Why Pricing Operations and Six Sigma Pricing
This chapter is from the book
This chapter is from the book
This chapter is from the book
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The superior man, when resting in safety, does not forget that danger may come. When secure, he does not forget the possibility of ruin. When all is orderly, he does not forget that disorder may come.
—Confucius (551 BC–479 BC)
1.1 Introduction
If sales is the life blood of a company, then price is the oxygen in that blood. Yet in a 2006 interview with Harvard Business Review,1 the statements of Jeffrey Immelt, CEO of General Electric (GE), are quite revealing about pricing in his company. He said, "When it comes to prices we pay, we study them, we map them, we work them. But with the prices we charge, we're too sloppy."
If the CEO of one of the most admired and process-oriented companies perceives pricing-related processes in his company as "sloppy," one can imagine things are not exactly wonderful at other companies either. GE was able to bring control to many manufacturing and services processes using Six Sigma, so why not use Six Sigma for controlling and improving pricing processes as well?
According to a November 2004 survey of 16,500 executives, "Pricing is their preeminent worry—ahead of talent shortages and operational capabilities."2 CEOs do not feel they are in a situation to control prices at least in regard to increasing them or even sustaining them during shifts in market dynamics. As one CEO responded to an analyst's questions regarding pricing, "The business environment limits our ability to control prices."
It's true that companies can always "control" the marketplace by lowering prices, but the results can be disastrous for the bottom line. Conversely, the most efficient way to improve a company's profits is to increase the realized price of its products and services. Prices are not only influenced by external market conditions, but they are affected by less-than-perfect pricing decisions and operations within the company.
Consider the example of Lexmark International in 2005, which was enjoying growing sales in the profitable ink-jet printer segment under such brands as Dell Computers.3 Then as sales went down when Dell lost market share for printers, Lexmark cut prices up to 30% in some brands to gain sales growth—but ended up simply losing margin and had to cut 275 jobs. At the same time, rivals Hewlett-Packard, Canon, and Seiko posted better results. Indeed, pricing decision-making and expertise are integral to a company's ability to succeed and survive.
Controlling prices refers not just to the marketplace, but also to the internal processes that have as their final output the ultimate realized price from the customer in any specific transaction. This book focuses on improving these internal pricing processes in the context of business-to-business selling. These processes encompass setting transaction-specific discounts as well as creating pricing-related clauses within contracts that affect realized prices in future transactions. Companies need to look internally at these processes to improve realized prices and stem revenue leaks.
No matter how competitive and difficult the marketplace is, much can be done within the company to improve the overall level of prices by controlling price variation and thus improve revenues. Hence, pricing expertise comprises not only the ability to devise a pricing strategy, but also to manage internal processes to adhere to this strategy.
Companies are typically not bad at controlling manufacturing or service processes or at improving operations in general. Many companies have become skillful at managing costs and improving manufacturing efficiencies. The TQM and Six Sigma movements have seen to that. Six Sigma has been used in many global companies such as Motorola, Allied Signal, General Electric, and Citibank to name a few. There is broad interest in many different industries.
However, the discipline so often brought to the cost side of the business equation is usually lacking on the revenue side. As a result, many companies continue to leak cash from the top line sales because of "defects" in the form of excessive discounts in some transactions or in the form of opportunistic high prices in other transactions that lead to customer dissatisfaction and consequent loss in future sales. Many companies are already adept or are learning to be adept at improving controls on their manufacturing and some service processes with homegrown Six Sigma expertise. We show in this book how to leverage the expertise in decreasing manufacturing defects and variability to improve pricing processes.
There are several good books, primers, and handbooks for Six Sigma and TQM, but none address pricing operations or processes. Pricing is quite different from other application areas in its context and warrants adaptation of Six Sigma (or any other methodology) developed for manufacturing or services. Likewise, there are books on pricing, but surprisingly none focus on pricing operations, let alone discuss how to improve pricing processes with better controls or other adopted methods. This book shows how Six Sigma Pricing can help improve internal pricing operations—and thus profits.