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Do something about it: Pricing analytics in manufacturing
 

Do something about it: Pricing analytics in manufacturing

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    Do something about it: Pricing analytics in manufacturing Do something about it: Pricing analytics in manufacturing Presentation Transcript

    • Do something about itPricing analytics in manufacturing
    • Most leaders at manufacturing companies like those analysis of each sales transaction, delivering a in the process, industrial products, and consumer clearer picture of what’s working and what isn’t. packaged goods sectors already know that setting It can also reveal how capital allocations across the right price can have an outsized impact on the transaction-level profits for different segments bottom line. But many have yet to dig deep into their contribute to shareholder value. transactional data and take action. After all, pricing can cut both ways — the right price can have a Many companies are beginning to use analytics to big impact, but making the wrong moves on pricing understand the dynamics of pricing and profitability at can be disastrous. That makes it easy to stick to the the product and customer levels — and target business same “let’s just take what we can get” route. But activities that are deflating their stock prices. That can beware: that safe path could be leading to steadily have big implications for manufacturing companies. diminishing profitability. Pricing analytics can change the game for manufacturers and help them deliver new levels of performance and Furthermore, if leaders solely rely on accounting data, potential enterprise value. a company’s true economic performance and potential might be masked, leading to improper strategic choices and possibly negative shareholder value. Instead they need to ask some hard questions that can help put them on a track towards potential value creation. Which products and customer segments can really add value to my organization? Which ones are putting downward pressure on my organization’s overall market value? Until recently, it took a lot of effort to find the answers to questions like these. Many leaders relied on their instincts and intuition — rather than hard data — to make decisions. But analytics is changing that. Today, sophisticated pricing analytics approaches can deliver valuable insights into the nuts and bolts of pricing, profitability, and value creation — insights that most business leaders could have only dreamed about a few years ago. They can now get an atomic-level2
    • What do you really know? commodity goods. But they frequently What is value?Say your business is consistently apply a single service model to eachgenerating a profit. You have a clear transaction — typically the high-touch Business leaders often talk about value, wealth, marketstrategy in place: the markets that you model associated with specialty products. capitalization, and stock price. But they’re rarely ableserve are growing and you have an As a result, they over-serve commodity to draw a line from their business strategy or portfolioeffective and efficient business model to segments because of loose controls over of markets, customers, and products directly to valuesupport it. Why mess with a good thing? transactional policies, leaving room to contribution or planned value creation.Your perspective may shift when you improve margins and returns.put your business under the microscope Many leaders generally accept the theory that theand see what’s really possible. That’s Transaction-level pricing analytics can intrinsic value of a business is equal to the present valuebecause you could be missing out on a help company leaders get the real of its future free cash flows, which is also known as theload of potential improvements across economic facts to determine whether discounted cash flow. If investors knew what the trueyour business. their strategy is really delivering its future cash flows of a business were in perpetuity, they full value or if it is over-serving certain could theoretically discount them to a single presentFrom a high-level perspective your segments. Analytics can provide specific value. Unfortunately, no such crystal ball exists.business may appear sound and insights into performance that goprofitable, with returns exceeding beyond pure accounting data, drawing Instead, the investment community typically createsthe cost of capital. But your business from broader economic and operational mathematical proxies that attempt to mimic discountedis likely comprised of hundreds of data. It can help executives understand, cash flows for the purpose of assigning a value to anmoving parts — and each part is either validate, or modify their strategy and enterprise. Some commonly known models are cashcontributing to or detracting from the business model options. flow return on investment (CFROI), cash return on cashvalue of the company. For example, invested (CROCI), economic value added (EVA), return onsome manufacturing companies produce equity (ROE), and economic margin (EM) among others.both high-end, specialty products and For manufacturing companies, we prefer metrics such as return on capital (ROC), return on invested capital (ROIC), or return on net assets (RONA) because they are less complex, easier to apply to business segments, plants, or product lines, and can provide results that are generally similar. Do something about it — Pricing analytics in manufacturing 3
