The Role of Finance in Pricing Decisions

One of the key financial metrics constantly measured and monitored by the business is the level of profitability growth.

For any company, profit and positive cash flow, are both critical and with a company that does not initially have investors or financing, real and not paper profit may only be its capital. Without sufficient capital or the financial resources used to sustain and run a company, business failure is imminent.

The bottom line is that no business can survive for a significant amount of time without making a profit. That being the case, the measurement of a company’s profitability, both current and future, is critical in the evaluation of the company.

In an environment where competition is intense, customer loyalty is diminishing and business growth is not a guarantee, the scramble for the profit pie is far from over.

Faced with these mounting challenges, businesses embark on cost transformation initiatives to boost profit margins. Normally, the exercise starts by looking at the company’s Profit and Loss historical spend, analyze the cost drivers, justify the spending and then make the decision to wield the axe or not.

Sometimes an across the board approach is pursued whereby an equal percentage cut is applied to all business areas. The drawback of such approaches is that they only allow you to extract limited savings that are not sustainable in the long term.

Also, business areas that have future potential for growth and require continual attention and investment are sacrificed for short term gains.

In other cases, the focus is more on increasing revenues, either through new business development, growing the existing product line, up-selling or cross-selling. Provided there is demand for your new offerings and recurring costs are not significantly high, the results could be different.

However, there is another focus area, in my experience, I have noticed is often not granted adequate resources and effort despite its massive potential to grow both revenues and profitability.

Effective Pricing

Pricing has a substantial and immediate effect on company profitability and any significant price changes in either direction can have unexpected effects on the bottom line. Managing pricing is therefore a vitally important lever to increase profitability and generate funds for investment.

With margins increasingly getting squeezed due to costs escalations, using the wrong pricing model for your business increases the risk of losing money on some customers or contracts by applying the same pricing approach and margin across the board.

Although companies differ noticeably in their approach to price setting, the goal should always be to get the price right across all customers, channels, segments, products and service lines. The challenge today, especially for B2C businesses, is meeting the constantly evolving needs of consumers at a reasonable profit.

Consumers are increasingly demanding quality, immediate availability and superior after-sales service at a much lower cost than before. On the other hand, input costs are not declining. In such an environment, the effectiveness of traditional cost-based and competition-based pricing approaches is challenged.

Since these approaches are reactive in nature, perhaps the competition has raised prices or perhaps the COGS has increased, can you afford to raise prices without losing business to a competitor?

Finance and Sales & Marketing Collaboration

In a number of organizations, pricing decisions are the remit of sales personnel in the field. The absence of robust pricing processes in these organizations often result in sales personnel basing pricing decisions on gut feel.

Additionally, because of the pressure to bring in new deals and reach the sales quota, heavy discounting is widespread and chaotic.

Working hand in hand with sales and marketing teams, finance can help fix the broken system and bring transparency and discipline to pricing decisions.

  1. Clarity on customer sensitivity to price variations: With so many factors affecting a company’s profitability, it can be difficult to determine the best way to price your products and achieve the desired profit levels and customer loyalty. However, disciplined pricing execution is highly dependent on the specific products’ price sensitivity, or customers’ willingness to pay a different price for a product without affecting demand. Leveraging their commercial acumen and analytical strengths, finance personnel can help develop business rules and sophisticated tools that quantify customer price sensitiveness and willingness to pay and improve price levels.
  2. Document and implement new processes: In the absence of robust processes to ensure discipline in price setting and prize realization, the organizational consequences of not following pricing guidelines are too big to ignore. As process improvement specialists, finance can help put into practice processes and tools to document, monitor and communicate incentive systems, acceptable discount levels and price variances to sales and marketing teams and other decision makers. As a well-run business, you want to ensure that the price the company gets is a close as possible to the price the company wants. Thus, any price changes have to be justified and documented for approval.
  3. Define pricing boundaries: Companies usually use historical heuristics, such as cost information, to set prices. At the anniversary of each contract and during pricing review, very rare do most of them calculate the customers’ costs-to-serve. A standard increase is applied to previous pricing rates with the objective of getting a certain ROI or a certain markup on costs. This simplistic approach ignores the customer’s perceived value of the product as a critical factor for determining the final price. Finance can look to see whether or not the price points are too low, too many, or are at least profitable and value-based enough to be implemented. Through scenario planning practices, finance can run test-and-learn plans that help define pricing boundaries. New approaches are piloted, and prices are then optimized based on what works and what doesn’t.
  4. Drive change throughout the company: Evolving from pricing based on cost or competition (me too) to pricing based on customer value is a continuous learning process that requires a shift in culture. The process requires top management buy-in, sponsors and change agents who are committed to improving the organization’s pricing capabilities and overall system effectiveness. Finance business partners are well positioned to act as change agents, internalize value-based pricing and motivate the organizational changes required to support it. They are able to help colleagues understand the value reflected in prices. In turn, sales teams are empowered to address customer or client questions related to price variances and walk away from unprofitable deals.

