2.4.13

The Science, Art and Common Sense of Service Costing and Pricing

Expert Point of View: 

Interesting anecdotes, insights and pragmatic observations : Kevin Wheatland has worked with almost all aspects of technology services at junior, mid- and senior management levels and shares his thoughts with us in today's Expert Point of View : The Science, Art and Common Sense of Service Costing and Pricing.


Kevin has many years of practical director level experience in the computer and telecom services industries including roles such as head of Global Services, head of Strategic Planning and head of Professional Services Strategic Marketing in various Ericsson organisations. He has also been a visiting professor in High Technology Services Management at Liverpool John Moores University. Kevin is a Certified Field Service Manager and is ITIL accredited. Currently, he is Managing Partner and consultant with Service Pulse International specialising in advising service organisations to improve internal operational efficiency and external market effectiveness.


SERVICE COSTING AND PRICING – SOME PRAGMATIC OBSERVATIONS

Being invited to write an article on the subject of pricing, aimed at people who work daily with such a critical task is indeed a humbling challenge. It is highly unlikely that there is anything I can say regarding the science of pricing which would bring anything new to the table. However, having worked with almost all aspects of technology services at junior, mid- and senior management levels, I have been able to pull together a broad range of empirical and anecdotal experiences relating, amongst other things, to the art of pricing. I have endeavoured here to put down a few personal reflections in the hope that the reader will gain some additional insights, based upon practical and pragmatic observations.

TOP MANAGEMENT

Throughout my career as a service director, as a university lecturer and as an advisor to the global services industry, I have never ceased to be amazed at the relative lack of involvement by C-level executives in strategic pricing issues.  Typically, they are consulted, probably according to policy, when a sales team needs to offer a larger-than-mandated discount to a particularly demanding customer.  Otherwise they are seldom involved. Further, few top managers can tell you exactly how much of the total marketing spend is allocated to pricing.  Many C-levels I have discussed this with, proudly and rightly express that they are advocates of delegation, but I often sense that it is more a question of abdication when it comes to pricing.  Nothing is more pivotal to profit generation than the act and process of pricing.  By definition, pricing is therefore a strategic issue of the highest order that should be a permanent item on the agendas of the corporate executive committee and even the board of directors.  There are perhaps readers that do not recognise this scenario. In that case, congratulations - you work for insightful organisations! But I can assure you that this lack of attention from the top is highly prevalent.  In my consulting work,  I became so concerned with this situation, that I recently researched the matter among members of the prestigious Institute of Directors in London to check if I was alone in making such observations – or was it  that just my clients and my experience were narrow? Happily for me but also quite shockingly, there was considerable consensus among the respondents (all C-level and board members) that pricing is generally beyond the competence and understanding of the majority at the very top!   So the moral here is to engage and even educate top management. They don’t have to become experts, but they do need to understand the underlying, short- and long-term consequences of pricing practices.

COSTING

In every one of my recent pricing assignments, one common denominator has been consistent among my clients.  They do not know their true costs-to-serve! (Note we are talking about complex services here). Thus profit becomes an accident - albeit a fortunate one - rather than a deliberately designed outcome.  It seems then that inefficiencies and the lack of costing data are priced into their services to compensate  for miscalculations or margins of error. In effect, this means that some customers are inevitably subsidising others.  Let’s hope the customers remain ignorant of which is which – but we do know they talk to each other so this can only be a short term rationale!  Interestingly, when we started to dig deep into service costs, all clients have openly expressed how difficult and complicated it is to conduct thorough and detailed analyses.  Of course it’s difficult – otherwise we wouldn’t need pricing experts. We customised complex mathematical simulation models for our clients, but most said that they lack reliable input data. So then we played with the numbers to assess the sensitivity of the many various input parameters in order to arrive at a reasonable appreciation of total cost. Yet still in every case, the clients said they wanted “easy solutions” and were not inclined to allocate resources to get into pricing in a systematic and meaningful way.  In more than one instance, clients just wanted to visit the issue once a year in what appeared to be a mechanical exercise! In spite of this, the lesson we learned is that interesting things can start to happen with your margins only when costing is fully understood and controllable!

BIG DATA

The comments on costing above leads conveniently on to the subject of Big Data. The challenge of Big Data is to make sense of the vast amount of micro-information we collect so that smart, real-time decision making-is facilitated.  We strongly recommend that you pay careful attention to the design of your Field Service Orders / Job Sheets in order to ensure that the data necessary for effective management at each individual customer level is easily recorded and collated. Numerically codifying many of the inputs into a few standardised parameters (e.g. for billing, the codes might be 1-chargeable, 2-contract, 3-sales support, 4-product warranty, 5-service warranty, etc., or for work types: 1-Installation, 2-corrective maintenance, 3-preventive maintenance, 4-updating, 5-upgrading, 6-moves and changes, etc., or for work analysis: 1-symptom code, 2-cause code and 3-resolution code, etc.,) enables easy collation and analysis of data at aggregated or individual levels. Crucially, simple codification also makes it easy for the field engineers to remember and use. Again this promotes the manageability of costing and pricing and appropriately used data will provide crucial inputs to not only pricing, but also to  the design of new products and services, including more efficient service methodologies, etc., all aimed at increasing competitiveness.

