MARGIN MANAGEMENT

Defending Profitability
with Proactive Price Management
BY TOM NAGLE, JOSEPH ZALE AND JOHN HOGAN

As the global economy transitions through a period of unprecedented

volatility, the urge to wait out the economic storm is natural. But in
tumultuous times such as these—in which the recession coincides
with structural changes in global demographics, the spread of ubiq-
uitous connective technologies, the emergence of sustainability as a
key business issue and the blurring boundaries between commercial,
government and civic sectors which elevate expectations for corpo-
rate social responsibility—inaction is not an option. It is critically
important that commercial leaders resist the urge to hunker down and

Taking Advantage of Tumultuous Times is a series from Monitor offering insights into critical issues organizations face during this unprecedented period of
economic uncertainty, and how business leaders can use this time to seize opportunities for lasting change and growth.
 instead adopt a proactive stance that enables Successfully navigating this recession, however,
them to protect and grow profits. does require a proactive approach to protect and
grow margins. In such uncertain times, business
In this difficult economic period, customers are
leaders need to identify moves that generate cash
considering lower-cost alternatives and reevalu-
MARGIN MANAGEMENT

flow in the short term while also positioning

ating their essential needs, and these shifts in
their organizations for long-term profit growth.
buying patterns are creating new winners and
This article will identify smart moves you can
losers. For example, sales of traditional PCs are
make both internally and in the marketplace that
down dramatically in the recession. At the same
will help you take advantage of opportunities to
time, sales of lower cost (and lower functional-
improve your competitive position—now and in
ity) netbooks have jumped more than 160 per-
the future, so you will be in a stronger position
cent over the prior year. Importantly, many of
when the economy improves.
those customers are finding that they don’t miss
the incremental functionality of traditional PCs;
GROWING MARGINS
it’s fair to wonder if they will return to buying
FROM THE INSIDE OUT
PCs after the recession.
Even in the best of times, it is a given that com-
Just as the recession has changed customer
panies must continuously improve execution
behaviors, it is changing the behaviors of sellers
of key business processes such as price setting,
as well by intensifying competition. For example,
negotiation and contract compliance. But tak-
Wal-Mart leveraged its cost advantage in gro-
ing control of a corporation’s pricing system is
SUCCESSFULLY NAVIGATING ceries to launch a price
even more urgent in an economic downturn.
THIS RECESSION REQUIRES A war in late January that
While companies never operate in a vacuum,
PROACTIVE APPROACH TO PROTECT already has seen Bruno’s,
tough times often make players more aggressive
AND GROW MARGINS. IN SUCH a regional chain in the
with pricing in an attempt to achieve sales goals
UNCERTAIN TIMES, BUSINESS Southern United States,
despite declining market demand. Recessions
LEADERS NEED TO IDENTIFY MOVES file for bankruptcy.
increase the risk of price wars in which all sides
WHICH GENERATE PROFIT MARGINS Similarly, McDonald’s
lose, and those conflicts are often initiated by
IN THE SHORT TERM WHILE ALSO has stepped up price-
companies executing tactical pricing moves with
POSITIONING THEIR ORGANIZATIONS related advertising in the
no intent to spark broader price competition.
FOR LONG-TERM GROWTH. premium coffee sector to
By more tightly controlling and improving the
take share from Starbucks at a time when cus-
process by which prices are set and managed,
tomers are questioning whether a latte is really
managers can reduce the risk of inadvertent
worth four dollars. As these examples illustrate,
price wars, while also generating substantial
the recession has created opportunities and
incremental profit. Our experience suggests that
threats that companies ignore at their peril.
focused efforts to improve price execution can
It would be imprudent to suggest that all com- generate an incremental two to three percentage
panies should take aggressive pricing actions points of operating income, even in a downturn.
as McDonald’s and Wal-Mart have done. These improvements come from shoring up the

2
leaks in your pricing system to capture revenues A simple discount analysis discovered that
that would otherwise be lost in excess discounts, on and off-invoice discounts for key products
unenforced agreements and inconsistent applica- ranged from two to 75 percent with almost no
tion of pricing policies. correlation with volume. Moreover, the dis-

