Emphasizing value over price has to be the priority for smaller manufacturers with limited resources. Manufacturers in niche industries have unique insights into the specific needs and price sensitivities of their customers.
Pricing Optimization for SMB Manufacturers
Q&A with Tom Fitzgerald, Principal at | Earnest & Associates
Tell us about yourself and your role with Earnest & Associates.
My name is Tom Fitzgerald, and for over forty years, I’ve helped companies both large and small with navigating corporate financial management. I am a specialist in the design, deployment, and application of sound, synergistic, and timely enterprise resource planning tools grounded in sound business best practice (“ERP”). As a Principal at Earnest & Associates, I collaborate with C-level executives and implementation teams to assist them in the definition and implementation of business optimization strategies.
Together with my colleagues at Earnest & Associates, we recently published a guide on dynamic and optimized pricing strategies aimed at small and medium-sized manufacturers and distributors.
For small and medium manufacturers, balancing production costs with competitive pricing can be a constant struggle. What are the most common pricing mistakes you see these manufacturers making, and how does a more strategic approach to pricing help address the unique pressures they face?
Small and medium manufacturers often fall into the trap of 'cost-plus' pricing, where they simply add a fixed margin to their production costs. This seemingly straightforward approach ignores crucial factors like market dynamics and customer value. This approach can cause manufacturers to miss out on potential profits when the market would support higher prices, and can lead to losing sales to competitors offering more compelling value. Relying on intuition or anecdotal feedback rather than data-driven insights can hinder effective pricing strategies.
Pricing optimization helps manufacturers overcome these challenges by integrating cost analysis with market intelligence and customer segmentation. This comprehensive method provides a deeper understanding of the True Cost to Serve (CTS), encompassing not only raw materials and labor but also warehousing, shipping, and customer-specific expenses, thus revealing potential areas where profit is unknowingly leaking.
Furthermore, pricing optimization helps manufacturers gauge customer value perception, identifying what customers are willing to pay for specific features or products, which allows for value-based pricing that aligns with customer expectations. Using this approach allows manufacturers to make strategic adjustments to better capture and retain market share.
In today's environment of fluctuating input costs and tight margins, this granular level of understanding is essential. It empowers manufacturers to set prices that not only maximize profitability but also ensure they remain competitive even when market conditions become volatile.
How can optimized pricing help smaller manufacturers gain a competitive edge in their niche markets? Given their limited resources, what are the most immediate and achievable steps these manufacturers can take to start implementing a more effective pricing strategy?
Emphasizing value over price has to be the priority for smaller manufacturers with limited resources. Manufacturers in niche industries have unique insights into the specific needs and price sensitivities of their customers. This can allow them to fine-tune their offerings and pricing strategies to better attract and retain their ideal customers. This targeted approach fosters increased customer loyalty and repeat business, enabling them to thrive even when facing competition from larger players.
To start implementing a more effective pricing strategy, small manufacturers should prioritize understanding their most profitable customer segments by analyzing their unique needs and buying behaviors. Leveraging existing sales and customer data can reveal valuable insights into pricing trends and areas for improvement, and even simple spreadsheet analysis can uncover these opportunities. It's best to begin by optimizing the pricing of their most popular or profitable products, rather than attempting a complete overhaul of the entire pricing structure at once.
Staying informed about competitor pricing and actively seeking customer feedback through sales channels can also provide critical market intelligence. Finally, shifting the focus from simple cost-plus margins to calculating the true gross margin for each sale will lay the groundwork for a more data-driven and profitable pricing strategy. These initial steps require minimal resources and can be readily implemented to establish a strong foundation for pricing optimization.
Small and medium manufacturers often have limited IT resources. What specific, readily available data points should they prioritize for pricing analysis, and what technologies can they leverage to capture and analyze this data effectively?
Beyond the standard metrics of sales and production costs, a crucial metric for manufacturers in determining the right price for their products is the Cost to Serve. This is the combination of costs required to retain a customer such as order size, return rate, customer service resource time, etc.
Calculating true cost-to-serve is part of the customer stratification modeling process, which segments customers into different categories based on their performance and contribution. Two of the most difficult-to-distinguish categories are that of the Core customer, who has high loyalty, good volume and reasonable cost-to-serve; and that of the Service Drain customer, who has high loyalty and high volume but low margins, and most crucially, has a very high cost-to-serve, demanding high levels of service.
If a manufacturer can determine whether their client is a Core client or a Service Drain, they can then begin to price their products accordingly.
