When you’re in the business of consulting, you hear from people in many different industries and see the depths of the challenges they face.
Throughout my time at Revenue Management Labs, the 3 biggest challenges I hear about are the following:
- How do I grow top-line revenue and drive volume responsibly?
- How do I maximize the bottom line?
- What are the right investments to make?
Now, each of these questions poses a complex challenge that you can approach from many different angles. Over the course of this month, I will tackle each question separately, offering a solution from the perspective of Revenue Management.
Let’s dive right into the first question today!
How Do I Grow Top-Line Revenue and Drive Volume Responsibly?
In any basic Economics 101 class, you learn the following equation: revenue = price x quantity or volume. At first glance, the formula seems simple enough—in order to drive revenue, you must increase the price and/or volume. And yet, when this is implemented, the situation becomes much more complex. Let’s focus in on how a Revenue Manager would approach this scenario to get the best possible outcomes.
Sell More Product (Increase Volume)
In order to increase volume, businesses commonly jump to implement the seemingly quick fix of dropping the price of the product. This is a favorite approach of many salespeople that I know, and although it might work short term, in most cases, it does not offer long-term sustainability in your pricing strategy. In fact, when companies drop their price, it is usually a race to the bottom, as margin is compressed and competitors follow suit. This model is not sustainable unless you truly have a structural-cost advantage over your competitors.
In order to back-up the plan to drop the price, pricing experts will often proclaim, “You don’t take margin percentage to the bank, you cash-in on absolute margin dollar.” I couldn’t agree more! However, it is integral to make sure you have a clear understanding of price elasticity and how much volume the price decrease is going to deliver. Better yet, use the product margin to calculate the break-even elasticity (find out how here) to make sure margin dollars are going in the right direction. For those who are in a bidding situation, you can carry out the same calculations on win-probability elasticity (that is, what impact will the price drop have on changing the probability of winning?) Without these metrics, you should proceed with extreme caution.
On the topic of driving volume, another piece of advice that is worth repeating: if you want to avoid future conflicts, it is important that the sales team has the right incentives that are not just based on volume or revenue alone, but are incentivized by overall profitability.
Thankfully, there are alternatives to the unguaranteed success of simply dropping prices. Here are the techniques of revenue management that will definitely maximize your revenue
Offer Strategic Discounts
The keyword here is strategic, seeing as not all discount are created equal. The first thing to understand is the type of discount that can be offered. There are 4 major types:
- Operational (Standard Terms, Rebates, etc.)
- Performance-Based (Volume Thresholds, etc.)
- Behavioral Based (Exclusivity, Price Pass-Through, etc.)
- Exceptions
As you can imagine, operational discounts and exceptions usually don’t drive much incremental volume, so stay away from those. Instead, discounts are ideally linked to performance and behavior that is beneficial in the market. It’s ok to offer a discount, but make sure you get something in return!
When developing your strategic discount, if the discount is linked to performance, make sure to structure the program so that it can’t be exploited, such as in the case of year-end loading.
Summing up, if you take one thing away from this section, make sure to try and keep discounts:
- Variable vs. Fixed (to limit the risk of uncertainty)
- Contractual vs. Discretionary (to limit over investment) and
- Conditional vs. Unconditional (to incentivize performance and behavior)
Create Segment Specific Offerings
One way you can avoid rushing to drop the price or even offering a discount to increase volume is to ensure the area under the demand curve is maximized, as seen below.
In this, you can see that by having a segmented offer in-market, it allows much more revenue to be captured. This concept can be seen at play in both the consumer packaged good and software industries in a variety of ways.
For example, consider the miniature-sized Coca-Cola cans. They offer a unique experience for a specific segment of consumers that are calorie-conscious. In the SaaS world, on the other hand, we see examples of “feature engineering” that is demonstrated through segmented Good, Better and Best offers that differentiate based on features.
As you consider how to segment your offerings, here are a couple things to keep in mind to drive revenue growth:
Customer Segment Values
Understand what each customer segment values and make sure to build the offer around those value-drivers; if consumers don’t care about certain attributes it won’t matter to their purchasing decision.
Out-of-Pocket Price
Especially when looking to drive volume with entry-level offerings, be sure to consider the out-of-pocket price point and work backwards to engineer the offering in a way that achieves the desired price point. This method is often referred to as “Design to Price”, and IKEA uses this technique to ensure that there is an offering that appeals to every customer, regardless of their price range—have you seen how many chairs IKEA offers? It’s insane!
