Gain insight into the off-invoice discounts that directly impact your bottom line.
Popularized by McKinsey & Co., the concept of the "Pocket-Price Waterfall" is changing the way businesses worldwide set pricing. The waterfall itself is a visual representation of the transactional factors that impact price, commonly called the “levers of price”. A completed waterfall graph, such as the one below (click for larger image), is deceptively simple. The actual development of the underlying statistics can be complex
Defining the Waterfall
The basic pocket price waterfall begins with the product list price and first identifies various standard on-invoice discounts to arrive at invoice price, and then identifies the specific transactional costs associated with the purchase to arrive at pocket price. The waterfall can then continue with certain non-transactional related costs to arrive at pocket margin. Specific industries will have variations on this concept, for example, beginning with a base price and then add-ons that lead to a target list price. Regardless, the underlying concepts hold. The point being, every data point provides managers with the opportunity to negotiate and control the price value equation.
The completed waterfall chart itself is deceptively simple. Developing the underlying statistics is much more sophisticated. Our experience has shown that there are two general rules to follow. Namely, that the waterfall model is, 1) comprehensive and, 2) multi-dimensional.
Producing waterfall models in isolation (a single product, a single customer or a single channel) is seldom effective. If a comprehensive approach is not implemented, the analysis is usually unreliable either because certain pricing levers are overlooked, or if included, the magnitude of the lever is undervalued. The reason for this is that without a comprehensive approach, all costs are not included in the equation, either they are overlooked or underestimated. A comprehensive approach leads to an aggregate number that auditable to the source costs – that source being the general ledger.
Complexity in the waterfall arises in that you are seeking to define the variables at the reporting dimension of either the customer (where the negotiation is) or at the product (where the list pricing is set) while the costs attach at other dimensions, before arriving to the reporting dimension.
For example, let’s look at promotional expense. Promotion can occur a variety of levels, including:
- The product level. This is promotional expense that is geared to all markets that touts the value of the product.
- The customer level. This is promotional dedicated to encourage sales for a particular customer, for example, paid circulars distributed only to the client’s customers.
- The channel level. This is promotion for particular sales channels, for example, an industrial OEM exhibition.
In the above example, if your customer sells in the industrial marketplace, your customer may benefit from all of the promotional dimensions. Identifying this and then quantifying this at the reporting dimension of the waterfall requires sophisticated analytical capabilities that include the capability to provide an intersected approach to the analysis - one that will provide a complete view of costs at the intersection of the customer, product and channel. In fact, the waterfall analysis will likely move rapidly to a comprehensive cost-to-serve analysis and reporting requirement.
Quantalyst works with clients in a wide range of industries to provide accurate data to assist as new pricing strategies are developed that improve profitability. We can help you determine your Pocket Price and put systems and business processes in place to help you maintain on-going accounting of your Pocket Price.
A book to learn more about the waterfall concept (but, unfortunately, not the underlying analytics), is by McKinsey partners Walter Baker, Michael Marn, and Craig Zawada, The Pricing Advantage.
A good .pdf overview of the tool, also by McKinsey is The Power of Pricing.
If you are serious about the underlying analytics to get it right, see our work in cost-to-serve here.
Contact us for further information on our Pricing Waterfall or Pocket Price services.