INDIVIDUAL CLIENT PRICING

It is an interesting phenomenon that only about 3-5% of service organisations are able to assess the true profitability of each individual customer aggregated yearly or preferably on a rolling basis. (Trends can be changed, history can’t!) Herein lies the proof of the generalisations made in costing and pricing discussed above, since corporate profit should normally be expected to be the aggregation of each customer’s profit. Yet we don’t seem to approach accounting in this detailed bottom up way. Again this underscores our tendency to fatten margins to compensate for the lack of real-time manageability at the product, customer and activity levels. However, imagine the consequences of being able to price a service contract on the basis of empirically-assessed, likely costs-to-serve (for new contracts) and historical cost data for each client (for contract renewals). Customers that utilise a service more frequently can expect a price increase next year. (If they don’t want to pay, you are rewarded with less cost). Customers who use a service less have a reasonable right to expect a lower cost next year.  This is not a discount but a generator of fair, repeat business, which is equal to loyalty, the profitability of which is extremely well-researched and published. Certainly such pricing practices will enable you to avoid the downward price spiral that is the mark of commodity markets and your brand will be enhanced through the word-of-mouth voice of the customer..

SAYING NO, DISCOUNTING AND BUNDLING

Every manager I have spoken to on the subject  agrees that we don’t actually want every customer, yet we don’t really know in required detail which ones they are. As alluded to above, I never recommend ever saying “no” to a customer. Let the price speak for itself to such customers that do not deliver a reasonable profit for you – and not forgetting to condition the sales teams to collaborate in this matter. Sales commissions are often important, but if we could link part of the commissions to contract profitability, a lot of poor sales practices based on self-interest would be eliminated. Likewise, as a policy starting point, I never recommend discounting service contracts. It conditions the customer to expect rebates for the entire life of the business relationship. All too often I have heard sales people complain that the service price is too high, yet when asked for context, (i.e. too high in relation to what), they seldom have an answer; a clear indicator of poor sales qualification when they accept the customer’s position without further analysis – even if the price really is too high! (By the way, let’s not forget it is the buyer’s absolute responsibility to get the best deal possible). Further, giving away future cash-flows in multiple year contracts, especially when future costs-to-serve are liabilities that are more often than not difficult-to-calculate, is simply unsound business practice.  It is far better to adjust the Service Level Agreement’s performance parameters and/or the service contents (of the various modules that make up the total service.) in order to reach a price that  is agreeable to the customer. In this context, it is also worth noting that only 1-in-6 to 1-in-8 product sales persons are able to successfully make the transition into services and solutions selling. On the subject of bundling, in the past, whole conferences have been focused the packaging of services.  The services industry, and in particular the IT-Services community has bundled various service modules into the total offering either in order to avoid later (and costly) up-selling, or to facilitate internal cross-subsidisation of  less efficient or attractive modules.  These have then been dressed as “total value packages”. Today, customers are smarter.  They are interested only in specific service modules that deliver specific and tangible benefits and are increasingly allergic to bundled solutions. Yet again we see the need to understand modularisation to create meaningful packages for customers where each component of service has a real, justifiable value proposition.  Failure to do so can so can eliminate us from the competitive race since our focus would appear to remain more on internal considerations, rather than external customer needs.

SUMMARY

As partially demonstrated above, pricing has many facets, implications and consequences. It permeates far more than the pricing or marketing processes. An costly investment in pricing expertise and infrastructure can easily be negated by poor selling and discounting practices.  Several years ago, when I was a service executive in a global A-listed company, I was invited to lecture in Service Management at a UK university. I immediately became humbled and  less full of myself and said to the professor, “But I don’t know anything – it’s just common sense!”  He replied “Yes! And common sense isn’t very common!”  So my final piece of advice is to invite the reader to think of himself as the buyer.  Every one of us has a vast experience of being a buyer every day of our lives. We know what we like and what we don’t like. We have an acute sense of what is fair and when we are being taken advantage of. In extreme cases, we decline to buy if we have a choice and resent the seller’s organisation if we don’t! Pricing is thus part of the relationship equation.  So after building on both the science and art of pricing, follow through with a little common sense so that your price can be easily justified with reason and clarity. If we make things too complicated, we can hardly explain things internally, let alone to customers.  Einstein said, ”Everything should be made a simple as possible, but not simpler!”  He also said “If you want to wear the shoes of another, you must first take off your own!” Solid advice from the master who didn’t even have a business orientation!