Focus on Opportunities
Lastly, it is a good reminder to ensure that you are focused on the biggest opportunities. I often see companies go after “sexy” opportunities and innovation to drive revenue but ignore the biggest elephant in the room that is an unmet segment. Go after the opportunities with the most leverage—don’t overcomplicate it.
Optimize Pricing (Increase Price)
Now, it’s time to take a look at the other side of the revenue equation: price. To drive revenue upwards, you need to get the price up!
The approach that I often see is called the Peanut Butter Spread. Despite its faults, it is surprising and scary how often I see this technique implemented. For example, if a company is looking to offset cost pressures and increase prices—let’s say by 4% for the upcoming year— what do they do? With the Peanut Butter Spread, every single product goes up 4% and done!
Unfortunately, in most cases, the price increase leaks from gross price to the net price. The result is that, more often than not, a 4% price increase on gross price is a 1% increase on net price.
Strategic Price Increases
In order to avoid the drawbacks of the price waterfall that comes from the Peanut Butter Spread, you can take a strategic price increase instead. Now you may be asking how to actually implement a strategic price increase. Let me walk you through the steps.
Integrate Price Increase Processes
The annual price increase process needs to be integrated into a business operating cycle and should involve updated granular assumptions about the following questions:
Price Elasticity
Are there pieces of the portfolio that are more or less price-sensitive than others? What about the customers?
Competition
Are there areas of the business that face fiercer competition?
Value Mapping
Are there opportunities to capture value in the market versus the competitive offerings? The input and perspectives on these questions need to come from the sales, marketing and finance teams in order to create a holistic score-card of where pricing opportunities are in the market, and how large they might be.
Reaching Targets
Some increases might be large, say 10%, while other areas might not have any increases. Whatever the case, you should still aim for an overall portfolio increase that aims for the company’s target.
As you aim to reach your targets, there are a couple of important things to remember when taking price increases:
- Don’t tie your price increases solely to commodities and cost. This undermines the value of the offering and is a hard cycle to break. Instead, try and associate price to value.
- Anticipate for the somewhat inevitable pushback and plan for contractual delays.
- Focus on the 20% of the portfolio that will drive 80% of the benefit
Pay Attention to Price Gaps
Another great way to increase price is by managing price gaps within the existing portfolio, or as we revenue managers like to call it “Mix Management”.
A great example of this technique is offered by Dan Ariely in his book Predictably Irrational, based on the experience of The Economist in setting up their subscription offerings. In this case, when presented with the following different sets of choices, the results differed dramatically. In the first case:
- Option A: Economist.com $59.00
- Option C: Print & Web $125.00
Here, 68% chose A, 32% chose B for an average price of $80.12.
However, when The Economist increased their offering to three choices, the results changed significantly:
- Option A: Economist.com $59.00
- Option B: Print $125.00
- Option c: Print & Web $125.00
Here, 16% chose A, and 84% chose C, and 0% chose B, for an average price of $114.44. This is a 42.8% increase in the overall price paid per subscription just by adding option B. With this prime example of anchoring, The Economist demonstrated the power of moving individuals through the portfolio.
If you’re thinking of implementing a similar strategy, here are some things to keep in mind when managing price gaps.
Cross Elasticity
It’s important to understand the interaction between your offerings—how much volume is sourced between the portfolio? This understanding can be gained by looking at historical changes, statistical modelling or research.
Phase-In Your Strategy
Don’t be afraid to phase in a strategy; opening price gaps too wide all at once can often cause shock in your customers. It is better to create an ideal index and a roadmap to the desired outcome over a time period of several increases.
Try and focus on premiumization, but don’t forget about margin. It is great to increase the gross price, but if the margin on the more premium offering is lower than the less premium offering, be careful. Make sure the margins are consistent with the pricing strategy before starting.
Wrapping up, I hope this was helpful in thinking about how to Grow Top-Line Revenue and Drive Volume Responsibly? Notice my emphasis on responsibly!
I would love to hear thoughts and feedback, and if any of these ideas are usable in your business. That’s all for now, but be on the lookout for Challenge #2 next week!
ABOUT THE AUTHOR Michael Stanisz is a Partner at Revenue Management Labs. Revenue Management Labs help companies develop and execute practical solutions to maximize long-term revenue and profitability. Connect with Michael at mstanisz@revenueml.com