    • Peel back the onion Figure 1: picture that emerges from emerges by aggregating profits and returns A common A common picture all value analytics and pricing projectsTransaction-level analytics can help business leaderspeel back the layers of information to get real insight. Profitability ReturnsBy dissecting a business by transactions, products, Large Growingcustomer groups, and other segments, executives cansee areas that are actually adding value — and wherethey’re losing money. Small ShrinkingWhile more companies today are using analytics to Negative Profitability Positive Profitability Dilutive Returns Accretive Returnsmake better pricing decisions, many are just skimmingthe surface. Today, analytics is mainly used to help Transactions Customer Products Assetsmake or change pricing actions in the marketplace. Forinstance, a company may use it to alter the price of aproduct that’s being sold to a customer for a loss, orthat has an unjustified volume discount. These actionscan show an immediate benefit and improve margin.But is that it? It’s likely that more value can be extracted. Segment Product Business Units EnterpriseFigure 1 shows different views of pricing profitabilityby segment. Developing this kind of view canhelp executives determine whether the differentcomponents of their business are making a positive ornegative contribution to the company’s overall value. Source: Deloitte Consulting LLPAggregating transactions, customers, products, andsegments in this manner can help expose areas withina company that are unprofitable or tell leaders that thestrategy needs to be refreshed. Am I serving profitablemarkets? Am I serving my markets profitably? Is mybusiness model producing the results I want? Is thecapital used producing an accretive return?4
    • If you can’t identify specific areas where your company be significant. A product with a high net margin mayis struggling and where it’s performing well, then you appear attractive, but if it consumes a disproportionatemay not have the fundamental economic intelligence amount of working capital and fixed assets it may be arequired to take the next step: wealth creation. Without negative contributor. Returns only get worse when morethis economic intelligence, business leaders will likely capital is allocated to increase capacity for products thatbe hard pressed to figure out how to make choices, consume a disproportionate amount of manufacturingdesign plans, and set their business on a course that can time. Companies that understand the relationshipproduce shareholder value. between profit and capital consumption and can enrich the mix of value creating products through a sales focusCapital conundrum or targeted pricing action can enhance their returns.Even if you know the profitability of your products, youcould still be making decisions that lead you toward Consider a more sophisticated scenario — businessesdiminishing capital returns. The relationship between with a strong focus on growth through innovation.profit and capital consumed is what drives return on These companies are focused on revenue growth ofcapital — and it is a more highly correlative indicator products that are less than five years old. They mayof enterprise value than earnings per share (EPS), which even have sophisticated financial analyses, such as ais what executives typically use. Although EPS is an full-blown return on capital projections to justify salesimportant metric, there is little correlation between EPS of new products. However, some of these companiesand improving shareholder value. This is largely because generally go off course when they set a return targetearnings leave out the capital required to generate those that is too low or proliferate SKUs in search of growth.earnings. If you boost earnings at the same time thatyou increase the amount of capital consumed by your For most U.S. companies, the weighted average cost ofproducts, then you may not create additional value. It’s capital varies between 8 and 10 percent, leading manyessentially fool’s gold. CFOs to establish a slightly higher return-on-capital threshold of about 12 percent for new products.1 WhileMany companies use accounting data to justify a this may seem like a good target, it can only havebusiness activity or focus. After all, a business should a positive impact on company value if its enterprisesell more of the products that have greater gross or net performance is at or below that number. However,margin per unit, right? That accounting may be correct, some companies still aim for that 12 percent thresholdbut the balance sheet is not factored in. True economic even though their existing products are producing aprofit cannot always be extracted from traditional much higher return. As a result, these companies oftenaccounting systems. You should have data about how launch new product after new product, increase capital 1 Source: http://pages.stern.nyu.your asset is used. That’s because no two products expenses, produce diminishing returns — and lower edu/~adamodar/New_Home_Page/consume the same amount of line time, raw material, their overall value. datafile/wacc.htmand inventory and, in some cases, the difference can Do something about it — Pricing analytics in manufacturing 5
