Pricing pains? More CFOs turn to software for better profits
Fast-growing 'optimization' products often can work, McKesson Medical-Surgical CFO Britt Vitalone learns from experience.
The medical-surgical supply unit of McKesson Corp. has few products that are more commodity-based than table paper: dispensed from rolls and replaced from patient to patient. But how to adjust the prices for those rolls from medical customer to medical customer? And in that pricing process, what tools to give sales personnel to help them "optimize" the price for better profit?
Questions like those led Britt Vitalone, McKesson Medical-Surgical's senior vice president and finance chief, to look for price-optimization software several years ago. "One of the things I recognized was that there was inconsistent pricing with various product groups" --- including the group that table paper was in. He also saw that because of the decentralized nature of medical-supply selling, the company badly needed to give sales people real-time decision-making capabilities. That required getting them "richer data" about what prices different customers -- from family practices to obstetricians to radiology specialists, in small towns and cities -- might be willing to pay.
Without the best information, "two things could happen," says Vitalone: "You could lose the sale for having the wrong price, or you could get the sale, but leave money on the table."
The need to solve costly problems like that, from the frontlines of sales and distribution, today leads more and more companies to purchase price optimization software. The market has experienced a turnaround in 2010, according to that analysts at Gartner, and now generates nearly $200 million in revenues annually for the range of providers, which include Oracle, PROS, Vendavo, Vistaar Technologies, and Zilliant.
Profitability's 'Pricing Lever'
In most cases, CFOs like Vitalone --- who uses a PROS product --- are the target purchasers of such software.
"We see CFOs as the guardians of profitability, and one of the greatest levers they have to guard it with is pricing," says Andres Reiner, CEO of PROS. Reiner sees finance as needing help in dealing with issues like wild commodity-price variations and currency fluctuation, in addition to the normal "transactional basis of how their businesses are charging." His software makes companies more agile, he says, by providing real-time information about "product attributes, customer attributes, and transactional attributes" --- including information about how much the buyer may be willing to pay for various products.
Vitalone says his own unit's small pricing group -- put together after he became CFO nearly three years ago -- started by "stepping back and cleansing our data, which alone can be pretty muddy and unkempt." He found prices "all over the board for similar SKUs, and the question that jumped out at us was why, since there seemed to be no rhyme or reason to it?"
Putting information in the hands of sales people "is something you almost have to do in a business like distribution, where the number of transactions is so great," he says. "To think about how many people you'd need in a centralized location for that work, the economies of scale just aren't there."
'It's All the Same Product'
When it comes to table paper, for example, "it's all the same product," Vitalone notes. "However, you may be dealing with a customer with very high volume, or very low volume. And that's just the starting point for sales people, who also benefit from information about what other customers in the same specialties, in other parts of the country, are paying.
Then, the results are processed nearly real-time, and fed back to the sales personnel in a "constant feedback loop," he says. "That way, the business takes ownership of the data, and information about how customers are reacting."
The finance chief doesn't talk about the increase in margins resulting from use of the software at his unit, noting that "it really does vary widely," and that his segment of McKesson doesn't break out such numbers. "Leave it to say that we did see a marked improvement in our pricing," he says, pointing to an oft-quoted 20-year-old McKinsey study that showed a 1% increase in price delivering as much as a 10% rise in operating profits. "That roughly translates to our experience," Vitalone says.
There is, however, a training side to arming sales people via the technology, in part because so much information makes them analysts, in effect, capable of gaming the system for their own benefit. "There is a big communication aspect to this," according to Vitalone. "Data can be very powerful, but it's also very dangerous."
The Price of an Airline Seat
Andres Reiner, the PROS chief executive, believes that the profit-boosting power of optimal pricing is a critical advantage for companies facing the current turbulent environment, "with commodity prices, currency fluctuations, and other elements playing havoc with conventional planning." Firms, he says, now must "be more agile in triggering price changes during the year, rather than once every year or two."
Software offerings from the range of providers --- mostly aimed at transmitting data to individual sales personnel --- have multiplied to help business-to-business customers cope, he says. In decentralized sales operations, especially, "companies today have very rich data, but they don't have the tools to utilize that data to help them price better." Pricing-optimization software lets companies "create like segments that behave together," something that normally is "a very heavy, manually intensive process." Using his company's software, he says, "you manage your discount policies, compare segments that are alike," and include information, tailored to a company's own situation, to help "focus on moving your lowest prices up to an average price."
PROS got started 25 years ago, helping airlines with yield management: the near-science of pricing airline seats based on demand and many other factors. "Seats can get spoiled, and you need to get the right price for the right fit," says Reiner, whose company, he says, still has 80% of the market in an airline yield-management business that has become very mature.
One key measurement of today's wide range of pricing-optimization software products for various industries did derive from the lower-tech airline model: an evaluation of the customer's "willingness to pay," using, in the airline case, booking records, and indications such as whether ticket-buyers planned a short stay, or business or vacation-based flights.
For PROS and other software providers, the information processed in the front-end for corporate clients becomes extremely simple when it is processed for sales personnel on the back-end. It may arrive in the form of a simple quoting tool, product by product, with a target price, a stretch price, and a floor price that sales can use, depending on the situations encountered on-site.
The PROS organization itself uses its own software --- not surprisingly --- and its own CFO, Charles H. Murphy, reports in an e-mail that he, too, benefits. The company's pricing strategies are employed "together with our quoting capabilities to deliver the right price for the right customer, combined with the right approval workflows that support our profitable growth strategies." (Says Reiner of his CFO of 13 years, Murphy has been "instrumental in ensuring PROS' long record of continuous profitability," working with the sales organization and both customers and prospects, "forging long-term, consultative relationships.")
Optimizing Its Own Pricing
The software can be expensive --- for external customers, anyway. Indeed, for the largest companies it can be in the range of $2 million or more. But PROS says that in its case, at least, charges, based on the customer's revenue under management, aren't assessed until customers meet critical implementation milestones and calculate the return on their investment.
Plus, of course, PROS considers the cost to its clients to be dwarfed when the profit result reflects McKinsey's 10%-or-so profit expectation for each 1% boost in pricing. And, says Reiner, "Payback is most times within the first year."
McKesson Medical-Surgical's Vitalone can't report quite that degree of value; payback will be "perhaps a bit longer in our case, as there is an implementation and ramp-up time that need to be factored in," he says. (While he won't discuss what the company pays to PROS, when the $2 million figure is cited he notes that "we did not invest near this level.")
Whatever the actual cost is, though, he adds, "suffice it to say I am pleased with the return for the investment."