How to realize the full benefit of price increases in volatile markets

Volatile markets have prompted companies to rethink pricing. But to protect margins, many may need to restructure how changes are implemented.

In brief

• Inflationary pressures have prompted many companies to institute across-the-board pricing increases, but many are finding traditional tactics don’t work.
• Companies can improve end-to-end pricing capabilities by conducting routine pricing reviews and enhancing pricing functions.
• These flexible strategies can help protect margins and enhance the bottom line.

With volatile markets and ongoing geopolitical disruptions, executives are faced with urgent repricing decisions. To protect margin rates while still preserving, or even winning, market share, these repricing decisions may need to factor in potential customer pushback, competitive actions and supply chain implications. In fact, most companies never fully realize 100% of their intended price increases and margin targets. To succeed, companies likely need to pay meticulous attention to often overlooked factors, such as downstream execution, including compliance management and sales enablement.

The EY 2022 Global CEO report, which surveyed more than 2,000 executives from across the globe, found inflation to be the top concern, with 87% saying that they have seen an increase in “input” prices or the costs incurred to develop a service or product (Figure 1). Input increases, which are partially a result of the recent pandemic and subsequent supply limitations, have significantly eroded margins for many companies across industries.

Organizations are addressing these rising and volatile costs in a wide variety of ways. For those that have not invested in the capabilities of tracking true customer profitability and measuring price sensitivity, applying a cost-plus approach to uniform price changes is common. However, they may be leaving money on the table. According to a recent EY internal proprietary analysis, by setting segment-specific price increases based on the changes in cost-to-serve structure and price sensitivity, companies can gain 1%-2% additional margin as a percentage of sales.

Where to start – knowing your true cost-to-serve is no longer just a nice-to-have

Understanding cost-to-serve is a critical first step. Pandemic-related shutdowns wreaked havoc on the global supply chain, leading to elevated costs of labor, energy and other raw materials. Since the end of 2019, freight prices have jumped more than 400%. Coupled with increases in warehousing costs and lost sales due to delays, it adds to an increased cost of doing business across the board. Despite data technology and analytics advancement, many companies still lack visibility into these metrics at the right granularity for pricing decisions. Customer profitability is often assessed at the gross margin level (see Figure 2) instead of looking at the net margin level. It is not uncommon to see rebates, freight and other services being allocated as a percentage of revenue without factoring in key metrics, such as seasonality, the share of orders and service-level requirements.

For example, a “profitable” customer that demands frequent small-quantity delivery and receives their price concession via large rebates may actually be a negative net-margin customer.

By contrast, leading organizations invest in integrated data infrastructure and dashboarding capabilities that enable ongoing pricing decisions at a net margin level. This helps to accurately factor both up-front and hidden costs while maintaining visibility into unallocated downstream costs to ensure a minimum level of operational profitability.

Are you realizing the full benefit of target price changes?

Another common miss for organizations in this volatile market is not paying enough attention to price execution. According to EY benchmarks, price realization measured (net of unplanned additional discounts and rebates) could range greatly, from less than 20% to close to 100%. To achieve target prices, leading companies relentlessly focus on price execution and sustainability.

Following are three critical, but commonly missed, lessons to realize price increases:

1. Hold customers accountable for what they promised.

Track, diagnose and manage customer compliance against contracted or good-faith metrics that drive preferential pricing and incentives (e.g., sales, share of wallet, product mix). Noncompliant customers undermine strategic pricing and margin realization efforts and could be a signal of larger underlying issues.

But how?

• Let’s start with the basics. Identify and address data quality issues that undermine pricing effectiveness, including multiple sources of truth, overstated and understated pricing metrics across functions, and lack of access to accurate data.
• Data stewards, armed with governance rules, can drive consistency and accuracy at the right level of granularity, which is important for differentiated pricing and overall execution. Lack of access or trust in quality data is a common reason that organizations opt for broad-brush pricing.
• Investing in building or buying technology solutions for compliance tracking and alerts can also be effective for sustainable price improvements, especially for large organizations with complex volume-based tier discounts or rebate contracts.

