The pocket price waterfall is a simple but effective framework for determining profit leakage and how minor pricing adjustments can produce significant changes.
This strategy is crucial for revenue optimization in an uncertain economy where customers are warier about spending and businesses are under extra pressure to keep profits up. Here’s what you need to know to apply it today.
Pocket Price Waterfall Definition
Pocket price is a term that refers to the effective price a customer pays in a transaction after accounting for promotions, discounts, rebates, or anything else impacting the final price.
As a pricing strategy, waterfall pricing refers to evaluating all discounts and promotions and determining the optimal price a customer will pay which maximizes company profits.
Often, companies aren’t aware of all the revenue they’re losing to discounts and other costs, so evaluating it can stop unnecessary “profit leakage.”
Examples of Price Waterfall
Example 1: Consider a package in which a customer pays $1500 for a website build. To help upsell that $1500, the service provider throws hosting, website management, and SSL encryption into the package. Those “add-ons” that the customer isn’t paying for directly lessen the effective profit the service provider is making. Their effective profit is $1500 minus the cost of providing those add-ons.
Example 2: Bulk pricing is another example of the pocket price waterfall strategy. If each unit is $10, and bulk pricing gets you 10 units at $80, then each item is effectively less, or $8 per unit.
Using The Pocket Price Waterfall Strategy
In today’s uncertain economy, where customers are more careful about spending, universal price increases are risky. It’s too easy to push prices above a customer’s willingness to pay and lose their business.
Instead, companies can use a price waterfall analysis to analyze their effective profits per transaction and make adjustments on a case-by-case basis.
McKinsey’s analysis found that for the average S&P 1500 company, a price increase of 1% would lead to an 8% increase in operating profits. This impact is “nearly 50% greater than that of a 1% fall in variable costs,” including labor and materials.
This data means the converse is also true: a 1% drop in price decreases operating profits by 8%. Companies can lose a lot of revenue by failing to identify profit leakage.
Using the pocket price waterfall strategy, companies can evaluate the following metrics to optimize sales and increase profits slightly, making a significant impact on overall revenue without driving away customers:
- Free delivery or returns
- Discounts for cash payments
- On- and off-invoice promotions/discounts
- Carrying costs (holding inventory between sending an invoice and getting payment)
- Transportation costs
How optimized are the above metrics? Is there a way to reduce transportation costs, limit the availability of free returns, or better optimize off-invoice discounts?
Important note: Be wary of using excessive perks or discounts to attract new customers. Stay on top of any profit leaks to keep revenue optimized.
If your company has sales reps, make sure they’re given a list of promotions and discounts to offer that is based on pricing data. Offering this guidance avoids discounts handed out on gut feelings just to close a deal.
Here’s a graphic from Competera that visualizes a price waterfall:
Pocket Price Waterfall Benefits
Carrying out a pocket price waterfall analysis has many benefits. It allows you to do the following:
- Determine which mix of products optimizes margins
- Understand what discounts are suboptimal
- Figure out which channels have the greatest opportunity for growth
- Quantify the monetary impact of deductions
- Figure out which discounts and price allowances seem to drive customers and use those to influence purchasing decisions
Overall, price waterfall analyses help you communicate better with customers, stay on top of market diagnostics, keep costs under control, and optimize promotional positioning.
Pocket Price Waterfall Challenges
Although well worth it in the end, here are some challenges a company may face when conducting a price waterfall:
- Insufficient systems, including data and analytics, to make the appropriate analyses
- Ineffective tracking and reporting, even with the correct systems in place
- Inexperienced talent
Having the right pricing experts in your organization will significantly reduce the challenges associated with pocket price waterfall analyses. Jennings Executive specializes in recruiting the best pricing talent on the market. Contact us today to build a pricing team and optimize your revenue for the long term.