Maintaining or increasing profit margins is key to the development of a company, but in many cases, it represents quite a challenge. I can see two main reasons for this: price pressure on the revenue side and inflation on the cost side. Recently, inflation has been low, but the pressure to reduce prices from year to year has increased. This blog explores 5 ways finance can support a company’s revenue maintenance.
1. Set the right price for product innovation
Desirable products command high prices. There are well-known examples in the consumer industry such as smartphones. The key factors that make a product desirable are a strong brand name and innovative product features that meet customer needs.
Business-to-business (BTB) companies can use the same strategy to secure a strong negotiation position with their customers. For example, in the automotive supplier industry, it is common that yearly price reductions are agreed contractually. Interchangeable products (“commodities”) suffer the highest price pressure. Product innovation is a way to fight against this customer requirement.
During the product development phase, finance should ensure that pricing for the new products is set in line with business case expectations. Finance should monitor market prices and approve product definition and pricing.
2. Establish a pricing strategy over the entire product life-cycle
At product launch, customers expect an improvement in the value offered in comparison to the previous product generation. Additionally, sales departments try to set attractive prices to maximize sales volumes. However, at this stage, the price opportunity is at its best as a result of the competitive advantage of the new product.
In the years that follow, competition attacks with attractive new products. A price-value enhancement is needed. Price increases become more difficult to achieve and price reductions become necessary. This can take place through a direct gross price reduction (“repositioning”), or through a sales allowance increase.
Finance should review and approve the price changes suggested by the sales department, to ensure they meet with the original business case assumptions.
3. Implement a smart sales allowance strategy
Sales allowances are an essential part of successful pricing strategies. Although they are mostly known to customers as discounts, they also include other tools providing a financial advantage to the customers. Sales allowances are an essential part of successful pricing strategies. The level of the allowance will differ based on the sales channel and the product or service type. Their common purpose is to defend the product against competition and to boost sales.
Customer-facing discounts are the most visible instruments for consumer products, but they are in many cases quickly followed by competitors. As a result, customer-facing actions are very costly and their effectiveness is often questionable.
Retailer facing allowance schemes enable a more subtle and targeted approach. They are less likely to be followed by the competition and are less detrimental to brand image. Some sales allowance methods used for consumer products have been copied in BTB. Retailer facing actions and BTB campaigns are usually more financially viable than customer-facing discounts.
Finance should review and approve the sales campaign proposals. The assessment should be carried out using standard templates to ensure comparability. The net revenues of the proposed campaign should be compared to a “do nothing” alternative, considering a reasonable sales elasticity.
4. Exploit every revenue opportunity
Companies confronted with contractually fixed or reducing prices usually try to compensate their situation by agreeing on additional contractual clauses with their customers. Such clauses allow them to charge customers for additional services or for disturbances encountered in the production process.
These clauses are mostly applicable to BTB contracts. Finance should review these contracts before they are signed, and include recovery clauses as much as possible. During contract execution, finance should be informed about actual cases and ensure invoicing of additional services or incurred disturbances.
5. Manage revenues on a net basis
In order to increase overall revenues, companies try to compensate for price erosion and customer losses through higher volumes and new customers. Finance should provide transparency in the overall revenue evolution, by separating price effects from volume and mix effects.
This way, the financial impact of the price erosion becomes visible. The production efforts necessary to deliver the higher production volume also become measurable. In order to maintain the overall company profitability, productivity improvements are necessary. The next blog will address how to measure operational efficiency gains.
The article was first published in Unit4 Prevero Blog