Case study

A full-service environmental contracting company observed variations in discounts across sales representatives and customer types. Though the company had processes to approve discounts at different levels, there were no workflows or systems in place to track policy compliance. EY-Parthenon teams designed a new discount approval and deal desk process and built a tracking dashboard by customer size and sales representatives to confirm compliance with the new discounting policy. Over a 12-month period, the company improved gross margin percentage by ~250 basis points (EBITDA improvement of $10+ million and $450 million in sales) while maintaining a similar win-loss ratio on potential accounts and growing revenue.

2. Take the time to discuss benefits of change to salespeople and the commercial organization and provide turnkey insights.

Your salespeople’s conviction in headquarter pricing decisions can make or break how well your new prices are achieved in market. Promote an agile culture and communicate the benefits of differentiated pricing to sales teams and throughout the entire organization.

How?

• Develop a top-to-bottom change management plan for the organization to drive behavioral change. Without these, even ambitious pricing initiatives can give way to bureaucracy and prompt a return to legacy processes. 
• Empower sales teams with the right insights, data and incentives to hold margins. Curating targeted playbooks (e.g., deal renewals or noncompliant customers) in partnership with the pricing function can be helpful to support better deal execution and manage erosion.
• Effective communication is also a vital tool for deal negotiations and account retention. Best-in-class organizations educate and train their sales force to clearly articulate their value proposition to customers.

Case study

A global beverage company looked to gain better transparency and improve return of its price support investment. EY-Parthenon teams designed, developed and implemented a new cloud-based analytics tool across 10+ countries to measure promotion effectiveness. The change management team was established six months before go-live. Salespeople were involved early on to influence the output and user-interface designs. To give salespeople the comfort that the return on investment (ROI) insights would drive better results, the training program included a data science overview, multisession user training, proof-of-concept working sessions to deep-dive in select brands and markets, and monthly review post-go-live. Instead of running the same promotion events year after year, sales teams leveraged the ROI insights to take out unproductive events and adjusted brand size or discount levels in their promotion calendars, resulting in an improvement of 0.11 basis points.

3. Recognize that price realization requires cross-functional discipline.

Traditionally, brand defines strategy, finance establishes margin target, pricing sets prices in IT system, and sales executes in market. In many organizations, these functions operate in silos with limited feedback loops and disjointed wiring elements, such as key performance indicators (KPIs) and incentives. Leading companies design organizational wiring to orchestrate agile and open dialogues between these functions.

How?

• To start, leaders can’t delegate price execution. In today’s era of high costs and supply volatility, organizations may need to establish a pricing steering committee to facilitate ongoing pricing dialogues between cross-functional leaders.
• Leaders may need to review gaps in price realization, prioritize levers to close the gap and participate in the mobilization of aligned action plans.
• Some companies are setting up friendly competitions between cross-functional teams to accelerate teaming between pricing and sales.
• Over the longer term, companies may want to review and pursue structural changes to KPIs and incentives to drive price realization.

Case study

A global industrial chemicals company instituted a broad-brush price increase across its entire portfolio, targeting an average of 5% increase across the portfolio. The company did not evaluate which products and customers were willing or able to accommodate higher pricing, nor did it understand competitive scenarios or how to adjust the rebate process to enable full realization. Consequently, the company realized only about 66% of the expected impact. During a second price increase, only two quarters later, the company instituted an integrated cross-functional pricing execution team to design, track the customer negotiations and validate price conformance. The team’s goal was to institutionalize a formal role to oversee price increases and develop an integrated set of dashboards to track and realize the full impact of pricing increases.

Conclusion

Macroeconomic issues, including surging commodity and energy prices, may mean that inflation, supply disruption and demand volatility are here to stay. Executives need to enable dynamic pricing now and be prepared to adjust pricing nimbly as those variables start to loosen.

Companies can ask themselves a few questions when assessing pricing capabilities, including:

• Is our organization ready for the next round of significant cost increases or market disruptions? 
• Do we know what products to select for price increases and which of our customers would walk away from the slightest increase? 
• Do we know the true cost-to-serve for our customers so that our sales force can clearly articulate the value being provided during negotiations?
• Are we confident that we have the right discount governance in place so that we can get the highest return on our intended price increase?

If the answer to any of these questions is “no” or “not sure,” acting now to improve end-to-end pricing capabilities can significantly improve financial performance. By conducting routine pricing reviews and enhancing pricing functions, companies can stay one step ahead of competitors with flexible strategies that protect margins and enhance the bottom line.

Yog Parihar, Juhi Gupta and Brendan Happ contributed to this article.