Pocket Price Waterfall
According to Marn, Roegner and Zawada in book "The Price Advantage" what is needed for successful pricing is to manage the entire range of components that contributes to the final transaction price, not only the list price or the invoice price. In many businesses the pricing does not stop at invoice prices. There are usually a number of pricing components that occur after invoice price that substantially affect revenues resulting from a customer transaction. When these transaction-specific, off invoice items from the invoice price, what is left is called the pocket price (the revenue that are actually left in a company's pocket from a transaction to cover costs and contribute to profit. Pocket price - not invoice price or list price - is the right measure of the pricing attractiveness of a transaction.
Examples of typical off-invoice items:
Examples of typical off-invoice items:
- Annual volume bonus: an end-of-year bonus paid to customers if preset purchase volume targets are met.
- Cash discount: a deduction from the invoice price if payment is made quickly
- Consignment costs: the cost of funds when a supplier provides consigned inventory to a retailer or wholesaler.
- Cooperative advertising: an allowance usually paid as a percentage of sales to support local advertising of a manufacturer's brand by a retailer or wholesaler
- End-user rebate: a rebate paid to a retailer for selling a product to a specific customer, often a large or national customer, at a discount.
- Freight: the supplier's costs of transporting goods to a customer.
- Market-development funds: a discount to promote sales to a specific market segment.
- Off-invoice promotions: a marketing incentive that would, for example, give retailers an additional rebate for each unit sold during a specific promotional time period.
- Online order discount: a discount offered to customers ordering over the Internet or an intranet.
- Performance penalties: a discount that the seller agrees to give buyers if the seller misses performance targets, such as quality levels or delivery times.
- Receivables carrying costs: the cost of funds from the momeent an invoice is sent until payment is received
- Slotting allowance: an allowance paid to retailer to secure a set amount of shelf space and product positioning.
- Stocking allowance: a discount paid to wholesalers or retailers to make large purchases into inventory, often just before a seasonal increase in demand.
- Free of change: customer receives a product free of charge if fulfilling a specific requirement, for example 2 for the price of 1 or the third item for free.
The components of the pocket price waterfall are not the same for all industries, competitors or even for customers to a specific company. Different starting point list prices are used for different customers sets. Order size and total annual purchase volume affect discount and rebate levels. The difference in the pocket price between different customers to a company creates a range that are referred to as the "pocket price band". Wide pocket price bands indicate differences between customers and the possibility for pricing opportunities that can be captured. Wide pocket price bands should not be seen as negative, nor should they be perceived as needing to be aggressively narrowed. They should be seen as a positive sign of rich variability and texture in the markets served - variability and texture that can ultimately be managed to your advantage. With wide price bands a small change in the shape of the bands can move the average price for the entire band up by multiple percentage points. When price band are narrow such changes tend to be more difficult and have less impact on average pocket price.
The picture below, from the book "The Price Advantage" by Marn, Roegner, and Zawada, shows the price components for a manufacturer that sells large rolls of linoleum to national, regional and local flooring retailers, who in turn resell them to residential and commercial customers. The starting point is th dealer list price, $6 pr square yard for this particular product. From that list price, an order-size discount (based on the total dollar volume in that order) and a "competitive discount" (a discretionary discount negotiated before the order is taken) are subtracted to arrive at the invoice price of $5.78 per yard. In addition, the company gave dealers a payment term discount of 2 percent of invoice price if they paid an invoice within 30 days, and also incurred carrying costs on receivables as it awaited payment. It offered an annual volume bonus, paid at the end of the year, of up to 8 percent of a dealer's total invoice purchases. Retailers received promotional funding to support in-store promotions as well as cooperative advertising allowances of up to 4 percent of invoice price if they featured the flooring manufacturer's products in local newspapers and broadcast advertising. Finally the company paid freight and delivery costs on all orders exceeding a preset dollar value. Taken individually, none of these off-invoice discounts significantly affected transaction economics. Together, however, they amounted to a 23 percent additional drop in revenue from invoice price down to pocket price.
The picture below, from the book "The Price Advantage" by Marn, Roegner, and Zawada, shows the price components for a manufacturer that sells large rolls of linoleum to national, regional and local flooring retailers, who in turn resell them to residential and commercial customers. The starting point is th dealer list price, $6 pr square yard for this particular product. From that list price, an order-size discount (based on the total dollar volume in that order) and a "competitive discount" (a discretionary discount negotiated before the order is taken) are subtracted to arrive at the invoice price of $5.78 per yard. In addition, the company gave dealers a payment term discount of 2 percent of invoice price if they paid an invoice within 30 days, and also incurred carrying costs on receivables as it awaited payment. It offered an annual volume bonus, paid at the end of the year, of up to 8 percent of a dealer's total invoice purchases. Retailers received promotional funding to support in-store promotions as well as cooperative advertising allowances of up to 4 percent of invoice price if they featured the flooring manufacturer's products in local newspapers and broadcast advertising. Finally the company paid freight and delivery costs on all orders exceeding a preset dollar value. Taken individually, none of these off-invoice discounts significantly affected transaction economics. Together, however, they amounted to a 23 percent additional drop in revenue from invoice price down to pocket price.
Source: Michael V. Marm, Eric V. Roegner, Craig C. Zawada, The Price Advantage, 2004, New Jersey
