The price waterfall tracks pricing decisions and sources of price variance between the list price and the pocket price. As such, it can be used to delineate not only the pricing decisions, but also the responsibilities of different agents that contribute to pricing.
At a high level, we can classify price variances into seven different types, with four important price points along the way. While we do so, we will also indicate who makes decisions and who informs them. (A template price waterfall is shown [above].)
The starting price point is the list price. The list price represents the aspirational price for a product: the highest price a company expects an end customer to pay for that product. In general, marketing should make the decision on the list price using market research and value-based pricing, with the advice and consent of other members of the pricing council.
From this end-customer aspirational list price, companies generally offer distributor discounts to ensure distributors can make a profit from selling the product, and therefore encourage distribution. This is denoted as the standard distributor discount. Standard distributor discounts are generally industry norms. Here, we come to one of the first decisions that is often made collaboratively by the pricing council, or at least by marketing and/or sales leaders aligning.
Other forms of discounts and rebates may also be offered. Discounts appear on-invoice while rebates appear off-invoice as credit notes. While the discounts and rebates encourage or enable different behavior, we will focus herein on the decision management aspect of these price variances.
Strategic discounts and strategic rebates both have the common attribute of being somewhat long-term price variance policies. By “somewhat long-term,” we mean they typically last for a year with annual review and adjustment. Examples may be an order volume discount, an annual purchasing volume rebate, or shipping terms. Like standard distributor discounts, strategic discounts and strategic rebates decisions are generally made collaboratively by the pricing council, or at least by marketing and/or sales leaders with the approval of the pricing council. Specifically, shipping terms may be set by logistics or operations again with the approval of the pricing council.
Promotional discounts and promotional rebates both have the common attribute of being somewhat short-term price variance policies. By “somewhat short-term,” we mean they typically last for a day, week, month, or season. Examples may be an end-of-year promotion or seasonal promotion. Promotional events are generally marketing driven yet their execution is dependent on the sales force. As such, promotional discounts and rebates are usually best structured by marketing with the advice and consent of sales leaders and the approval of the pricing council.
After applying all standard distributor discounts, strategic discounts, and promotional discounts, one arrives at the target transaction price. The target transaction price represents the best price at which a company should expect a salesperson to close deals. Most product companies allow salespeople to negotiate with distribution customers. During negotiation, distributors may extract additional tactical discounts leading to the invoice price. These tactical discount decisions can be managed through escalation policies and incentive alignments (see Understanding Deal Points: An Approach to Profit-Based Sales Incentives.) As a tactical sales decision, the sales leader manages them. Because they impact the profitability of products, the amount of price variance that could be allowed in a tactical decision should be managed collaboratively with leadership by marketing, and approval of the pricing council.
Payment terms, a credit note often applied to invoice, are often extended to encourage early payment of invoices. As payment terms directly impact cashflow and the need for financing, the finance leader—with the approval of the pricing council—generally determines these terms.
Once all discounts, rebates, and payment terms have been applied to an order, one arrives at the pocket price.
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