Customer Experience and Customer Perceptions

It is vital for businesses to develop a deep understanding of their customers’ needs, perceptions of value for money and how any shifts in prices alters their willingness to pay. At the core of value-based pricing is having the ability to balance costs and the benefits attributed to your product or service.

One of the grave mistake you could make as a business is falsely assume that customers will immediately recognize and pay for your innovative and superior product. Today, rather than base their purchase decision solely on price, customers first want assurance that your product is the right one to fulfill their Jobs-to-be-done.

Instead of asking, “How can we achieve higher prices in spite of strong competition?” you need to start asking, “How can we generate additional customer value and increase customer willingness to pay, in spite of strong competition?”

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Leading in Uncertain Times

One of the biggest challenges facing business leaders today is making the right decisions that will ensure their organizations succeed, survive, and remain competitive in an increasingly uncertain and complex environment.

A recent post, The best way to lead in uncertain times may be to throw out the playbook, by Strategy+Business has several good points.

The article is about the COVID-19 pandemic, how global companies navigated through the crisis, and how best to prepare for future disruptions. Here are some key points and my comments.

  • Rather than follow a rigid blueprint, executives must help organizations focus on sensing and responding to unpredictable market conditions.
    • Comment: Senior leaders play a vital role in providing clarity about the organization’s strategic direction, creating alignment on key priorities to ensure the achievement of enterprise objectives, and ensuring the business model is continuously evolving to create and capture value in the face of uncertainty. They must not rest on their laurels and stick to the beliefs and paradigms that got them to where they are today and hope they will carry them through tomorrow. Regulatory changes, new products, competition, markets, technologies, and shifts in customer behavior are upending many outdated assumptions about business success. Thus, the businesses you have today are different from the ones you will need in the future hence the importance of continuously sensing changes in the global economy. Employees and teams often feed off the energy of their leaders and tend to focus their attention where the leader focuses attention. If the leader is comfortable with current business practices and rarely embraces the future or challenges the status quo, then the team is highly likely to follow suit.
  • When it became clear that supply chains and other operations would fracture, organizations began scenario planning to shift production sources, relocate employees, and secure key supplies.
    • Comment: Instead of using scenario planning to anticipate the future and prepare for different outcomes, it seems most of the surveyed organizations used scenario planning as a reactionary tool. Don’t wait for a crisis or a shift in the market to start thinking about the future. The world is always changing. As I wrote in The Resilient Organization, acknowledge that the future is a range of possible outcomes, learn and develop capabilities to map out multiple future scenarios, develop an optimal strategy for each of those scenarios, then continually test the effectiveness of these strategies. This does not necessarily mean that every change in the market will impact your business. Identify early warnings of what might be important and pay closer attention to those signals. In other words, learn to separate the signals from the noise.
  • The pandemic forced the organization’s senior management team to re-examine how all decisions were made.
    • Comment: Bureaucracy has for a very long time stood in the way of innovation and agility. To remain innovative and adapt quickly in a fast-changing world, the organization must have nimble leadership and an empowered workforce where employees at all levels can dream up new ideas and bring them to life. Identifying and acting on emerging threats and potential opportunities is not the job of the leader alone but every team member. To quote Rita McGrath, in her book Seeing Around Corners, she writes, “Being able to detect weak signals that things are changing requires more eyes and ears throughout the organization. The critical information that informs decision-making is often locked in individual brains.” In addition to the internal environment, the leader must also connect with the external environment (customers, competitors, regulators, and other stakeholders), looking for what is changing and how.
