![]() ![]() Unnecessary rush orders can be eliminated by improved scheduling or constraining Sales from “throwing it in for no charge”. Alternatively, the customer can be charged an additional rush order fee. Likewise, any last minute change orders can be prevented or up-charged. These two hidden costs have reduced the operating profit for this transaction by $350. These indicate pricing changes that can be made to the firm’s commercial strategy which can yield multiples of value. When you analyze this transaction, you will find the following pricing opportunities: In this step, analyze whether pricing is consistent and fair across similar customers buying similar products at similar volumes. Your goal is to discover if there is pricing integrity across similar accounts, and if not, any opportunities to increase the effective price to generate greater profits.Īs shown below, analyzing a sample of transactions for this product in the same volume range and geographic area uncovered an opportunity. The volume-discounted price of this transaction was $85 per unit (blue line). In this sample, there were 5 transactions below $85 and 17 transactions above $85 averaging $87.45 per unit (green line).īy increasing price by $2.45 per unit (+2.9%) to more closely reflect fair market pricing, the company would gain an additional $245 in operating profit STEP 2: Drill down and look for hidden pricing opportunities. But is the company’s pricing strategy truly optimal? Or is management leaving significant value on the table without knowing it and short-changing the shareholders? To know if the price is optimized you need to do two things: STEP 1: Analyze top-line pricing of this product across the firm’s customers (and the industry if the data is available). On first glance, an operating margin of 11.8% appears moderately healthy compared to market comps. Operating Margin of this shipment = 11.8%.Operating Income of this shipment = $1,000.Here is what happens in a typical customer deal: Take a look at this shrinking earnings problem in action at a fictitious aftermarket auto parts manufacturer with $240 million in annual sales. That means every 2% change in a company’s pricing without a volume change normally yields a 25% change in EBITDA. (These numbers can vary, but for traditional companies like retailers, manufacturers, large professional service firms, etc. Pricing Math and the Magical Shrinking Earnings ProblemĪs we’ve discussed before, experience across thousands of companies shows that changes in price impact EBITDA by an average of 10-12X. We are talking about the highly leveraged effect that top line pricing strategy has on the bottom line of a company. ![]() But we not talking about a Hollywood blockbuster or National Geographic documentary. The iceberg analogy conjures up images of ships going down in the night and polar bears drifting in the Atlantic. We call pricing strategy the “iceberg” of business value. ![]()
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