Excess capacity is the bane of many industries. It can be blessing in disguise, though, once manufacturers figure out how to use it to their advantage without threatening their core businesses.
Food manufacturers have known this for years. Many established their B2B foodservice businesses as a tactic to improve their capacity utilization. It created a “win-win” bargain: big-name foodservice operators such as QSRs and contract services companies benefit from bulk access to low-cost quality ingredients, and the suppliers enjoy a practical way to keep their plants running.
But a funny thing happened as the years went on. Revenue on the foodservice side grew so large that it begged a strategic question: shouldn’t we be making more money?
When one leading food manufacturer approached us with this strategic question, we knew in theory that the answer is “yes”. After helping them apply greater scrutiny to their foodservice business, we found enough compelling improvement opportunities to know in reality that the answer is “yes”.
To go from theory to reality, the first two steps are to understand where you stand along our five levels of Pricing Excellence, and then set an objective to achieve a higher level. Our five levels of Pricing Excellence range from Level 1 (ad-hoc) to Level 5, which is mastery or World Class Pricing.
For this engagement, we aimed for a pricing strategy that will support a consistent, value-based pricing approach and strengthen their business by delivering short, medium and long term bottom line financial results. The reasons for saying “strategy”, “consistent” and “strengthen” became clear once we dug more deeply into how they went to market.
Stalled at Level 1: Recognizing how ad-hoc pricing hurts profitability
Historically, they had done little benchmarking and provided limited pricing guidance to their sales teams, who in turn made inconsistent one-off pricing decisions and offered customer-friendly but costly terms and conditions. These actions combined to drain profits. But this ad-hoc pricing approach was tolerated for years, as long as the division continued to move sufficient volumes
That is not an indictment of the salespeople themselves, but the context they operate in. Few if any companies at Level 1 commit the time and skills to understand how their customers perceive the value they add. In the foodservice business in particular, most food company managers would steer incremental investment toward their more lucrative, highly competitive, and strategically important consumer businesses. The less exciting, more tactical foodservice business receives only the resource which are absolutely necessary.
Committing to make the move from Level 1 pricing to Level 3 turned out to be a lucrative decision for this company. The approach we describe is not radical. Success boils down to looking at a historically low-profit business such as foodservice with the same intensity, skills, and accountability that you apply elsewhere.
Solidifying Level 2: A new bracket pricing structure
A reasonable set of margin targets is important for achieving and then solidifying Level 2, which is controlled pricing. The new bracket pricing structure we developed enables the company to tighten terms and conditions in a fair and balanced way. Elements include efficient order allowances and inefficient order surcharges to incentivize distributors to manage their order behavior more cost-effectively.
These changes provided a source of quick wins, established a baseline of success, and whetted the division’s appetite for more improvement. They saw that a more consistent, data-driven, and value-based approach to pricing could generate targeted higher prices and higher margins, without threatening key customer relationships. Now the challenge was to make these changes permanent and avoid regressing back to Level 1.
“As a rule, companies should be able
able to achieve higher margins as they move
from the bottom right to the top left corner of the matrix”
Moving to Level 3: The secret lies in segmentation
We helped them move away from their ad-hoc approach and achieve Level 2 (“controlled pricing”) and Level 3 (“value-based pricing”).
A company’s ability to identify and quantify differentiation and then define improvement opportunities hinges on one critical marketing tool: segmentation. First, we segmented their customers by volume, growth, product mix, order patterns and other factors. We ultimately created four segments: bronze, silver, gold, and platinum. Then we segmented their products by type, value-add, pack size, and other factors in order to define a rational, reasonable set of margin targets. We defined their products as undifferentiated, slightly differentiated, or differentiated.
The combination of these two segmentations, which we have displayed in the figure above, exposed where this foodservice division had its greatest untapped profit leverage. As a rule, companies should be able to achieve higher margins as they move from the bottom right to the top left corner of the matrix. But a sales team can’t meet its margin goals without a consistent way to evaluate opportunities and make pricing decisions.
Maintaining the gains: Implementation and beyond
We prepared them for the long haul by providing easy-to-use tools and a comprehensive implementation plan with “hard” and “soft” components. The key element on the “hard” side was a set of new, stronger sales incentives aligned with financial objectives. Sales teams would be rewarded for achieving the new target prices. The “soft” side included sales training to bring the teams up to speed on the details of the tools and the new pricing structure, and also to bolster their confidence that this new strategic approach will yield results which benefit both them and the company.
Ultimately we helped the company identify well-defined, bottom line improvement in excess of 2 percentage points of return on sales.
Foodservice businesses may have begun as a tactical way to absorb excess capacity and overhead costs, but after decades of ad-hoc pricing they are now poised to move closer to World Class Pricing and achieve their future financial goals. If you are a food manufacturer with a foodservice business, Pricing Solutions has the knowledge and expertise to help you identify your pricing opportunities and implement pricing skills and accountability.