Beware of averages - Price management in the pulp and paper industry

By Colin Carroll, Vice President, Business Consulting, Vendavo

BRUSSELS, Oct. 12, 2009 (RISI) - Many commercial organizations in the pulp and paper industry do not realize that pricing is their most powerful and underutilized revenue lever. Despite pricing being the fastest way to improve margins, organizations still fail to manage pricing with the same project focus and statistical process control techniques that improve procurement, supply chain and manufacturing efficiency and effectiveness. Why? They lack the right pricing insight, guidance and capabilities.

Every day, business managers accept a degree of variation in pricing that would get any mill manager fired. Unfortunately, confronted by weak backlogs, managers find it difficult to stand firm in the face of ongoing discount requests. But even in a downturn, smart pricing practices can help preserve margins, ensure that they leverage pricing power where they have it, and position themselves to extract maximum margin benefit from the eventual upturn.

Starting with analytics

To improve the margin performance of a product portfolio, begin by aggressively and precisely measuring and managing customer and product profitability. Measuring profitability at the customer level is a start, but it provides only an average metric. Paper companies must have visibility into detailed levels of customer and product profitability, down to individual transactions. Ship-to, product and shipment-specific profitability information is necessary to make informed product and customer mix decisions.

Business users need help visualizing price and margin analysis at a very granular level. The price waterfall framework, Fig. 1, is a best practice for visualizing pricing analysis. It shows how prices and revenues change, as well as data such as price points, discounts, and costs.

Figure 1 - A typical price waterfall framework

This window into customer profitability identifies price leakage and suggests corrective actions. When it comes to price and margin analysis, beware of averages; they mask profit improvement opportunities and are not sufficient for managing pricing. Many companies that do some form of profitability analysis today make the mistake of relying on averages because they are the easiest analyses to obtain. Averages fail to include all revenue reducers and costs, or lack the ability to drill down to transaction, customer ship-to and product profitability. Transaction-level analytical capability is essential to stay competitive in today's paper industry, and it's likely that your customers have this level of visibility into their costs.

Identifying outliers and poor performers: Waterfall-level transaction visibility will identify top- and bottom-performing customers and products. First, establish a definition of poor performance. Are margins less than 12% unacceptable? The answer probably depends on product family and phase of the cycle. Perhaps 10% is acceptable for customers with annual purchases in excess of $1 million. Rather than leave the definition of good and bad up to subjective interpretation, define performance expectations in terms of measures and waterfall elements.

Once the objective measures of good and bad performance are defined, employ scatter plots, price bands and other analytical frameworks to identify poor performers. In an average paper industry business unit, 80% of customers generate 150% of margin dollars, and 20% of customers actually destroy value. Begin by employing price waterfall analyses to identify those worst 20% of customers.

Figure 2 isolates the bottom 20% of volume in one product family, ranked by contribution margin per CWT, a common waterfall element at paper companies.

Figure 2 - This figures isolates the bottom 20% of volume in one product family, ranked by contribution margin per CWT, a common waterfall element at paper companies

Combining a customer- and product-specific waterfall analysis with analytical frameworks will:

• Provide much greater insight to the commercial organization
• Debunk conventional wisdom about "best and worst" customers
• Provide actionable insight into the specific factors contributing to pocket margin performance.

Finding the root causes

Companies must have the analytical capability not only to identify outliers, but also to isolate the causes contributing to or impeding profitability.

For low-margin customers, the cause might be as simple as a low price, a high rebate or steep freight costs. By evaluating a weak performer against its peer group, companies can identify the key differences driving poor margin realization and begin to consider specific corrective action. For example, to determine why a commercial printer's margin performance is lower than its peers, compare its price waterfall with those of the other firms. Is its freight relatively high? Is this printer's product mix poor? Is it a combination of factors?

Having identified poor performers and each contributing cause, pricing teams (yes, pricing teams; not sales, not the mills) can define and execute corrective actions, and then monitor execution.

