The Price Change Equation

The late Richard Beckhard, industrial psychologist and adjunct professor at the MIT Sloan School of Management, developed an equation for change. He called it a "change equation" when really it was its vector equivalent -- progress -- but as he's not a physicist, he can be forgiven.

His equation describes how to achieve change in a positive direction. Three factors are multiplied together to achieve change. Being a multiplication product, if any factor is zero, the result is zero, and change won’t occur. The three factors are a desired future state; an unsatisfactory current state; and some critical first steps to create some momentum. If the multiplication product is greater than the resistance to change, change will occur.

The formula is: (C=a.b.c>R).

This same formula can be applied to pricing, once the appropriate factors are identified. In my previous blog, I described target pricing as a desired future state. (See: Calling the Shots in Component Pricing.) So one of these factors, current pricing, is quantifiable through benchmarking; along with target pricing and some critical first steps, this would make the Price Change Equation:

Price change = target pricing x benchmarking x critical first steps > supplier resistance.

The price change equation is a useful model to prepare for price negotiations between suppliers and customers. Being unsatisfied with current pricing and having targets to guide your suppliers makes a difference in your negotiating leverage. You will push harder for improved pricing if you know current pricing is out of line and if your targets allow salespeople to go back to the factory to try for a better deal. Often the regional salespeople are frustrated because the factory is out of touch with competitive pricing, and it uses your targets as a tool. That can be the difference between true progress and random change.

What steps can be taken to create pricing momentum and reduce supplier resistance? Benchmarking and target setting are two good first steps. Another step: Provide an annual forecast to your supplier and tell it your company's story. This will help suppliers see the long-term advantage of working with you. Both of these efforts increase momentum and reduce resistance.

Creating leverage also addresses momentum and resistance. A supplier that wants your business will be less resistant than one that doesn’t care. How you pay your bills, your payment terms, and your reputation will all play a role in how the equation plays out. Other factors such as volume or supply chain design can also work to your advantage or disadvantage.

Tools such as the Freebenchingmarking.com gold report can help with target pricing and benchmarking, as well as other factors that can create leverage and better pricing. The report provides component-level detail for your most out-of-line components and advice on the pricing you should be getting, given what your company has achieved on its more competitive negotiations. The report also benchmarks the commodities that are your worst performing, to provide you with specific areas to focus on.

I look forward to discussing these and other factors related to price competitiveness and leverage during the EBN LiveChat scheduled for March 10.