MARGIN MANAGEMENT
count spread had increased substantially over
The key to improving price execution is to
the very same period that margin growth had
diagnose the sources of profit leaks in your com-
stalled. Subsequent investigation revealed two
mercial system and build the business case for
root causes for the problem. First, key market-
change. Managers often underestimate the com-
ing managers were heavily focused on growing
plexity of their pricing processes and as a result
market share and had essentially been buying
don’t fully understand the drivers of undesirable
that share with aggressive price discounts. The
pricing behaviors and the barriers to better ones.
discounts were not highly visible because of the
For example, a life sciences company had been
loose, poorly controlled process for discounting,
experiencing relatively flat margin growth of one
rebating and waiving charges.
to two percent for nearly 18 months despite the
fact the sales had been increasing at a healthy The second root cause of the disappointing pric-
five percent clip during the same period. ing performance was found in the sales organiza-

TECH CO. MOVES FAST TO IMPROVE PROFITABILITY

The management team at Tech Co., a Fortune 200 technology
manufacturer, recognized a coming recession and made aggressive
moves to use it to their company’s advantage. Historically, the man-
agement team responded to downturns with aggressive cost cutting.
In this instance, however, cost cutting was ill-advised because the
company needed to aggressively support a pipeline of promising
new products when the business cycle turned. The question the
team addressed: How could the company generate incremental
operating profits to avoid critical headcount reductions that would
endanger future growth?
Tech Co. attacked the problem by focusing on price execution
improvements to identify opportunities to deliver bottom line results
by the end of its fiscal year. The project leaders focused on three
critical areas:
THEY PERFORMED A FAST-CYCLE DIAGNOSTIC to identify
the best opportunities to realize short term improvements. The
diagnostic mined the transaction data base and mapped key
pricing processes to identify “profit leaks” where prices were not
implemented according to policy. By analyzing transaction prices,
for example, Tech Co. was able to identify many customers that
were purchasing key products at very low prices—often resulting in
negative profit margins. This was just one of 25 potential opportuni-
ties the company uncovered in the global diagnostic.
THEY FOCUSED ON EXECUTING those opportunities with the
biggest impact and fewest barriers to implementation. Tech Co.
acted quickly to enforce pricing floors for low-margin accounts and
reducing the variability of its pricing of key products. The company
offered a price discount for online orders, restructured contracts to
minimize special price breaks, and established rates for premium
service delivery and the charge for a minimum product order. Tech
Co. gave customers three months to transition to the new pricing
model, to minimize the loss of customers to rivals.
THEY IDENTIFIED CRITICAL ENABLERS to ensure the changes
created lasting impact. The management team wanted to ensure
that any changes in their pricing processes would be long lasting
and form a solid foundation to support the company’s upcoming
product launches. They ensured that every improvement was
embedded in the organization by ensuring that the necessary data,
systems, incentives and processes were in place so that pricing
decisions would be made consistently throughout the organization.
Through these efforts, Tech. Co. identified millions of dollars in addi-
tional operating income by focusing on internal improvements to their
pricing process. Moreover, the effort created awareness of pricing as
a strategic growth lever.

3
 tion. The long-time sales strategy was to build Here are three strategies that will help you find
deep relationships with customers to become market openings in a recession:
a trusted provider of solutions to their most
1. I ncrease Category Spend through
pressing technical challenges. The goal was to Precision Discounting
make price less important in the selling process
MARGIN MANAGEMENT

Recently, select Hyatt hotels implemented a new

to enable higher prices and volume. The reality
discount program targeted at local residents,
was that over time, sales people developed close
offering substantial discounts for dinners in their
personal relationships with their customers and
underused restaurants. While hotel guests con-
often felt obligated to provide their closest cus-
tinued to pay regular rates, the hotel was able to
tomers with the best prices. Thus, as marketing
bring in more customers to dine, thus covering
gave deeper discounts to win new customers, the
fixed operating costs and building brand recog-
sales organization responded by ensuring that
nition in the local community.
their relationship accounts got even better dis-
counts to protect their preferred status. The power in Hyatt’s approach is that it
accounted for the fact that, even in a downturn,
This example is but one of the opportunities that
not all customers are highly price sensitive. The
the life sciences firm discovered as it began to
management team could simply have dropped
identify and seal the leaks in its pricing execution
prices in their restaurants, but that would have
process. A detailed analysis of the company’s
cut profits for the business travelers staying in
pricing discount practices, combined with an
the hotel who are less concerned about prices.
analysis of its sales organization to identify root
Instead, Hyatt used a laser-like focus to identify
causes for its poor pricing performance, enabled
a growing segment of price sensitive custom-
the company’s leaders to build a robust business
ers and then designed a discount program to
case for the size of the opportunity. In the end,
ensure only those customers got lower prices.
the firm was able to reverse the margin declines
By analyzing price change and sales volume
while maintaining its sales volume growth.
data, a pricing organization can determine which

