The Power of a Pricing Model

Improve the price of goods or services

A well-structured pricing model can assist a company to gain a better understanding of anticipated financial returns from servicing a new contract, service or project; based on a specified price and the incremental allocation of all indirect costs. A pricing model is not a quick exercise; the model developer must be aware of drivers impacting the activity, and also have a detailed set of your Company’s financial statements to complete the model.

More accurately measure expected financial returns

Integrating a pricing model into the pricing decision making process of a service or product, will improve your company’s ability to more accurately measure expected financial returns. It will enable corporate executives and management to better understand, how incremental price or volume changes can materially impact and improve profit and cash flow from the service or product being modelled.

Value-adding corporate governance tool

The pricing model is also a value-adding corporate governance tool, not simply a number-crunching tool; because companies can control the input and computation of financial returns based on an inputted price. A financial executive can require all operations management to fill out a “light” version of the tool, such as the preliminary price and direct costs (cost of sales), which will calculate an initial gross profit figure. They will send the preliminary pricing model to the company’s executives, who will then incrementally apply indirect costs to the potential service, which will provide them with an earnings and cash flow generated figure. They will then be able to decide whether to “sign-off” on the potential service based on the pricing model outputs.

Added analytical capability

A sensitivity analysis will provide further insight into revenue and cost drivers impacting margins. The addition of dashboards or graphs will help to further convey returns based upon a stipulated price. Greater usability for executives and other stakeholders will be realised by drop-down boxes with the graphs; this permit users to observe how pricing is driving profit margins, earnings or cash flow.

The use of waterfall charts or other graphing presentation will provide a high-level representation of financial returns. It will give model users an idea into the impact of pricing, revenue and cost drivers, upon the relevant activity that is being analysed in terms of its added value to the company.

The importance of proportional allocation of indirect costs

Some would perceive potential conflict with a company using a “light” version for management and a full version for executives. Management may view the allocation of indirect costs by executives to achieve final sign off, as being the over-engineering of commercial reality for quoting and bidding for services based on price. It is true there are some contracts or services that might require some special dispensation, given their important long-term or strategic importance. A comprehensive pricing model will provide your company with such flexibility, to alter the proportion of indirect costs to this potential service.

Realising the power of better pricing

The implementation of a pricing model into your Company’s price decision making for the servicing of a service or good, will greatly improve executive management’s perception of expected returns on servicing a contract based on price. Graphing and sensitivity functionality will further improve executive decision making upon a suitable pricing regime, because it will further assist the understanding of price, volume and cost drivers on the service’s financial returns.