In terms of choices around technology, as the bar for organizational efficiency continues to be raised, it is important for an organization to have an ERP solution that is both agile and stable enough to interconnect with the various specialty solutions that departments require. Think of ERP as the backbone application solution environment. It keeps all the pieces in alignment so they can work together solving both department and company-wide issues.
ERPs on their own however don’t present data in meaningful ways that drive transformational improvement or growth. Nor do they convey a keen perspective through cross-referencing key data relationships. Investing in the right business improvement applications to augment your ERP’s standard capabilities can produce a game-changing combination that in the end fuels both growth and profitability. And it requires far more than tacking on ERP modules. Robust business performance management tools that integrate with your ERP will bridge the gap between big data outputs–which are typically devoid of analytical value–and robust thinking that drives growth and profitability. Invest in tools that empower decision makers to be able to see and understand how multiple activities inter-relate to drive end results and how these activities relate to company goals.
In manufacturing, direct customer relationships are often key. How can manufacturers empower their sales teams to better understand customer value and market dynamics, and how can they ensure these teams are aligned with the company's overall pricing strategy, especially when dealing with custom orders or long-term contracts?
In many organizations, what members of the sales team “think” they know about customers drives decision making around pricing. Pricing decisions are made with anecdotal information at best–guesses at worst. To understand market dynamics, sales teams should be trained on how to conduct competitor analysis, track industry trends, and gather customer feedback on market changes.
Most importantly, sales teams should accurately identify the Cost to Serve for each customer, allowing organizations to create more targeted and effective strategies to attract the most profitable customer type, develop products and customer service programs that meet the specific needs of different customer groups. This ultimately, builds stronger relationships and more loyal customers.
Custom orders and long term contracts can also be viewed through the lens of Cost to Serve. Adjusting long-term contracts to include price adjustments based on fluctuating costs or market conditions, for example, keeps customers from becoming a Service Drain in the future. Variables for custom orders such as material costs, labor, and potential volume discounts also feed into Cost to Serve.
Finally, structuring sales team compensation that distinguishes between profitable sales rather than just sales volume is crucial. Sales teams can use customer data to reinforce behaviors that reduce the Cost to Serve, and resolve issues that increase it.
For manufacturers dealing with fluctuating material costs and production schedules, dynamic pricing can be particularly valuable. What key production and market variables should they track, and what practical, adaptable methods can they use to adjust their pricing in real-time to maintain profitability while remaining competitive?
Dynamic Pricing takes a prospective focus to either avoid negative consequences on margin erosion or exploit opportunities on margin boosting from a fluctuating cost market environment. In other words, a seller needs to know what is coming at them that will significantly impact their current pricing model (which may be based on stratifications).
Dynamic Pricing is about adaptability of the pricing plan or strategies. Hence, for a manufacturer, they need to be forward focused on 1) determining disruption to the raw material costs and their cost of production that may be coming at them and 2) constantly tracking their available production capacity.
As to (1), it’s imperative to know as much as in advance of upcoming cost changes that could significantly impact pricing and define strategies to adapt such as a) adjust pricing to preserve margins or leverage cost opportunities advantages to grow margin or b) hedge against potential negative margin erosion via proactive purchasing arrangements with vendors to preserve cost. As to the latter, determine your most valuable vendors and work to obtain favored customer terms with them.
As to (2) knowing your capacity availability is essential to pursuing opportunistic pricing. The goals here are to ensure that the orders running through the production floor are generating the optimum margin possible at any one time in light of the demand for your services / product. Obviously, when demand is lean, one needs to be more progressive in their pricing to win orders, however, it’s imperative to know how low one can go in pursuit of work. As the production queue is filling, pricing should start to reflect a capacity availability premium. At full capacity, pricing should never be giving work away. This is easier said than done, but a seller needs to know and believe in their core value and defend it in their pricing. The cardinal sin is for a manufacturer to load their production queue with low margin work. An ancillary to this is that the higher margin work should always receive the priority fulfillment commitment dates. It’s all about the cash conversion cycle and running the higher margin work through production faster than the lower margin work.
I’d like to end with two caveats. First, these comments relate to a discrete manufacturer. Second, these decisions cannot be made in a vacuum. One needs to know its competition so as to be able to set practical limits be it on the conservative side or the aggressive side in setting pricing.
The content & opinions in this article are the author’s and do not necessarily represent the views of ManufacturingTomorrow
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