How to Eliminate Margin Leakage in the Manufacturing Industry
July 22, 2020
Eliminating Margin Leakage in the Manufacturing Industry
Margin leakage can have a devastating effect on your profits, leaving your “pocket price” – the amount of money you receive after all discounts and incentives have been accounted for – way below the value stated on your price list.
Margin leaks range in threat level from drips to torrents, but as anyone who’s ever experienced a weeping pipe will attest, a drip can be every bit as damaging as a flood!
In this article, we identify the critical sources of margin leakage in the manufacturing industry. And explore how the manufacturing industry can eliminate manufacturing industry margin leakage to improve price realization and profitability on the frontline.
We focus on three major lines of inquiry, asking: How can I empower my sales team to negotiate and quote more confidently and productively? How can sales capture more margin by serving off-invoice incentives when quoting prices? And, how can I enable my sales team to manage incentive performance with maximum efficiency?
Let’s find out how much money you’re leaving on the saleroom floor and how to be hot to eliminate margin leakage.
How can I empower my sales team to negotiate and quote more confidently and productively?
Not all sales reps are created equal. Often, there’s a vast disparity between those that provide the best and worst results when it comes to price realization. But the blame shouldn’t lie at the door of your weakest performers. Because, without robust deal profitability guidance, your sales team is effectively flying blind.
Sales need strong direction and close supervision when it comes to pricing. To eliminate margin leakage in the manufacturing industry, pricing managers have to foster a shift in focus among sales teams away from “costs” and towards “value”. Only a value-based pricing strategy accounts for your customers’ actual willingness to pay, mopping up the consumer surplus that cost-plus pricing leaves behind.
While value-based pricing is the ideal choice for the vast majority of companies in the manufacturing industry, there are plenty of exceptions. For value-based pricing to be successful for your company, the following factors must apply:
- You must be able to differentiate yourself and your product from the competition.
- Your product must be customer-focused, meaning any improvements and added features are based on customers’ wants and needs.
- Your product must be of high quality.
- You must have established communication channels and strong relationships with customers.
- You must be targeting a specific type of customer or segment.
- There has to be a “next best alternative” that your customer can buy instead.
Pricefx has two key modules that you can use to ensure sales teams confidently tow the company line when quoting and negotiating. The first is PriceOptimizer, which analyzes your business at the most granular level, grouping customers with similar buying behavior into segments, and optimizing pricing strategies for each accordingly.
With its powerful machine learning capabilities, PriceOptimizer digs deep into your data, uncovering trends and running simulations to identify the optimal target margins and price parameters for your sales team to leverage when doing deals. Complex data is displayed in easily digested visual charts (including inline scatter and deal waterfall), giving sales teams an in-depth insight into your pricing strategy while promoting collaboration.
The second module is QuoteConfigurator, Pricefx’s CPQ (configure, price, and quote) software, which works in tandem with PriceOptimizer to provide sales with instant and error-free responses to price inquiries. Sales can provide quotes faster than ever before and see information regarding similar customer purchases and products, giving them greater confidence to up- and cross-sell.
How can sales capture more margin by serving off-invoice incentives when quoting prices?
If deal profitability fluctuates wildly within your organization, it could be mismanagement of on- and off-invoice incentives that are to blame. If your sales team can’t accurately visualize and account for “margin squeezers” on deals, such inconsistency shouldn’t come as a surprise.
Your sales team needs instant access to the complete deal waterfall when quoting, showing all profit reducers at a glance. Without this data at their fingertips, they’re unable to quote accurately, causing margins and overall deal profitability to shrink as a result.
McKinsey identifies 12 different types of incentives that contribute to price and margin leakage. These are the main ones to look out for, and they’re listed below.
- Annual volume bonus: an end-of-year bonus paid to customers if preset purchase volume targets are met.
- Cash discount: a deduction from the invoice price if payment for an order is made quickly, often within 15 days.
- Consignment cost: the cost of funds when a supplier provides consigned inventory to a wholesaler or retailer.
- Cooperative advertising: an allowance paid to support local advertising of the manufacturer’s brand by a retailer or wholesaler.
- End-customer discount: a rebate paid to a retailer for selling a product to a specific customer – often a large or national one – at a discount.
- Freight: the cost to the company of transporting goods to the customer.
- Market-development funds: a discount to promote sales growth in specific segments of a market.