GROWING MARGINS IN customers deserve discounts and which should

UNFRIENDLY MARKETS
The economic downturn has led buyers, both
end consumers and business customers, to
change their purchasing behaviors in notable
ways. Customers are more price-sensitive and
willing to shop in new channels for the goods
and services they need. They are willing to do
more to secure better deals while taking a hard
look at their needs and wants. These shifts in
customer behavior, combined with an analysis of
what your competitors are doing (or not doing),
present opportunities to gain share and margin.
be paying the same or more. The key mistake
to avoid is to assume that all customers will
respond to price cuts in similar ways. Instead,
take a segmented approach that accounts for
changes in price sensitivity as well as changes in
desired value.
2. Leverage Competitive Advantages
to Take Share
McDonalds entered the premium coffee cat-
egory in late 2006 with the belief that it could
take share from coffee powerhouses such as
Starbucks and Dunkin’ Donuts. McDonald’s fol-

4
lowed a seemingly infallible approach of improv-
ing its product quality at significantly lower
prices than Starbucks. Surprisingly, McDonald’s
coffee sales were disappointing through 2007
and into 2008 despite heavy investments in
advertising to support the effort. That changed
in the fourth quarter of 2008 when sales surged
as increasingly price sensitive customers recon-
sidered the price-value ratio of their morning
brew. As Starbucks is slated to close 600 stores
in the United States in 2009, McDonald’s is
accelerating the global launch of lattes to lever-
age the emerging opportunity.
It would be easy to dismiss McDonald’s aggres-
sive price moves as simply being in the right
place at the right time. But that perspective
would overlook McDonald’s inherent advan-
tages that ensured it would succeed in its share
grab. First, McDonalds was able to leverage
its position as a small market-share competitor.
When it cut prices on a high margin product like
coffee, McDonald’s knew that it only needed
to capture a few percentage points of share in
order to increase profits. In contrast, Starbucks
position as a market leader placed it at a dis-
advantage because it would have to cut prices
across nearly 50 percent of the market in order
to respond to McDonald’s moves.
A second advantage that McDonalds lever-
aged was related to brand equity. Starbucks has
invested heavily to build its brand around deliv-
ering high quality coffee in a relaxing environ-
ment. Much of that investment would be lost if
Starbucks chose to compete on price instead of
value. Combined, these advantages are enabling
McDonalds to take share from Starbucks with-
out significant risk of retaliation. Although not
all aggressive price moves are winners, the struc-
tural changes caused by recession can uncover
opportunities to improve your market position
if you are able to spot them and leverage your
MARGIN MANAGEMENT
advantages to press the attack.
3. Strategically Unbundle to Defend
Against Aggressive Pricing
In the 2001 recession, Distributor Co., a lead-
ing technology distributor in the U.S., found
itself losing share to a small competitor that was
competing largely on price. As the economy
worsened, the share losses mounted and spurred
an internal debate within the company about the
best response. Many senior managers advocated
for a broad and aggressive response that would
leverage Distributor Co.’s significant economies
of scale to compete aggressively on price. Others
argued for a more measured response that could
deflect the attacks without broadly undercutting
margins across the board.
To resolve the debate, Distributor Co. conducted
a careful analysis of customer business models
and value to better understand what custom-
ers valued and were willing to pay for if asked.
The results of the study were compelling. The
management team learned that most of the sales
losses came from a growing price-sensitive
segment whose business model relied primar-
ily on efficient logistics and breadth of supply.
Distributor Co.’s unsurpassed customer service
and technical support were not valued by this
segment and, not surprisingly, they were not
willing to pay a premium for it.
5
 SUCCESS FOR DISTRIBUTOR CO.: A REDESIGNED OFFER AND POLICIES THAT ENFORCE VALUE-PRICE ALIGNMENT

