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Pricing for Profitability: Understanding the Pocket Margin | WSJ

But to fully assess pocket costs, finance should identify the components that add or subtract value from the business on a marginal basis. Those include factors that are not part of cost of goods sold (COGS), such as expedited shipping, fixed-asset or fixed-cost productivity, the cost of capital included in payment terms, and the various discounts and promotions offered. And one effective tool to identify those factors is the price waterfall (see Figure 1). Working backwards from the list price, CFOs can use the tool to identify margin leakages and create visibility from a reference list price down to the pocket margin, including discounts, rebates and other cost elements. Moreover, the visual representation makes comparison with competitors very easy—and offers convincing proof of where price erodes in the multiple steps between making and delivering a product.

Such an exercise also allows finance to match revenue and costs for individual transactions. While a product that earns 40% margin may look like the a winner in the product portfolio, if it turns out to be highly engineered and highly specialized, and requires extra sales support, it may not be. Instead, it may be the product that earns 20% margin and only has to be packed and shipped that you should be expanding. Knowing what your costs are going forward may allow you to make the decisions that fit into the overall product strategy and build economic models that do the following:

Affect strategy. By making sure everyone involved in the pricing equation has a proper understanding of the economics of the business, CFOs can influence not just pricing policies, but overall business strategy.
Educate stakeholders. Having pocket-margin information can allow a CFO to educate his or her peers, CEO and the board about pricing policies that work. If, for example, the data shows that the sales and marketing are pushing pricing strategies that sell products that don’t contribute to the overall value of the business, those policies can be adjusted.

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Pricing for Profitability: Understanding the Pocket Margin.

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