article | August 31, 2016
How to Determine Product Pricing and Profitability
SBI recently spoke with Lauri Hanover, the CFO of Netafim. Netafim is the global leader in mechanized drip irrigation systems, and does business in over 110 countries. The topic of conversation was ensuring products are priced correctly. This requires a deep understanding of product profitability, an area of Lauri’s expertise.
We first turned our attention to determining the cost to build a product. How should this be done? For Lauri, this begins with the plant, the materials, the organizations that support the procurement, and the labor to package, truck and ship. There’s also cost associated with the support that’s needed to drive the manufacturing process. All of these together are the lion’s share of the cost to build Netafim’s products.
We also touched upon the cost to market and sell a product. For the marketing piece, Lauri looks at the special programs that are done to support the brands, and allocates a cost of the marketing department. When it comes to the cost to sell, it is a more economic view. “Clearly the sales force, sales management and related overhead costs of the sales structure are involved,” explained Lauri. She also recommends considering discounts and rebates as a cost of selling if you work with distribution networks. They look at what it means to make their product available, how much inventory is being carried, where it’s located, the cost of financing the inventory, and the cost of financing the customer. They also look for any ancillary costs in play that help the sales force close the sale or acquire the customer.
Additionally, Lauri also considers the cost to install a product. For Netafim, this is relatively easy as there is a dedicated staff that’s responsible for the installation. They also have dedicated teams for post-sales support, customer service, and technical support. She can easily identify the cost of these groups based on their time charts allocated per product. And finally, to determine the true cost, Lauri also recommends taking the cost of the back office that supports the product into account.
How does Lauri determine the price the market will pay? At Netafim, their products have been around for a number of years and there is a developed market so it’s a bit different. “Basically it has to be based on the value that’s perceived by the customer, assuming that you have properly targeted the customer,” explains Lauri. She recommends looking at a price that the customer can, and should pay to realize the value. At the same time, you must understand your environment and pay attention to whether the price you think the market will pay is sufficient to earn the required return.
We also asked Lauri how she figures out the value their products, and therefore what percentage can be captured in the price. She gave two ways to do this. First, one way to look at it is from a technical perspective to determine the minimum gross profit or margin. Another way to look at it, if the product exists in the market, is through the discount history. If it’s been fairly stable, chances are you can move the bar up.
Lauri wrapped up her interview by providing three pieces of advice our audience can use immediately. First, have a full understanding of what the product your selling really costs. This means taking the entire economic cost, which goes beyond the P&L line item called costs of goods sold.
Next, once armed with that information, understand the need for higher gross profit margins. There are a lot more costs that need to be covered than most people realize.
And finally, focus on efficiencies in reducing cost. The sales and marketing teams can be creative and even aggressive in their pricing after determining what the right target market is. They can maximize the value of what they’re offering in order to cover this extensive list of costs.
If you need more help figuring out product pricing and profitability, you can also download our 10th annual workbook, How to Make Your Number in 2017, to guide you.