Enforcing improvement

As noted, analytics are necessary but not sufficient for sustained improvements to price and margin realization. The business unit must execute the pricing team's corrective action by defining and enforcing policies. These policies should be established both to manage discounting behaviour and the drivers of service costs. Unfortunately, setting a policy and making it stick are two different matters.

Most paper companies have volume-based discount matrices. These discounting guidelines are themselves a policy. Can actual discounts be measured against the guidelines? Figure 3 maps discount guidelines (similar to those in the matrix beside it) on top of actual transactional results. The red bands represent the discount guidelines. Each data point is a transaction. Any point below those red bands represents a non-compliant transaction, a defect in six sigma terminology.

Figure 3 - This scatter plot maps discounts guidelines (similar to those in the matrix beside it) on top of actual transactional results. the red bands represent the discount guidelines. Each data point is a transaction

The high-volume, low-price customers are important, of course. They keep the machines running so that a company can take advantage of the low-volume, high-price opportunities when they come along. But look at the number of transactions, at all volumes, below the floor. Clearly there is room for better policy enforcement here.

Volume matrix price and discount guidelines need to be managed and enforced through targets and floors. Applied to the business unit in the aforementioned example, Fig. 4 shows what those policies might look like in a before picture. The target price and the floor price decrease with volume. All quotes, price reduction requests, or competitive situations are validated against the price/discount guidelines on this chart. Any quote that falls below target is escalated to Approver 1. Setting this escalation policy gives clear direction to the organization and ensures that the pricing director uses his or her time to review only the most important quotes.

The objective (and the way pricing projects end up paying for themselves) is to enforce these guidelines to reduce the frequency of low-price outliers and to upgrade the margin performance of the business by reducing pricing leakage.

Realistic guidelines, if frequently updated and rigorously enforced, drive better sales behavior. They also prevent companies from putting self-inflicted pricing pressure on themselves by reducing variation and communicating consistency to internal and external audiences. Further, organizations can automate the enforcement of policies like these (and the escalation to managers when required) to respond consistently to discount requests in a systematic and disciplined fashion.

Figure 4 - This plot shows volume matrix price and discount guidelines in a before and after picture

Helping sales become informed negotiators

The next step in linking analytics with negotiations is to put waterfall-level analysis in the hands of salespeople as they respond to quotes or competitive situations.

The most profitable paper companies enable their salespeople to see transaction margins at the time of quote. Provided with a competitive situation of $52 per CWT, or 12% off of list, the salesperson should be able to instantly answer questions such as:

• Is that competitor price net of rebates?
• Is the competitive situation delivered or FOB mill?
• What is the estimated freight cost for this delivery? Is that high relative to most transactions?
• Is this a strategic buyer? What cost-to-serve policies are in force for customers in this category?

This level of visibility into profit at the time of quoting helps sales to push back on unprofitable transactions and to discuss all price elements with the customer. In addition, the sales team needs pricing guidance such as defined targets and floors. For example: "At the target price, this quote will be promptly approved. A price below this, well, your boss will have to approve it." These guidelines beg the question: "At this point I have a choice: do I push harder on the customer, or on the pricing desk?"

The most profitable companies in the industry have real-time visibility into mill, product and ship-to margins at the quote level. They also enforce segment-specific, cost-to-serve policies at the point of negotiation and afterwards, as the customer or distributor comes back to ask for order changes or rush freight. A company without these price management capabilities, is disadvantaged in its markets.

Summary

Analytical insights, and the well-defined policies they lead to, can assist paper companies in narrowing the gap between pricing strategy and execution. Linking analytics to negotiations through well-defined policies will enable sales, marketing and pricing teams to follow and execute repeatable, systematic processes even during the disorder and stress of a downturn. What higher calling can there be for the sales and marketing teams in the industry?

Colin Carroll is vice president of business consulting at Vendavo, a leading provider of price management and optimization solutions for business-to-business companies. www.vendavo.com

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