Managers in non-commodity businesses talk about branding, product/service differentiation, pricing strategies, and profitable growth. But their counterparts in commodity businesses talk about cost and volume, and seldom if ever use innovative pricing and marketing approaches. This need not be the case, however. Contrary to conventional wisdom, unexploited pricing and marketing opportunities exist on the order of 5 to 10 percent of return on sales—and they can be captured quickly.

Chasing tonnage

The standard approach to pricing and marketing in commodity businesses is "chasing any tonnage": taking orders irrespective of their profitability or attractiveness. The goal is to fill volume quotas and reach market share targets while passively matching competitors’ prices. This strategy leaves no room for the powerful pricing and marketing levers used by non-commodity businesses—account planning, innovative pricing schemes, customer/ order mix management, and so on. Focusing on volume alone erects a wall between sales/marketing and production. As a result, management loses the ability to distinguish between good and bad orders and to price and manage mix accordingly.

We believe it is possible for commodity businesses to exploit pricing and marketing levers by making true order economics along a company’s entire value chain transparent to decision makers in both sales/marketing and production. Transparency will encourage dialogue and make it easier to identify opportunities through joint problem solving between the two functions.

Understanding transaction economics

Our approach is founded on the pocket margin framework (PMF), which describes the true order economics of a transaction along the entire value chain.¹ It includes:

• Pocket price elements (such as customer-specific rebates and transport costs);
• Nonproduction costs (such as packaging and order handling costs);
• Fall-down costs (for example, material offcuts left over from orders for nonstandard widths and yield losses from nonstandard surface requirements); and
• Bottleneck costs associated with the manufacture of nonstandard products, which require more processing time in a plant’s bottleneck process.

These often neglected elements can represent as much as 15 to 30 percent of revenues, and may vary dramatically between apparently similar orders. Moreover, the nonproduction, fall-down, and bottleneck costs are often as big as or bigger than the pocket price elements, and vary more widely between orders. Consequently, the traditional pocket price framework alone is not enough; it needs to be complemented by a thorough understanding of the other three kinds of costs. Since the production process for many commodities involves successive refinement in a number of closely linked steps, these "unknowns" exist throughout the value chain.

Exploiting opportunities

Our experience suggests that it is possible to capture pricing and marketing opportunities quickly by following a three-stage process:

1. Establish a method for calculating true order economics—that is, to identify the often unknown elements. (A simplified matrix can be used to calculate the fall-down and bottleneck cost for each specific product type at every major process step. Pocket price elements and nonproduction costs must also be calculated for each product type and customer group);
2. Develop tools such as sales screens and reports that use these order economics to guide pricing, sales, and order acceptance decisions; and
3. Utilize non-commodity pricing and marketing methods, such as joint sales/marketing and production account planning, customer/order mix management, channel management, and effective price structures.

Results to date have demonstrated the power of this approach, not only in identifying new opportunities to improve ROS, but also in providing the basis for bottom-up strategy development in commodity businesses.