customers will be able to achieve, whilst the marketing department typically lead the development of the business building terms.

Considering the framework from the perspective of the trade customer right from the outset is critical to project success. Trade customers need to be given the opportunity to shape and influence the framework to encourage smooth implementation. This dialogue enables the manufacturer to gain valuable insights into how the new framework can be made to work effectively in customer operations.

Step 2 – Development of the business case
Implementing a new pricing and trade terms framework involves a major operational and financial transformation, and must therefore deliver a good return on investment. Once the proposed framework has been agreed, the likely impact of its implementation must be forecast. Working with historical sales data, and with account managers who have the best view of the likely response of their customers to the changes, a qualitative and quantitative assessment must be made to predict which terms trade customers will access, and what the impact will be on volumes. For an accurate picture, this analysis should be undertaken at the lowest level of detail realistically achievable, for example individual sku’s and individual customers. These results can then be brought together to provide an overall picture of the impact on the business as a whole.

Financial modelling for a leading UK brewer
A financial modelling specialist worked with a leading UK brewer to assess the financial impact of a new pricing and trade terms framework. A bespoke financial model was developed that could simulate the structure of both the existing pricing and commercial terms, and the proposed new framework. Data gathered from account managers for a range of outcome scenarios was analysed against the brewer’s own forecast base-case. The model helped the client understand the likely impact of the new framework on their business as a whole, by sales channel, and for individual customers, as well as highlighting a number of areas for improvement to the framework before live implementation.

Once the likely impact of the introduction of the framework has been identified, this can be coupled with implementation costs such as negotiation training and systems changes, to give a picture of the overall business case. This high-level business case can be driven down to a greater degree of accuracy as more details become clear through the later steps of the project.

Step 3 – Prepare the organisation for the new framework
A new trade pricing framework will require new processes and tools. Crucially, it also demands new behaviours and fresh ways of thinking. A full internal assessment is needed to establish the scope of change across systems, data, people and processes. The output from this will be a series of projects and initiatives that need to be delivered to ensure the organisation is operationally ready for implementation. These changes may be lengthy, and will most likely have to be scheduled alongside ongoing projects within the organisation. Consequently, this preparation phase can last many months, and is dependent on the size of the delta between the current state of the organisation and the required future state.

Step 4 – Selling the new trade pricing framework and supporting transition
Changes in attitudes and behaviour do not stop at the boundaries of the manufacturer’s organisation. A change management programme needs to be implemented through many levels of the trade partner organisation, from local store managers to board executives. Management and staff within trade customers need to understand the objectives of the new pricing and trade terms framework, and how they need to change the way they order, store, distribute, pay for, promote and display products to achieve benefits.

It is essential that the manufacturer clearly explains the business benefits and engages fully with its wholesale / retail customers at an early stage (see Step 1). Investing time to understand the operations, systems and processes within these partners is effort well spent; this knowledge ensures that the trade partner achieves the best pricing and terms possible, to the mutual benefit of the manufacturer.

Step 5 – Tracking effective implementation and measuring the benefits
The implementation of the new framework must be closely tracked to ensure its effectiveness. Monitoring activity and evaluating results is essential in ensuring that variances and discrepancies are quickly identified and corrected, and that both internal and external staff do not revert to previous practices. Putting in place a series of metrics or key performance indicators supported by a regular reporting schedule and a performance dashboard for executives and staff helps embed accountability into day-to-day processes. Contents might include:

• Compliance reports – that indicate where trading partners have modified activity and behaviour in compliance with the new trade pricing framework and highlight areas where they have not
• Quantification of benefits – maps actual performance in terms of order quantities, price discounts, category management and logistics against the original objectives
• Net revenue management – measures like-for-like net revenue contribution from each trade partner, product, category and distribution channel. Uses price waterfall analysis to demonstrate the effectiveness of cooperative trading arrangements and trade promotions

Companies that do nothing to address the current challenges within the CP industry will encounter continuing downward pressure on prices and margins. It is understandable that some manufacturers may be reluctant to embark on a major transformation that can require changes across multiple internal departments, and difficult conversations with trade customers. Forward-thinking companies are taking positive action to proactively manage trade pricing and ensure that discounts are delivered within a framework that provides a more consistent approach, regains control over margins, and enhances relationships with trade partners.

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