  • It’s worthwhile for leaders of any team to absorb the lessons of sense-respond-adapt, even if there is no emergency at hand.
  • Sensing: Treat the far-flung parts of your enterprise as listening stations. The question leaders must ask is, “What are we learning from our interactions beyond the usual information about costs and sales?” Train your people to listen for potentially significant anomalies and ensure that important information is not trapped in organizational silos.
    • Comment: Cost and sales data are lagging indicators that reveal the consequences or outcomes of past activities and decisions. Although this information can help leaders spot trends by looking at patterns over time, it doesn’t help understand the future and inform what needs to be done for the numbers to tell a different story. In addition to lagging indicators, pay attention to current and leading indicators and understand the relationship between these indicators and outcomes.
  • Responding: Improve communication across intra- and inter-organizational boundaries. Leaders should view business continuity as an essential function that acts as connective tissue for the enterprise.
    • Comment: In addition to creating mechanisms that allow the free flow of information both inside and outside the organization, decision-makers should also be comfortable receiving information that challenges their personal view of the world, even if it’s not what they want to hear. Create a culture of psychological safety where people are not afraid to share bad news for fear of getting punished, but rather are acknowledged and rewarded for speaking up. Leveraging the diversity of thought enables leaders to anticipate the future as an organization, decide what to do about it collectively, and then mobilize the organization to do what’s necessary.
  • Adapting: Challenge assumptions, and question orthodoxies. There’s always the temptation to mitigate threats simply by applying existing practices harder and faster. One way to get at those deeper issues and encourage double-loop learning is to ask, “What needs to be true for this to be the right approach?”
    • Comment: In an increasingly uncertain environment, it’s difficult to survive and thrive with an old business model or outdated technologies. Many businesses fail because they continue doing the same thing for too long, and they don’t respond quickly enough and effectively when conditions change. As a leader, stay curious and connected to the external environment, look for market shifts, understand what needs to be regularly refreshed and reimagined, adopt new technologies and capabilities, and adapt in ordinary times but also during times of transition. Unfortunately for many leaders, it’s just more convenient for them to continually downplay the fact that conditions are changing than take the appropriate course of action that drives business success.

How are you preparing your organization for potential future disruptions?

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The Collaborative Organization

These days the term collaboration has become synonymous with organizational culture, creativity, innovation, increased productivity, and success.

Let’s look at the COVID-19 pandemic as an example. At the peak of the crisis, several companies instructed their workers to adopt remote working as a health and safety precautionary measure.

Two years into the pandemic, they are now asking their employees back to the office full time or are planning to adopt a hybrid model.

The need to preserve our collaborative culture and accelerate innovation are two of the top benefits being cited by organizational and team leaders for bringing workers back.

Collaboration is indeed essential for the achievement of team goals, functional objectives, and the overall success of the organization.

Today’s breakthrough innovations are emerging from many interacting teams and collaborative relationships.

When teams, functions, and organizations collaborate, the whole is greater than the sum of its parts; group genius emerges, and creativity unfolds.

But, what makes a successful collaboration? What are the key enabling conditions?

