The Right Price
Here are five things to know about price segmentation.
By Kim Long
Price optimization is the single most significant profit lever distributors have at their disposal today. When part of a well-thought-out plan, it offers the fastest path to improved profitability. However, when implemented incorrectly, it can just as quickly lead to some dangerous dead ends.
Why Segment Prices?
The central goal behind any price optimization strategy is to align the price with the perceived customer value for any given product or service. Different customers perceive value differently across the same product or service being offered. By identifying these differences, pricing can be optimized across the various customer segments and overall margin can be optimized. It sounds simple in principle, but achievement can become a complex task.
Consider the countless combinations of customer, transaction, product and market factors at play for every single pricing decision you can make. While the idea of addressing each and every possibility sounds tantalizing, there’s simply no logistical way to manually tailor prices for every single transaction or deal you make with your customers. It just doesn’t scale, particularly in the distribution world where you’re dealing with millions of products and thousands of high-volume customers while negotiating with both suppliers and customers.
Savvy organizations will look for an edge in pricing by grouping customer transactions into compelling peer groups, and then basing prices on the best estimation of the perceived value of a transaction for anyone within that group. If an organization can cluster customers in such a way that they share the same willingness to pay for particular products, it will win against one-size-fits-all pricing and maintain a model that is simple enough to sustain long-term. This is the fundamental principle behind price segmentation, which should stand as the foundation for all future price recommendations.
Generally, you should start by looking at historical data for all customers within a given segment, then overlay current market factors that would not be seen within historical data to get price guidance for future deals within that peer group.
Attributes to Consider
A number of basic attributes are typically relevant across many different types of businesses going through the segmentation process, no matter the industry. These include such things as region, industry or customer size, product category or end use as well as purchase volume. But beyond those, organizations need to drill down into segmentation dimensions that are tuned to the realities of their particular industry and markets. Here are the 5 most common:
- 1. Contracted market basket items versus on-contract items: Among the million or so items distributors might stock, customers will negotiate heavily for only a handful. These so-called market-basket items are the ones customers buy frequently and will typically comparison-shop among a number of competitors to achieve the best possible prices.
- Commodity versus non-commodity: Think about an office-supply distributor. A failure to price segment sheet paper from larger, colored paper that customers are willing to pay more for means money has been left on the table.
- Product with pricing linked to a commonly watched index: As you segment for price optimization, ask yourself whether you have products that are based on some other outside influence. If so, these should be grouped together on a separate branch of the segmentation tree. This will make price updates easily actionable and less labor-intensive.
- Private label versus branded product: Obviously, you want to ensure that the sell price of a private-label item is lower than that of a corresponding branded product. But at the same time, the business doesn’t want to lower that price to the point where it gives away everything it negotiated to get a better cost on that unbranded item.
- Stage of a product lifecycle: To improve the reliability of your segmentation model, another consideration is the stage of the product’s life cycle along with other important product dimensions. Consider increasing prices on certain high-demand but discontinued product types because they’re being phased out. This way you can maximize what you make before it goes off the market. In other product categories, late in the life cycle might mean close to obsolescence. In that case, you will want to lower prices to make space in the warehouses for the soon-to-be-released updates to that same product.
The segmentation assumptions you establish today will determine the prices you set tomorrow. If those assumptions aren’t based on the realities of your business model and key data elements, you could be setting your price optimization efforts up for failure.
Kim Long has more than 25 years of professional experience in the distribution industry ranging from product management to procurement and pricing. Prior to joining Vendavo, Kim worked at OfficeMax where she was the senior director of pricing for the B2B business and was responsible for pricing strategy, profit management, performance measurement and process re-engineering.