by Finn Hansen, Founder and CEO of Stratinis.
We often find ourselves discussing an interesting decision that businesses are faced with: whether or not to inform salespeople of just what costs go into the products they sell. Two of the main arguments can be summed as follows:
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Don’t give access to cost information to sales people as they then tend to lower the price as long as the margin is positive and focus on cost arguments with regard to the customer – instead of producing value arguments and getting customers to pay more.
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Do give access to costs (and thus margin) as sales people cannot optimise profits (“price” minus “costs”) without knowing the costs.
As an aside, it is important to understand what actually constitutes “costs”, as incorrect cost information could lead to poor pricing.
Many companies debate this question. There is generally a reluctance to share confidential information with more people than absolutely necessary, however, the key question must be: what is the outcome if the sales team does or doesn’t know the costs?
Take the following example of a sales person selling two products:
Product A has a price of 100, and marginal costs are 50; fixed costs are allocated to this product at 30 per unit, so the variable margin is 50 and margin against full costs is 20. Product B meanwhile, is priced at 120 and the marginal costs are 51. Fixed costs are allocated the same way as product A, i.e. 30 per unit. The demand for the two products is the same at their current price points. We will furthermore assume that both prices are value-based prices, i.e. the price is what the customers are willing to pay.
Even if they were not optimised value prices, there is nothing to indicate that any issue of lack of value arguments would be worse for product A or product B.
On the other hand, the bonus scheme of the sales force can play an important role in the outcome.
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Knows Costs
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Doesn’t Know Costs
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Bonus on Sales
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Confusion, but tendency to sell more of Product A if it is cheaper and thus easier to sell.
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Sell Product A as it is cheaper
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Bonus on Profits
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Push Product B as it is more profitable
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Confusion/Unknown.
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Pushing product B is the best option for the company, as it delivers most profit (remember, demand/market size is identical for the two). Selling product A leads to lower overall profits.
Therefore the best outcome is achieved if the sales force knows the costs AND is bonused on profits, not sales.
Companies should always deliver value-based communication arguments to their sales people - as this will drive prices higher. However, when companies sell more than one product (as most do), using only this approach can lead to incorrect behaviours if sales people are not informed about pricing and are bonused only on sales.
Coming up with a good profitability measure is then secondary, and can be achieved either by “true” costs or using a proxy, such as marginal cost plus an allocation. Activity-based costing (ABC) can often be used with success for allocating fixed costs.
First and foremost pricing is about optimising profits, not just sales. Pricing people must help sales by helping on the pricing side, but should not seek to prevent sales people from doing what is best for the company by barring them access to cost data. In fact, an argument could be made that it is the pricing people who should be kept away from cost data - as this will force them to push value-based pricing strategies rather than thinking about costs when coming up with internal pricing policies.
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Stratinis has a range of functionality to help ensure your pricing and sales people have the information they need to deliver the best prices. Please visit us here to learn how our software solution can help increase your profits.