  • It extends beyond the boundaries of the organization. Business success is a function of internal and external relationships. Instead of viewing your business in vacuo, understand that you are part of an ecosystem. External to your organization, who do you need to partner with to enhance your value creation processes, achieve/exceed your objectives, or successfully execute your strategy?
  • Ensure the objectives are clear and there is shared understanding by everyone. Unclear objectives are one of the topmost barriers to team and organizational performance.
  • Foster a culture that encourages opinions and ideas that challenge the consensus. People should feel free to share their ideas and not hold back for fear of others penalizing them or thinking less of them. Collaboration is hindered when one or two people dominate the discussion, are arrogant, or don’t think they can learn anything from others.
  • Groups perform more effective under certain circumstances, and less effective under others. There is a tendency to fixate on certain topics of discussion amongst groups which often leaves members distracted from their ideas. To reduce the negative effects of topic fixation, members of the group should be given periods to work alone and switch constantly between individual activity and group interaction.
  • Effective collaboration can happen if the people involved come from diverse backgrounds and possess complementary skills to prevent conformity. The best collective decisions or creative ideas are often a product of different bodies of knowledge, multiple opinions, disagreement, and divergent thought processes, not consensus or compromise.
  • New technologies are making collaboration easier than ever, enabling us to increase our reach and broaden our network. Although new technology helps, it will not make your organization collaborative without the right culture and values in place. First, define what you want to achieve through collaboration then use these tools to promote creative collaboration.

How else are you championing collaboration within your organization to create value and succeed?

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Preparing for Geopolitical Shocks

Geopolitical instability has steadily increased over the past years, and uncertainty in the global economy is at an all-time high. Thanks to globalization and advances in technologies, we now live and work in a tightly interconnected world, one in which the boundaries that previously separated domestic from global issues have disappeared.

Threats are no longer confined to traditional political borders, social structures, and geographic boundaries. Geopolitical shifts have dramatically altered the global economic landscape and brought politics and business together.

The rise of China as an economic and politically influential power has threatened the dominance of the United States as the world’s largest economy. Although the opening of China and a market of 1.4 billion people have benefited both countries, it has also intensified competition and sparked U.S. economic and technological espionage accusations against China, leading to strained relations between the two giants.

U.S. companies operating from China have felt the impact of this tense relationship. The opposite is true for Chinese companies in the U.S.

Across Europe, national populism is on the rise and now a serious force. In 2016, the United Kingdom shocked the world when it voted to leave the European Union, generating reverberating effects across markets.

Banks and financial services companies that once benefited from the EU passporting system have had their cross-border banking and investment services to customers and counterparties in the many EU Member States impacted, causing them to reimagine their value proposition models.

The recent invasion of Ukraine by Russia is another example of a geopolitical event that has had devastating effects on human livelihood and businesses. Although the conflict between the two countries has risen over the years, I think it’s fair to say that few political analysts, governments, and businesses predicted a war to happen.

The war has created a humanitarian crisis, rattled global commodity and energy markets, caused prices to soar, and forced many international companies to temporarily suspend their Russian activities or completely cut ties with the country.

Global supply chains which are already fragile and sensitive due to the COVID-19 pandemic are now facing new challenges in the aftermath of the Russia-Ukraine crisis. Multilateral economic sanctions have been imposed on Russia. A state of affairs that was unthinkable months ago and is now threatening to derail the nascent global economic recovery from the COVID-19 pandemic.

Given the global domino effect of geopolitical events and the shrinking of the distance between markets and politics, the need to better understand and more effectively mitigate geopolitical risk has become more urgent. The business impacts, whether direct or indirect, vary by company type and industry sector.

Your company may not be able to prevent wars between nations, but you can anticipate and better prepare for geopolitical shocks:

  • Integrate strategy, risk, and performance decision-making. Consideration of risks to business success is an important part of the strategy selection and execution process, not an afterthought.
  • Develop a better understanding of geopolitical trends and how they are changing. For example, what are the megatrends in business, politics, and technology that are making geopolitical risks more diverse, prevalent, and consequential?
  • Assess the links between these geopolitical events and business performance. What are the events that matter most to your business? For example, how might current global political trends pose physical, business, and reputational risks to your parent organization?
  • Anticipate how these trends are likely to play out in the short, medium, and long terms, and develop mitigation strategies for each geopolitical scenario. Proactively anticipate and plan for radically different worlds, instead of reacting to problems as they arise
  • Review your mitigation strategies as the world changes. Are they effective enough in case of a major shock?
  • Develop capabilities for continuous learning to anticipate, address, and recover from geopolitical crises.

What do you think?

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