Top management is always looking for new ways to increase shareholder value. To improve profits, they focus primarily on costs. However, reducing costs further is becoming increasingly difficult and managers must now turn their attention to the revenue side, in particular to changing their pricing processes. Improving pricing processes has three clear advantages versus cost cutting (see Figure 1).
First, it brings an investment advantage. Costly severance packages or plant closures are not necessary. Second, pricing process improvements have an immediate positive impact on profit and cash flow while the real effects of cost cutting usually don’t emerge for several quarters. Third, our experience shows a clear profit advantage. Improvements to pricing processes often have a substantially higher impact on return on sales (ROS) than cost cutting.
The average after-tax profit margin of large European companies is slightly above two per cent – a catastrophic situation. Increasing prices by just one per cent would improve profit margins by about 50 per cent. How does one enact such measures?
Forget about simply hiking list prices across the board or commanding the sales force to push through higher prices. Such blunt measures are bound to fail. The proper way is the total restructuring of the pricing process itself. This represents a fundamental strategic challenge that strikes at the core of each economic transaction (see Figure 2 overleaf).
Most companies are good or even very good at value delivery but fall short in value extraction from their customers. Simply put, they fail to harvest the full value of their products. How else can one explain that even innovative, market-leading firms achieve a profit margin of only one or two per cent despite massive cost reductions over the last few years?
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