    • Businesses that already create good value need to be Figure 2: Creating an economic view of the business from the ground up canvery cautious and not fall into this trap. They should inform a complex set of choices that can drive shareholder value and overallhave new products that can add to the company’s business strategy. of the business from the ground up informs a complex set Creating an economic viewoverall value, meaning they should produce returns of choices that can drive shareholder value and overall business strategyequal to or in excess of the company average. Target Ent-pricing, pricing strategies, transactional policies, and erprise Enterprise ROC and earnings growth correlate to market valuebusiness model choices will likely have a significantimpact on the outcome of these decisions, and leaders Business Unit Business unit ROC and earnings growth drive market value contributionneed to consider them carefully.Pricing analytics and economic modeling can help Capital Productivity Earnings per dollar of capital (working capital + net PPE) drive returnsexecutives understand the earnings potential of eachcustomer segment and product to determine whetherthey’re adding to or subtracting from overall value Product Profitability Product profitability and mix will drive earnings growth(see Figure 2). This can be achieved by analyzing and returnsthe contribution of each transaction and thenaggregating transactions by product, customer, plant, Segment Profitability Segment profitability and mix per dollar of SG&A drives product profitabilityor geographical region, for instance. Once you canunderstand this, it’s easier to make informed decisions Customer profitability and mix per dollar ofabout how to address your challenges — whether it’s Customer Profitability SG&A drives product profitabilityby changing the customer or product mix, for example,or considering a different business model. Transactional Profitability AnalysisPrice and pricing analytics: The gateway to valueFor years, manufacturing CEOs and other top-level Source: Deloitte Consulting LLPexecutives have paid scant attention to pricing,preferring to focus on innovation, engineering, supplychain, and manufacturing. But if pricing and analyticscommanded the same attention as, say, businessstrategy, supply chain productivity, or safety, companyleaders might be surprised at how effective thesetools can be in driving more value from existing productsand services.6
    • Price is almost always measured against the value What now?provided by the product, its features, and the business Pricing analytics can only be a game changer if it’svalue proposition, most of which can drive capital supported at the top. This is where C-suite executivesproductivity and operating expenses. In other words, can do something about it. Armed with the relevantthey are directly linked to returns and enterprise value data, they can assess business performance againstcontribution. Manufacturers should understand that strategy. They can analyze transactions by product,the right price is a function of the value they create for customer, plant, or geographical region. Analytics cantheir customers and the value they can create for their then help them understand, validate, or alter theirbusiness. For instance, ask yourself whether you should strategy and business model. And in the end, businessraise or lower the price of a particular product. There leaders will likely be better able to make changes thatis no straight answer to the question, because there can improve performance and step up to their primaryare so many other variables to consider. For example, mission: delivering shareholder value.if a customer wants a two-day turnaround for a smallmade-to-order quantity that requires a plant to alter But putting pricing analytics to work requires moreits production wheel, then the price should probably than adopting new methods and tools. It can require aincrease. But if you sell made-to-order products in large different mindset — one that values data-driven insightsvolumes twice a year with a 60-day lead time, then you as much as the well-honed instincts of experiencedcould sell the product at a much lower price. leaders. Is your organization ready to make that change? A better question may be: Given the vast amountTransaction-level analysis across an organization can of data being captured today and the increasinglyprovide economic insight that an accounting system is sophisticated tools available for extracting valuableincapable of producing. It can allow executives to take insights from that data, can you afford not to?a deep dive into their business to see what’s makingmoney and what isn’t, across their products, customers, For more information, please contact:and other segments. By understanding transaction- Richard Hayeslevel analytics, organizations can make more informed Principalpricing decisions and improve their overall profitability Deloitte Consulting LLPand use of capital. Left solely to the sales, marketing, +1 215 405 7627or accounting domains, pricing analytics would be of richayes@deloitte.comlimited value to a business and might even be applied ina manner inconsistent with the need to create value. Do something about it — Pricing analytics in manufacturing 7
    • This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business,financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional adviceor services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or takingany action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any losssustained by any person who relies on this publication.About DeloitteDeloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network ofmember firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed descriptionof the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detaileddescription of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rulesand regulations of public accounting.Copyright © 2012 Deloitte Development LLC. All rights reserved.Member of Deloitte Touche Tohmatsu Limited