You’re up early, hit the Peleton, and then grab a coffee and flip open your email.
There it is right on top of the stack: another note from sales requesting a pricing variance. This is the third one this month…what started as a one-time ask is rapidly becoming a jailbreak.
You’ve got an active, multi-year cost reduction program up and running that is being led by your manufacturing engineering team, but the reductions always seem to be behind the price pressure coming from sales. You have a gnawing, gut feeling that there needs to be a better response than passing out precious margin to your clients, but when these notes come in, it’s easy to get your lunch eaten one small bite at a time.
Pricing reductions that are out of step with operational efficiency is a long road that leads to your firm’s stakeholders receiving less payback for the investment in product, plant, and equipment. This can be the start of a downward cycle that results in a variety of outcomes, such as lower support team investments and increased pressure on your supply chain.
It’s in your best interest to reset the expectations.
Experience says much of the pressure is more controllable than you might think
Having lived this adventure and helped multiple P&L owners with this issue has convinced me that there are two components contributing to this, both of which are influenceable by the ops leader:
- The first is that along the way, some activity that does not contribute to customer value got inadvertently inserted. This can happen in a variety of ways, including creeping internal testing or handling that might have been to resolve a one-time supplier issue…or perhaps a single customer needed something that got applied across the product line.
- Secondly, over time the sales team gets less adept at holding the margin on mature products. As a whole, a firm typically does not provide sales teams the background and training to keep the value dialogue fresh. If you haven’t helped them to stave off competitive pressure, you’ll get nibbled to death with price variance requests.
The Organizational Headwinds That Work Against You
Pricing is one of those areas that is devilishly decentralized. It’s usually set by consensus during the product development cycle and lands between a cost-plus and value approach. The reason cost-plus is so stubbornly entrenched is that, on the surface, it appears to be the most objective and rational approach. It also allows a single individual to do the ‘analysis’ and set an unimpeachable figure.
A much stronger approach is a value-driven one. Value is added or removed by everyone in the entire firm. To get your arms around a value takes more effort and collaboration than a cost-driven path, but deals effectively with requests like those highlighted above.
The value approach studies the client’s end-use very carefully, accounts for all the value created, and sets pricing based on the fraction of that value that is reimbursable by the client. For example, if you provide a critical component at a wholesale value of $400 per device, it is not unreasonable that you might be enabling a life cycle value of 5% or $20. This is irrespective of the fact that the device costs you $4 to produce. In a cost-plus world, you might set that price at $6 – leaving significant value on the table.
You may wonder if this is just a “more profit” discussion. While that may be a result, the more important item from your client’s point of view, is that appropriate pricing sets you up to invest in creating better products, train people more thoroughly and have customer support levels that they appreciate.
Getting pricing right is important to both of you.
Creating this culture and end-to-end value capture is a substantial cultural shift in many manufacturing firms that have grown up in a cost-plus environment. The only way to get this approach in place is to reach outside the op’s ‘bubble’ and create a cross-functional team that includes the people closest to customer value, sales, product team leads, engineering, and (of course) the ops leader. Be sure to open the value discussion far enough to include ‘softer’ items such as delivery reliability, packaging recyclability, contributions to the local content requirements and contributions to the device’s end-user reliability, etc.
My favorite way to do these discussions is to put the digital equivalent of tracing paper on the wall and trace the journey of the product and service from our supplier all the way to the customer’s hands. We add as much info as we can to each element:
- Who made it?
- Where is it headed and how is it handled?
- What offline activity was needed to provide this moment of creation?
- What tests are needed and why could they be combined?
- Could we do more or less work on this?
This discussion has the dual role of creation, along with training the group to seek and provide as much value as possible so the sales team can make the case for above parity pricing the next time it arises.
Wrapping it Up + Key Notes
- Recognize that this needs to be a “whole-brain” approach to finding a solution.
- Build a cross-functional team to look at the value stream all the way to the client application.
- Remove any content or action without a line of sight value to the client – and (very important) make much of any discovery for an incremental value that the client recognizes.
- Take the lead in listening to the client and delivering what you’ve promised.
How I Can Help
One of the keys to getting this right is helping people to truly communicate about these opportunities. I have helped firms bring together teams with a diverse set of functional roles to have a rich and insight-filled outcome that allows them to truly move the needle for themselves and their client.
If you’d like to explore what this kind of coaching and facilitating service could do for you, please reach out to my direct line (847-651-1014) or use this link to put the call directly in my diary.
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