Discount Option Standard Option Full-Service Option

Pricing > Lowest Price Competitive Price Premium Price
Ordering > Must order online Can use any method of ordering Can use any method of ordering

>
MARGIN MANAGEMENT

Fulfillment Within two business days Within one business day Same day

Handling Fee > For orders less than $1000 For orders less than $500 For orders less than $100
Free freight for orders Free freight for orders
Freight > All freight expenses charged
more than $2000 more than $1500
Pre-sales Requires minimum purchase Requires minimum purchase
Tech Support > Not included
of $50K per quarter of $30K per quarter
Post-sales Requires minimum purchase
Tech Support > Not included Not included
of $30K per quarter

Financing > At order 30-day net terms 30-day net terms

Available for complex Available for placement pricing, Available for placement pricing, availabil-
Sales Support > orders only availability, and order verification ity, and order verification

The solution was straightforward once the A STRATEGIC APPROACH

problem was clearly defined. Distributor Co. TO PRICING PAYS OFF
unbundled its high value solution to create a
From our experience, it’s clear that a stra-
lower price, lower value offer for the price-
tegic approach to pricing can generate sig-
sensitive segment (see table above). This
nificant returns, even in a recession. Those
approach enabled them to compete aggressively
returns may take many forms including higher
on price against the smaller competitor and do
prices, lower discounts and increased volume.
so profitably because of the lower cost of the
Success requires organizational commitment
unbundled offering. The power in the approach,
and thoughtful leadership to see an enterprise
however, stemmed from the fact that the aggres-
through tumultuous times. And those that make
sive pricing was not attractive to Distributor
it through the downturn will have strengthened
Co.’s other customers whose business models
their position when the recession ends.
relied on quality technical support. For these
customers the added value of the technical sup-
port far outweighed the incremental price they
had to pay.

6
 Taking Advantage of Tumultuous Times is a series of articles from Monitor offering
insights into critical issues organizations face during this unprecedented period.
Today’s economic uncertainties, combined with multiple, significant and disruptive
forces, change the nature of industries and competition across the globe. The articles
explain how business leaders can seize opportunities during these times for lasting
change and growth. Read more at www.monitor.com/tumultuoustimes.

About Monitor works with the world’s leading corporations, governments and social sec-
tor organizations to drive growth in ways that are most important to them. The
firm offers a range of services—advisory, capability-building and capital services—
designed to unlock the challenges of achieving sustained growth.

About TOM NAGLE Tom Nagle is a partner at Monitor and founder of the Strategic Pricing Group, Monitor’s com-
pany focused on pricing and value capture strategies. Dr. Nagle is a frequent keynote speaker
and former professor of marketing and strategy at the University of Chicago and Boston
University. He is the author of the bestselling book The Strategy and Tactics of Pricing, and
has published in MIT Sloan Management Review and Harvard Business Review. E-mail him
at Tom_Nagle@monitor.com.

About JOSEPH ZALE Joseph Zale is a Partner and Global Account Manager in Monitor Group, where he leads
the pricing strategy practice. Prior to joining Monitor Group, Joe was a Vice President and
Managing Director at Strategic Pricing Group (SPG), which was acquired by Monitor Group
in 2005. Joe has worked across multiple projects in a diverse set of industries including
medical products, data services, basic materials, capital equipment, publishing and print-
ing, and semiconductors. E-mail him at Joe_Zale@monitor.com.

About JOHN HOGAN John Hogan, co-author of The Strategy and Tactics of Pricing 4th ed., is a recognized
thought leader on the topic of strategic pricing and building pricing capabilities within the
firm.  As a partner at Monitor Group and leader in the strategic pricing practice, John has
worked with clients to develop more effective pricing strategies in technology, software,
distribution, manufacturing, financial and professional services, and pharmaceutical sectors. 

Copyright © 2009 Monitor Company Group Limited Partnership.

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