Let’s start with a refresher on the impact of pricing: a 1 percent increase in price leads to a whopping 12.5 percent improvement in profitability for the average business.
As a result, gaining control of price can unlock greater profit.
This makes the price waterfall one of the most effective tools to improve the bottom line. With it, you can uncover leakage, hidden discounts, and ineffective pricing practices.
A simple, powerful way to harvest hefty benefits.
Sadly, many believe prices are driven by the market. They think price is largely governed by external factors over which they have little control. As a result, reactive steps become the norm as opposed to proactive approaches.
Consider the sales department… a function our business knows well.
This group has an unusually high degree of influence, but there can be a tendency towards “let’s make a deal” pricing. The result is not always good: the best negotiators get the best prices, not necessarily your best customers.
The power of the price waterfall approach comes from providing the visibility you need to take control.
Summarizing the benefits of a price waterfall.
While building a price waterfall requires resources like people, time, and money, the advantages are worth every penny.
If you are not satisfied with your performance in a particular geography or market, the price waterfall helps inform whether you should improve the price or product.
Better customer communication.
The price waterfall is a reliable way to find out if you should upgrade how you communicate the value of your product.
Using a price waterfall helps you identify if both on- and off-invoice discounts are relevant and financially justified. Reductions in either category fall directly to the bottom line, so the impact is immediate.
With a price waterfall, the implicit and explicit elements of real product costs have nowhere to hide. This makes it the perfect starting point to optimize value chain operations and pricing policy.
Who doesn’t find this benefit appealing? Use the price waterfall to pinpoint leakage across customers, products, and transactions. This way, you can achieve the optimum price in every single transaction.
Bonus benefit: value-based negotiation.
A seldom used, but powerful technique is to break the price waterfall into smaller parts up to the “pocket” price level. This gives the sales force multiple negotiating levers to achieve the best price.
Examples include off-invoice discount, or a price reduction in exchange for performance reduction, like service level or transaction quality.
The result is fair exchange, not a lopsided commercial relationship favoring the buyer.
Major components of the price waterfall.
Let’s start by specifying the major elements that make up a price waterfall. This can be more or less complex depending on your business. We’re keeping the example simple.
- List (recommended) price. The starting or initial price set for a product or service. Also known as the manufacturer suggested retail price (MSRP).
- On-invoice discount. These “regular” discounts appear explicitly on an invoice. This could reflect a price discount for paying annually as opposed to quarterly, as is common in software as a service (SaaS) businesses, or payment terms like “2% 10, net 30” in the manufacturing industry.
- Off-invoice discount. These are price reductions not shown on an invoice. Typically these include costs like advertising rebates or distributor volume allowances.
- Invoice price. At this price level, explicit discounts are withdrawn from the list price.
- COGS. Pretty self-explanatory: this is the production cost of the product or service.
- “Pocket” Margin. The amount of money that the seller gets at the end, after all explicit and implicit costs and discounts are considered.
The price waterfall can cover other categories too. Examples include other non-direct labor charges and shipping and handling.
The price waterfall can flex easily to support both direct and channel-led sales. Simply add a new transaction category called “reseller price.” Our clients have found value with this category addition.
Now you’re ready to get started.
Five steps to build up a price waterfall.
- Identify your goals. The most common ones have to do with a pricing audit, money leakage, a new channel, or the real revenue gained from every transaction. Be intentional about what you want to accomplish.
- Organize your data. A best practice is to divide the data into marketing, sales, customer, and product segments.
- Create meaningful visuals. Visualize the price waterfall by showing how every transaction segment impacts the price.
- Identify opportunities. Find strong and weak points up and down the waterfall where the business loses money.
- Fix them. Often easier said than done, but always worth the effort.
How do you know if changes you made are successful?
The simplest way to measure success is with a key performance indicator.
For example, you could set a 90 percent compliance target at the pocket price level. Translation: the realized pocket price should meet the target pocket price for at least 90 percent of the transactions.
You could mirror this for the marketing and sales functions to ensure that the right prices are set and implemented.
Even the simple act of reporting these on a regular basis will lead to improvement because of the attention paid to the topic.
Make the price waterfall work for you.
We hope you found this post helpful!
The price waterfall is a powerful, effective method of pricing policy evaluation and diagnosis. While many pricing software options are available to help, you don’t need any of them to start.
Good data and a spreadsheet work fine.
If you have any questions, send them our way! We love helping businesses build out pricing strategies as part of our direct and channel-led Revenue as a Service™ offering.