These days it seems like everyone is focussed on cost savings. This is not a bad thing, considering the vast majority of companies are not best-in-class, which means the vast majority of companies, on average, are probably spending too much on their purchases. But despite some vendor claims that revenue is, and will remain, flat, or that there’s nothing you can do about it since the market sets the price and constitutes the demand, this is not true.
We all understand that the fundamental goal of business is to make money, or profit, and we all learned the same calculation in our first business class: Profit = Revenue – Cost. This tells us that, as a business, there are two levers we can manipulate to increase profitability, Cost and Revenue. Now it’s true that we as sourcing and procurement professionals have a lot more control over cost then we do on revenue, but that does not mean our focus on cost should be myopic. We should also understand the revenue side of the equation and work with marketing on the pricing side of the equation, because neither the market price, the highest price marketing predicts they can get, nor the price at which demand (or consumption) is maximized is the optimal price.
If your goal is to maximize profit, the optimal price is the one where the profit equation is maximized, and this means this price is determined as much by cost as by revenue, and we all know that the cost for a product is not fixed – it depends upon the supplier we use (which determines a host of physical attributes such as quality, appeal, etc.) and, more importantly, the quantity we order. Generally speaking, the cost per unit will decline if we order more units, but this is usually only true to a certain point. Each supplier has a base capacity they can produce on their production lines during their regular hours of operation. To exceed this capacity they will have to add shifts, add lines, or both – which will increase the cost per unit. Or if your product requires a raw material in short supply, costs will increase as you try to divert supply away from your competitor, and there will be a point where you just will not be able to secure more material.
Is marketing, or if you’re big enough, product pricing, going to understand all of the factors that contribute to product cost – and, if so, are they going to understand the factors and inter-relationships as well as we do? Probably not. And that’s why sometimes we need to get Rapt up in revenue – to make sure that not only does the organization choose a price-point that theoretically achieves their profit, margin, or market-share goal (which, without our assistance will probably be based on cost-data that is only an approximation, and not necessarily a good one), but that the price-point is realistic and that the forecasted demand can be met in the intended time-window.
Furthermore, as the users of some of the most advanced analytic and business intelligence tools in the organization (spend analysis, cost modeling, and decision optimization, for example), we are much more likely to understand that our historical data alone is not necessarily sufficient or accurate enough to predict future demands, that different product features and price-points will have a considerable impact on actual sales, that costs can vary significantly by feature and demand level, and that the only way to analyze all of these variables and make the best pricing decision is to use a good decision support tool based on sophisticated analytics and optimization to model the different scenarios at different price points and obtain a true picture of feature – price point – demand level correlation.
And that’s why tomorrow I will introduce you to Rapt, a decision analytics and price optimization solution provider whose gaol is to help companies maximize their revenue opportunities.