Finance & Accounting

How to Increase Profits Using Price Waterfall Method?

As businesses worldwide grow more competitive, it has become equally crucial for them to have a more in-depth understanding of the market. Further, if an entity wishes to increase its earnings, it must have an efficient price management system to identify the right price for its customer transactions and sale of products/services. It must analyse “leakages” and additional costs it incurs such as business operations and expenses to determine the actual transaction price. Price waterfall is one of the assessment methods to identify the actual cost of such transactions. This article analyses the meaning, importance and vital elements of this assessment methods for businesses.

What is the Meaning of Price Waterfall?

Price waterfall assessment is an assessment used to identify hidden costs or expenses that could be responsible for profit leakages in a transaction. It helps businesses to know their actual earnings from the products/services that they offer to their customers. The methods takes into consideration factors such as discounts, rebates, etc., the business offers to its customers.

By carrying out such assessment, the enterprise can transform its sales process along every pricing level. It can help the business set the correct prices for their products that will not only work well in the market, but also ensure that it is well above the breakeven benchmark.

Importance of Price Waterfall Assessment

Price Waterfall is significant in revenue management as it provides the best way to use a business’s existing sales transaction data and identify margin improvement opportunities. It helps the business visualise its margin and revenue from every transaction it makes with its customers. Further, it can also help the business to know about the leverages given to the customers and their impact on the entire profitability. Conducting such an analysis helps business understand its internal sales and service costs that directly impact its profitability. It is, therefore, considered as one of the best ways to achieve pricing excellence.

Transaction pricing is pivotal in the success of a company; however, many companies fail to understand the components that affect the final price of their customer transaction. Through this analysis, a company can use its sales transaction data and identify improvement opportunities that can help it identify the problem areas that “leak” its profits.

Primary Elements of Price Waterfall

Price Waterfall comprises certain vital elements varying from business to business. Here we shall discuss some of its significant elements:

Retail Price

It includes the recommended or prevalent retail price^[1], which is the starting or the initial price set for a product or service.

On-Invoice Discount

Another central element of the waterfall is the on-invoice discount which appears on the invoice. While developing the waterfall, a business must not forget to define each type of reduction separately.

Off-Invoice Discount

Then, specific price reductions are not displayed on an invoice, such as the costs like advertising rebates or distributor volume allowance. These deductions are not limited to what is mentioned above but can include various things related to the cost of selling or servicing the customer.

Pocket Price

The cost of research and development spent on a product or service or its marketing is another major element of the waterfall.

Pocket Margin

It is the margin left with the business after all the deductions and expenses.

Benefits of Price Waterfall Assessment

There are several benefits of using price waterfall assessment. Some of them are discussed below-

• Price waterfall helps a business to identify the areas of improvement in its transactional price or the product.
• Further, it is a valuable and reliable tool to understand whether the business needs to improve how you communicates with its customers and how the product’s value is shared with them.
• Through this tool, a business can identify if on-invoice discount and off-invoice discounts it offers are relevant and justified.
• It also reveals the elements of actual product costs. Therefore, it helps in optimising value chain operations and pricing policy.
• With this analysis, leakages in products and transactions can be identified. This way, it can help a business in achieving optimum prices in all transactions.
• By dividing it into multiple parts that are up to the pocket price level, it can provide the sales force with negotiating levers to help achieve the best price.

Challenges Associated with the Assessment Method

A company cannot leverage price waterfall effectively if any infrastructure or structural shortcomings exist. Such shortcomings hinder the accessibility of accurate and timely transaction data.

Infrastructure shortcomings arise from insufficient data and lack of analytics capabilities to support such analysis. The business should dedicate staff members to managing dedicated infrastructure.

Infrastructure or structural shortcomings can also stem from not having talented and expert professionals to facilitate optimised transaction pricing. The business also need a competent leader who can lead its revenue management function effectively. After the human resource aspect is taken care of, the business must develop support for pricing function to gain insights.

Moreover, there are times when required systems are in place, but the company is unable to use them correctly to monitor and produce accurate results. Improper reporting of such results is another part of this cycle that can lead to improper assessment. Therefore, for price waterfall assessment method to work, a business needs to configure and reconfigure its infrastructure to avoid such shortfalls and identify the profit leakages in its operational functions.

Conclusion

Price waterfall assessment can be used by a business to assess its revenue and margin data, and understand its profitability. Its benefit can be best understood when it is used to adjust the pricing and achieve the company’s revenue goals. The assessment can provide a roadmap to the business to identify more profit-earning channels and determining the source of profit haemorrhaging. Such an analysis is, therefore, one of the easiest tools to use for systematically reviewing the business strategies and commercial policies to multiply profits and identify shortcomings.

Read our Article: A Brief Overview on Profit Margin