Among the many things that jostle for attention in the typical CFO's agenda, pricing isn't usually a priority, crowded out by more visible demands like cutting costs or structuring mergers. Yet a straightforward review of major contracts or a structured analysis of the costs to serve individual customers can reveal considerable opportunity to increase profitability. The unintentional accumulation of discounts and incremental concessions to buyer demands (for benefits like customized design, exceptional payment terms, or prioritized delivery) can significantly undermine a company's intended pricing structure. Given strong evidence that a sound pricing strategy can create real value, some CFOs are being enticed into this neglected area.

Committed leadership on pricing strategy improves a company's operating profit margin by between 2 percent and 7 percent

When CFOs do get involved in pricing, the impact can be significant. In McKinsey's experience with more than 500 pricing studies over the past two years, committed leadership on pricing strategy improves a company's operating profit margin by between 2 percent and 7 percent, often doubling historic profit margins. To put this in perspective, the average 5 percent improvement in returns on sales from improved pricing creates $1.5 billion of additional value over five years for an average S&P 500 company.

How can such dramatic gains be achieved simply by getting pricing initiatives in place? Consider the case of ChemicalCo,¹ a leading chemical company with global sales of around $10 billion. At one time, ChemicalCo boasted profit margins approaching 10 percent but a cyclical decline in the chemical market eroded margins to below 2 percent. Complicating the situation was the fact that price discipline had been lost across all businesses during the downturn. The company had no guidelines to protect price integrity when facing defections of large accounts. Downward pressure on commodity products was contagious, too, infecting even specialty products where ChemicalCo had once earned significant premiums. And a steady deterioration in prices throughout the industry turned even well-positioned corporate peers into the fiercest of competitors—with price becoming the sole differentiator between products.

It was the CFO who in 2001 elevated price performance to the top of the company's priority list, championing a pricing diagnostic across the organization. The diagnostic highlighted opportunities in transactional pricing (unwarranted variation in prices and lack of consistency in the terms and conditions of sale on a transactional, customer-by-customer level), product market pricing (eroding premiums for value-added products or premium customer segments), and strategic pricing (declining industry price levels in the absence of legal price leadership in the underlying market). Pilot projects to address each category of pricing opportunity have delivered 2 to 5 percentage points in margin improvements—more than any cost-cutting or growth initiative that ChemicalCo has ever achieved.

The advantages of CFO-led pricing change

Our experience shows that CFO-led pricing projects are more successful in identifying opportunities, ensuring that their full value is captured, and creating an environment of continuous price improvements. CFOs have the clout to raise the issue among the broader management group, to ensure that the appropriate data and analyses are available, and to push for standardized metrics and reporting. Most importantly, their position and influence means they can ask the necessary tough and probing questions to sales, marketing, and operations heads whose performance lags behind the performance of their peers. In short, the CFO is uniquely positioned to champion sound pricing behavior throughout the organization.

Calling attention to pricing opportunities

Most sales organizations are predominantly volume driven. If sales incentives exist, they typically contain a volume component; when volume incentives are complemented by a margin-based element, it typically kicks in only after a volume quota has been hit. So when the volume/margin trade-off is made, the former usually wins, especially when sales forces are faced with the additional pressures of downturns.

On their own, sales organizations find it very difficult to make even incremental improvements in performance. This is where the finance organization is useful. It can put up a financial mirror in front of sales and marketing teams that makes clear the reality of decisions made by account managers while they are pushing for volume discounts. Finance can also bridge a potential conflict of interest between operations managers, who aim to maximize plant utilization, and the objective of profitable growth, which may require uncomfortable tactics like downsizing.

For example, the sales organization of one North American basic materials manufacturer—we'll call it BaseMat Incorporated—consistently delivered against an aggressive internal annual growth target of 10 percent through the decade since it entered a stable, slightly declining European market. Although the operational director constantly encouraged growing the business, the CFO showed the executive committee that a strategy based on "buying market share through lower prices" was not sustainable. An analysis of BaseMat's three largest customers showed that the company was actually incurring cash losses with what it regarded as its most important accounts. Yet at the same time, other customers that had grown in volume were producing high profit margins. The CFO concluded that a lack of pricing transparency and discipline within the sales organization had led to an inappropriate prioritization of sales activities.