- Off-invoice promotions: a marketing incentive that would, for example, pay retailers a rebate on sales during a specific promotional period.
- Performance penalties: a discount that sellers agree to give buyers if performance targets, such as quality levels or delivery times, are missed.
- Receivables carrying cost: the cost of funds from the moment an invoice is sent until payment is received.
- Slotting allowance: an allowance paid to retailers to secure a set amount of shelf space.
- Stocking allowance: a discount paid to wholesalers or retailers to make large purchases into inventory, often before a seasonal increase in demand.
QuoteConfigurator forms the basis of Pricefx’s solution to these pervasive off-invoice incentive challenges. It does so by first analyzing, through machine learning, your current quote and discount management processes, before establishing a streamlined system of team workflows to approve off-invoice incentives. The greater control and visibility that pricing managers have over incentives, the more margin leakage can be avoided.
How can I enable my sales team to manage incentive performance with maximum efficiency?
The majority of companies in the manufacturing industry are fixed discounters – they offer the same discounts to all of their customers, usually in return for larger order values. But fixed discounting is a weak strategy. It completely ignores the crucial differentiating factor that affects all buyers – their willingness and ability to pay. Some buyers will be happy to pay full list prices, but you’ll never really know which ones they are, and without this information, you can’t take strides towards eliminating margin leakage.
If you’re offering standard discounts across the board, your competitors will soon uncover this strategy and lower their prices accordingly, triggering a race to the bottom that benefits no-one (but the customer). What’s more, over time, fixed discounts are taken for granted, buyers start to expect them, and their potency as an incentive is diminished.
Smart pricers practice value-based discounting by structuring incentives in such a way as to sculpt customer behavior towards meeting specific business goals and objectives. A range of discounts are applied to different customers, channels or segments, in a highly bespoke and carefully considered manner, taking into account past performance and current market conditions.
The problem with value-based discounting, however, is that the higher the number of different incentives you offer, the harder your incentive infrastructure becomes to manage. And how can you be sure you’re devising the incentives that will eliminate margin leakage most effectively?
A rebate is one such incentive that’s incredibly useful for eliciting behavioral change. With a rebate, a customer is re-paid some of their outlay in return for hitting specific targets. But rebate management can snowball into a disaster when claims are processed manually with a pen, paper and Excel. Pricing professionals can be dealing with thousands of rebate claims each month, which is extremely time-consuming and labor-intensive, not to mention prone to error. There can be huge numbers at stake, which only adds to the level of tension and pressure under which pricing teams work.
Legacy processes for tracking all incentives, not just rebates, constitute a significant cause of margin leakage. A common complaint among our clients is that customers frequently receive rebates and other rewards without ever holding up their side of the deal! Why? Because companies don’t have a systematic approach in place to track engagement and compliance effectively. They lack the foresight to analyze data at the end of specified incentive time-frames thoroughly, which means they never really know if they’ve been successful in sculpting customer behavior or not.
RebateManager deals exclusively with the management and calculation of special off-invoice conditions, in particular, rebates and credits. From a custom dashboard inside the module, you can build out any off-invoice agreement, storing it in a rebate library for simulation, testing and tweaking. You can create custom review and approval processes with waterfall comparisons to keep a close eye on rebate performance. And once approved, incentives can be sent from RebateManager to your accounting system with ease.
PromotionManager lets you define special bespoke pricing, bundle and discount rules, applying incentives, with varying start and end dates, to individual customers or customer segments. You can manage and monitor all of your promotions easily from one centralized hub, giving you total visibility over any number of campaigns. You can analyze the efficacy of your incentives inside the module, taking what you have learned to inform your next major promotion.
Workflows are a central pillar of the PromotionManager module. These ensure all of your incentives are carefully reviewed, controlled, approved, changed or canceled by the appropriate person before they’re launched to your ERP system. The thrill of the sale blinds sales reps to margin leakage – they tend to focus too narrowly on revenue (the vanity metric). Workflows guard against this short-sightedness.
As we’ve laid out in this guide to eliminating margin leakage for the manufacturing industry, there are plenty of ways that manufacturers are susceptible to margin leakage. The tools outlined in this article ensure that your team is fully equipped to make informed decisions about incentives while competently tracking outcomes and applying learnings to future deals. Clear deal guidance, improved quoting accuracy, and intelligent incentive agreements will enable you to stem the flow of margin leakage if not plug it altogether.