Kevin Wheatland is an internationally recognised thought-leader on technology services and will be speaking on Life-Cycle Value at the upcoming EPP Aftermarket Forum in June. 

To take advantage of Early Bird registration at 1.100 Euro for the 2 forum days, please contact Nicolene.Barnard@pricingplatform.eu.


2 comments:

Merab Dekano said...

I can only agree with Kevin; top management is largely unaware of not only day-to-day pricing, but also of strategic pricing issues. Based on my humble experience in a number of large companies as a pricing professional, the reason happens to be that most of the top guys and girls are either former marketing experts, or top salesmen, or brilliant engineers, or even financial experts. I myself have not seen yet a pricing professional reach CEO position (I am not saying there are not such people). Neither have I seen so far a Pricing VP (companies are, however, teeming with Sales VPs, Marketing VPs, Finance VPs and so on). Therefore, top management thinks that pricing is part of either marketing, or finance or product management or worse even, of sales. The reason fewer pricing professionals reach top positions is that there are simply fewer pricing professionals, if any, in a given average organization. Some have none. And yet, margin leaks and sales people are not the right answer to tackle on the problem.

Relating to the costing issues, fairly true; most of the large organizations cannot tell you what the cost is for a given product or part number. For service it is even worse. I agree with Kevin; data collection is important. I would add, however, data integration is crucial. It is a chain; you cannot integrate anything if it is not produced in the first place (IT professionals are terrific people, but they are not magicians). In any case, companies will be able to make better pricing decisions if they integrate all the existing data in single gateway comprehensive reports. If they do not, the data becomes useless. Frankly speaking, dedicated pricing software is the answer for it comprises (it should) data integration from multiple ERP sources. Very few companies have it.

How to tackle rampant discounting? I have no answer to this question. I do have thoughts. Let the sales person be advocate of customers’ interests and let pricing people be ‘evil’. In other words, effectively execute your price. Let you sales people say to the customer: “This is as low as I can go, my hands are tied up by pricing team’s decisions”. Now, the pricing team needs to provide an explanation, every single price point needs to be explainable, otherwise it is pointless to have a pricing team. You can explain your prices to a B2B customer if you have pricing rules. You can have pricing rules only if you have pricing strategy. B2B customers are not consumers. B2B customers have budgets (if they do not, do not lose your time) and they need to get a solution, no matter if entire budget is spent. Just have good sales people, not dinosaurs. I have seen gross margins for the same product of 40% in some countries and negative margin in other countries. I do admit, having collected competitive data myself, that the prices vary across the countries, but they do not vary by double digit percentage figures. Sales people’s skills do vary by triple digit percentage figures. I have worked with a girl who sold on average 16 cars in a dealership every single month, while other sales people sold 2 or 3. And that statistic was consistent over the time. Same cars, same price, same dealership.

Last and not least comment going back to the beginning of the discussion. Top managers do not ‘care’ about pricing. They do, let me tell you, care about something called ROI. If you are a pricing professional within a company, please never lose this from your sight. You have to be a profitable pricing professional. Companies invest in us and they need their money back, and more… And no company will give pricing team carte blanche, so expect pretty challenging environment.

Merab Dekano

Nicolene Barnard said...

Thanks Merab. It’s nice to know that I seem to be hitting the right buttons. You mention the sales discounting issue. In terms of sales techniques, customers will always (or should ) press the salesman to see how much discount can be squeezed out. The best defence a salesman can have is to refer to official policy when he cannot promise more. The customer will know that a salesman cannot change policy and will therefore know that the limit has been reached at which the salesman can agree. Further pressure will then require escalation.

I am not sure about the issue of pricing professionals becoming CEOs. You are right in terms of the typical CEO having other previous experiences that most often do not include pricing, but being an expert in pricing alone is hardly sufficient credentials for such a huge broad-based task. I often hear the same complaint from purchasing managers (i.e. top management doesn’t understand strategic buying either). They too lament the fact that buyers seldom make CEO. Essentially a CEO is measured by his board on four issues: shareholder value, profit, growth and sustainability. As a member of the board of directors of a number of companies, I expect the CEO to be extremely broad rather than deep. He needs to understand the big picture more than the vertical details.

I am an advocate of dedicated pricing software as long as they are able to handle complex services and not just standardised offerings, but again, if you do not secure reliable input data, then regardless of whatever tools you have, they will be unable to provide the desired level of output quality. The big challenge is deciding what the correct input data should be. There are so many vested interests to be satisfied and the worst thing that can happen is that IT solutions are defined by the IT department!

Posted on behalf of Kevin Wheatland
kevin.wheatland@spulse.com