As a result of this analysis by the CFO, the company introduced a sales tool that allowed sales staff to evaluate each deal against historical and comparable deals, implicitly reprioritizing sales activities to focus on profitable customers. During the first four months after implementation, the company experienced an improvement in profit margin of 1.5 percent on the underlying sales.

Ensuring data availability and analysis

Identifying and quantifying pricing opportunities requires the collection of transaction-specific data, including things like discounts, rebates, payment terms, logistics, and actual customer-specific product and service costs. Typically, a separate database needs to be created that can synthesize the information available from a number of different systems controlled by the CFO. Its central position within a company makes the finance organization the natural owner of such a database, given that data sources may cross both functional and business unit-specific borders but feed into established financial reporting systems (Exhibit 2).

Beyond owning the database, finance organizations can have an enormous impact on pricing performance, both in developing a new product offering and negotiating sales to individual customers. In developing an offer, the finance organization can provide crucial cost data and revenue projections to support product/service configuration trade-offs, bundling, and pricing decisions. Without such input, decisions are typically made on the basis of incomplete information and intuition. For example, at one large high tech company, the finance organization supported pricing decisions with a sophisticated modeling of revenues that assessed the range of risk for a new product offering depending on various assumptions of how much product would be sold.

When negotiating with individual customers, many companies are finding that procurement agents increasingly demand that core suppliers assume more of the financial risk of their transactions—including payment terms, insurance, or the cost of on-site field engineers, for example. Because sales forces are not equipped to assess their full value or the financial risk associated with them, products and services often have financial elements to them that are simply given away, even at a loss. An instance of this is a large telecom infrastructure vendor that, until two years ago, routinely provided huge financing or leasing agreements to new or high-risk operators without fully evaluating the financial risk to the company. As a result, the company was forced to write off several billion dollars in unpaid invoices. With support from finance, sales organizations can factor in the risk of selling to certain clients and develop bundled offers that are appropriate to the level of client risk.

The sales team relies on the deep understanding of price fluctuations, cost structure, and plant economics that only the finance organization can provide.

Larger contracts also often require continuous sophisticated risk assessment. For example, a leading basic material supplier serving the aerospace sector negotiates 5- to 10-year contracts with customers but experiences major swings in account profitability due to changes in product mix and raw material costs. To respond effectively, the sales team relies on the deep understanding of price fluctuations, cost structure, and plant economics that only the finance organization can provide to determine how each contract is performing at any point in time.

Maintaining pressure

Most companies feel that pricing cannot be tracked. While it is possible to institute clear metrics for operations or cost improvement, they tend to argue that it is too complicated, too expensive, or too time-consuming to develop measurements for pricing.

But pricing performance can be tracked and good companies do it on a regular basis. One industrial components company routinely evaluates and compensates the executive team on the percentage price premium attained over their two largest competitors. Other companies institute pricing-specific tools like pocket price or pocket margin metrics across particular businesses to monitor the total actual value of a sale once all discounts, bonuses, give-aways, premiums and the like are accounted for. Likewise, highly specific metrics can also be introduced to focus on particularly difficult problems such as unearned rebates, accounts receivable/days outstanding, rushed freight, consigned inventories, and unbilled service hours.

The finance organization is best positioned to design systems to track pricing performance, much as it already does for operations and cost-related performance indicators, and then to integrate findings into a company's other financial reports.

Implementing sound pricing practices companywide

When a company decides to focus on pricing, it often chooses a specific business or geography to analyze as a test case or pilot program. While the vast majority of pilots are successful, only a few companies have implemented new pricing practices across their whole business with the same levels of success. Typically, this is because of a lack of readily available and reliable pricing information: pricing failures are recognized too late to be corrected and, due to the sensitivity around the issue, pricing successes cannot be celebrated to maintain the momentum of the initiative.

The companies that are most successful at implementing pricing programs across an entire enterprise are those that have set up pricing organizations that report directly to the CFO. In best-in-class pricing organizations, the CFO commits at least 20 percent of his or her time to the pricing effort² and assigns dedicated responsibilities within the finance organization to manage pricing continually. These teams are made responsible for organization-wide implementation of pricing tools and are supported by timely and reliable support from the CFO's finance organization, which gives them the ammunition to force a discussion with sales and other management units if pricing performance deviates from plan.

Much attention is paid to the impact of highly visible cost-cutting efforts or mergers. But the value of those efforts, in fact, often pales when compared to the real gains from implementing and enforcing sound pricing policies, a job that the CFO is in the best position to get done.