Six Sigma Pricing

Many companies have developed solid pricing strategies and sales services – but without equally good pricing operations, these actions cannot deliver to full potential. The goal of pricing operations is to consistently control price deviations in transactional pricing over time and across customer segments. This goal of ensuring the prices are in line with pricing policy, not too low or too high, lends itself perfectly to Six Sigma Pricing.

A company’s pricing capability - the ability to execute its pricing strategy depends on the effectiveness of its pricing operations.  Pricing operations is the set of internal processes responsible for price and discount execution while pricing strategy is primarily market or external facing. There are two types of processes to ensure that pricing operations adhere to pricing strategy. These are: (1) processes involving list price changes, and (2) processes to ensure adherence to price discount guidelines, contract terms etc. The actual processes vary by industry or company depending on expertise and complexity involved. Whether market facing or internally focused, these processes require people from different functions - marketing, sales, finance, customer service, IT, inventory management, and legal - to work together in executing to pricing strategies. Despite the involvement of so many roles and functions and their success tied to the company’s profitability, pricing operations tend to be ad hoc and senior management mind share to price execution is usually limited.  Hence, improving internal pricing operations of a company remains an area where improvement can yield higher profits for a company without attracting much undue attention from competitors or customers.

Improving pricing operations with Six Sigma

Companies usually centralize their pricing strategy-setting effort – such processes tend to be tightly run and even though they occur fairly infrequently. However, setting prices for individual discounts for the hundreds or even thousands of individual transactions daily and entering into contracts with many customers is necessarily decentralized and somewhat ad hoc depending on a company’s situation and practices. Such an environment makes pricing operations prone to control breakdowns resulting in revenue leaks.  There is ample data where manufacturing operations have improved quality and reduced wastage by using Six Sigma by controlling variance in production within acceptable limits.  Pricing operations could similarly benefit from the improved controls and discipline available in Six Sigma and other quality tools.

The Six Sigma philosophy, using data and statistical tools to systematically improve processes and sustain process improvements, can be applied to pricing processes with a focus on eliminating the "defects" of excessive discounts or excessive prices. Six Sigma Pricing, or the application of Six Sigma to pricing, enables systematic elimination of process-related defects by exposing the sources of these defects.

      The five stages of Six Sigma Pricing are the same as that of Six Sigma except that they need to be adapted for pricing processes:

• Define the pricing-related "defect" in operational-, transaction- or contract-specific pricing processes and the extent of the defect.
• Measure the extent of the defect along with parameters of the pricing processes as well as the invoice, say by analyzing past invoices.
• Analyze the data collected in Measure to infer how the size or incidence of defects varies with different aspects of the pricing processes as well as brainstorm on the other causes of defects related to the existing process.
• Improve the process by making process change recommendations along with quantitative estimates of how much improvement in related prices or other metrics would take place following implementation of these changes.
• Control the proposed process. For example, recommend controls to ensure that people are following the agreed-upon modifications and that the estimated benefits are achieved.

Six Sigma Pricing

Six Sigma Pricing is the adaptation of Six Sigma specific to Pricing Operations since “defects” in pricing tend to be far more complex than those experienced in manufacturing operations.  The situation in pricing is more complex because:

• Multiple functions: Pricing spans multiple functions often without a clear decision point in contrast to manufacturing
• Diverging incentive structures for different functions.
• Ad hoc processes: The processes tend to be ad hoc in nature and lack a standardized specification which is the mainstay in manufacturing
• Customer responsiveness: Pricing decisions sidestep analysis and internal consensus in order to respond to customer demand
• Continual change: Ongoing internal (eg. pricing policy guidelines etc.) and external changes (competitive moves etc.) add variation which usually not the case in manufacturing even if the products are highly customized.

Hence, there is need to adapt Six Sigma specifically for pricing operations. However, Six Sigma Pricing is not intended to create a pricing strategy, but to improve pricing operations and their adherence to an existing strategy. It applies to pricing planning and execution which are repeated processes, such as controlling discount levels off list prices in contracts or in individual transactions.

Author Bios

Navdeep S. Sodhi is managing director of Six Sigma Pricing, a consulting firm based in Minneapolis and London. He has over twelve years of global pricing experience spanning several industries: airlines, medical device, and B2B manufacturing. He has an MBA from Georgetown University. He has applied Six Sigma and Lean methods to pricing in his work for industrial manufacturers. He is the recipient of the Award of Excellence from the Professional Pricing Society. His articles on pricing have appeared in the Harvard Business Review, Quality Digest, The Pricing Advisor and the Journal of Professional Pricing. Navdeep is based in Minneapolis.

Bibliography

ManMohan S. Sodhi and Navdeep S. Sodhi, “Six Sigma Pricing: Improve Pricing Operations to Increase Profits”, FT Press, Prentice Hall, 2008

ManMohan S. Sodhi and Navdeep S. Sodhi, “Six Sigma Pricing”, Harvard Business Review, June 2005

Navdeep S. Sodhi, “Improving Pricing Quality with Six Sigma Methods”, Quality Digest, March 2008