What is a price waterfall?
Price waterfall is an analysis method used by the business to find the hidden costs and money leakages at every price level. Price waterfall helps companies to both identify how much of real revenue is gained from every transaction as well as seal margin leakage by identifying areas where pricing is ineffective.
Before the price is printed on a shopper's invoice, it goes through the range of transformations at various price levels. Price waterfall is an effective means of visualizing and examining the entire process of price transformation. As every retailer knows, the initial price the business deals with is called a list price or recommended price. A list price is often recommended by vendors, it’s publicly open, yet it is not customer-specific. And that’s why the next step commonly implies reducing a list price at a regular customer discount. For example, if a list price is 200$ it is reduced at a standard 10%, so we get a net or pocket price of 180$.
Pocket price is the price customers pay according to an invoice. Pocket or net price often does not include the off-invoice costs, like volume rebates, payment terms discount, shipping conditions, and other services and activities. Here again, the price waterfall is used to detect and examine each of the implicit and explicit price transformations.
How to use a price waterfall in practice?
Before we go into details of a method workflow, it is necessary to specify the major elements constituting a price waterfall. Here they are:
List (recommended) price. The starting or initial price set for a product.
On-invoice discount. Often regular discounts used by retailers to increase the attractiveness of purchase for customers. It is explicitly shown in an invoice.
Off-invoice discount. Price reductions that are not shown in an invoice and typically include costs, like advertising rebates or distributor volume allowances.
Invoice price. At this price level, explicit discounts are withdrawn from the list price.
COGS. The abbreviation stands for the 'cost of goods sold'. To put it simply, COGS marks a product's production cost.
Pocket Margin. The amount of money that the seller gets in the very end, after all explicit and implicit costs and discounts are considered.
Besides the elements listed above, price waterfall may also entail other transactions that occur in particular cases. These might include special packing or freight options.
Now, after the pricing data per each level is gathered, the price waterfall method is unlocked.
In general, the practical implementation of price waterfall could be divided into three major stages.
First, preparation stage is carried on entailing allocating the needed resources and setting up a team of professionals, which usually includes marketing, sales, and financial department representatives. At this point, the pricing data for a future analysis is also collected and preprocessed.
The second stage is a concept development implying the specification of price waterfall goals and choice of the elements for further consideration.
Finally, the third stage implies an implementation i.e. an in-depth calculation of a price waterfall.
It is rather convenient to divide the three stages of price waterfall implementation into a few simple and explicit steps. Here are the five steps that the team should go through while building up a price waterfall:
Define the goals. The most common goals of a price waterfall include conducting a pricing audit, identifying the money leakages or evaluating the real revenue gained from every transaction.
Organize your transaction data. The segmentation of pricing data depends on the goals and teams involved in price waterfall calculations. One of the most common ways of organizing data implies dividing it into marketing, sales, customer, and product segments.
Visualize the price waterfall. At this point, the chart is built with every transaction segment drawn to show its impact on the price.
Analyze the price waterfall. Once the visual model of price waterfall is built, it is necessary to find the strong and weak points revealing the price levels at which the business loses money.
Finalize the results. Process the findings and create an action plan with the list of explicit deadlines and stakeholders involved.
What are the benefits of price waterfall?
Conducting a comprehensive price waterfall requires allocating substantial human, time, and financial resources. However, the advantages and merits of price waterfall overweight significantly all costs and potential inconveniences. As we’ve already mentioned, price waterfall helps to both reveal the money leakages and identify the revenue increase opportunities. In general, the benefits of price waterfall could be classified as follows:
Market diagnostic. If you're not satisfied with your performance in a particular region, price waterfall helps to understand whether it is the pricing that should be improved or product resiliency is the issue.
Better communication with customers. Price waterfall is also a good means to find if your product value communication is worth being enhanced.
Improved promo positioning. Price waterfall helps to identify if both on- and off-invoice discounts are relevant and financially justified.
Costs under control. Price waterfall gives a comprehensive vision of all the implicit and explicit elements constituting real product costs. What it means is that the method is a perfect starting point to optimize your value chain operations and pricing policy.
Eventually, price waterfall helps to both improve the planning process and identify whether the company’s current performance is enough to reach the business goals. That’s why the approach is extensively used across the retail industry regardless of the business maturity and a retailer’s position on the journey to demand-based optimal pricing.
Make price waterfall really work
Price waterfall is primarily a method of pricing policy evaluation and diagnostic. After the business finds weaknesses and opportunities using the method, the next step implies making practical steps out of it. And that’s where pricing software can help with no matter if a retailer uses a market-based, rule-based, demand-based or hybrid pricing approach.
Here is how we do it at Competera. First, we ask the business to provide all the necessary historical data so our algorithm can process it to identify the money leakages along with the revenue increase opportunities. Even if some data is lost or unavailable, our advance engine can recreate the needed data with a highly accurate rate.
After that, together with the client, Competera’s pricing architect analyzes retailer’s requests and business targets to design specific goals based on the findings. Finally, the solution architect is involved to customize and set up all the technical parameters for the market test. Eventually, the market test is launched to demonstrate the real value that Competera brings to the business.
If you’re eager to check some real-life proofs showing the benefits of the tech-driven pricing, here they are. Recently, Competera helped a leading Eastern European apparel retailer Intertop to reach the point of 10.3% gross profit saving along with 200 BPS of profit margin saving after only 6 weeks of using the platform. More examples and numbers you may find in the case studies section on our website.