The bigger picture

“ If we took the same approach to all aspects of our business that we used to improve our pricing, we would be using analytics to drive business performance and improve profitability”
-Tom Schwartz

While we were attending a conference on pricing optimization in financial services last fall, a colleague of mine made an interesting observation. We had spent a day and a half listening to presentations by industry observers and pricing practitioners focused on improving business profitability through the use of scientific pricing. Each presenter had described the methods and processes involved, the obstacles overcome, and to some degree the benefits of adopting this approach, which is relatively new to the financial services industry. My colleague’s observation was essentially, “what we are talking about here is not just pricing optimization; it’s about optimizing the entire business.” In other words, if we took the same approach to all aspects of our business (for example, originations processing or collections strategy) that we used to improve our pricing, we would be using analytics to drive business performance and improve profitability.

I’d like to take a few moments to expand on this idea, not to take away from the validity of pricing optimization as a means to increase profitability, but to discuss how the best practices used to deploy pricing optimization can improve business operations in a wider sense.
It should be no surprise that executive sponsorship is one of the leading factors in a successful pricing initiative. In fact, savvy solutions providers will not proceed on a project that they perceive to have weak or non-existent executive sponsorship. Executive sponsorship requires an executive decision-maker capable of shepherding the initiative from conception, through the internal approval process, marshalling internal resources needed for the project, and ensuring adoption of the solution as a standard business practice. The executive sponsor can assist in identifying and addressing change management concerns by ensuring that the business sponsor has included all relevant stakeholders in the process. In the context of a business optimization initiative, the role of the executive remains the same – to facilitate acceptance and marshal the resources needed to accomplish the task. The risks of pushing forward without strong sponsorship include making the business process worse rather than better, dissatisfaction among key team members, and unused solutions, sometimes known as “shelf ware”.

The identification and control of pricing exceptions is where much of the benefit of pricing improvement initiatives is achieved. Most firms in the early stages of pricing improvement do not have the routine ability to define, identify and take action on pricing exceptions, for example, rate or fee discounts greater than established thresholds. The first step is to put the analytics in place to measure pricing compliance. The next step is to quantify the impact of these exceptions on business profitability—this will often eliminate much of the resistance to change once the size of the problem is quantified. The ability to measure pricing compliance and measure its impact on profitability will lead to data-driven decisions about pricing strategy and policy. By extension, the application of exception management to other business processes—for example payment deferment processing, credit limit authorization, credit scoring exceptions, and the quantification of the profit impact on each is the next logical step in business optimization. By identifying the key metrics, understanding the drivers and changes over time, and displaying them in an easy-to-understand form on a daily basis, we give ourselves the ability to change business performance for the better. In many cases, the solution will not require a new business application or initiative, but the fuller utilization of existing data warehouses and business intelligence applications.

Once you obtain visibility on pricing compliance and its impact on profitability, the next area for improvement may be the alignment of incentives with performance objectives. One classic example of misalignment of incentives is the compensation of a sales force on revenue targets at the expense of business unit profitability. As you well know, our teams do what we incent them to do, and in order to drive business performance incentive programs must be aligned with the company and business unit performance objectives. This alignment process may include the redesign of the incentive metrics themselves. For example, our improved measure of pricing compliance might be used in conjunction with a revenue target to drive both revenue and profitability. Designing some flexibility in the program, for instance, quarterly readjustment of the incentive matrix, will allow the accommodation of changing business conditions while preserving the effectiveness of the program. The key to selling this type of change to both executive management and the team members affected by it is the ability to quantify the impact on profitability and make the plan and metrics understandable to the users.

Segmentation of the business is one of the approaches to pricing improvement where significant initial gains are often made, often without the benefit of a pricing solution. This is, of course, due to the fact that more appropriate segmentation causes delivery of more specific and appropriate pricing to the customer. This segmentation might occur along product lines, geography, channels or customer lifestyle segments. We can readily extend the concept of segmentation to other areas of the business, for instance, dealer management or collections strategy. By segmenting our approach to dealers (key dealer programs, sales territory alignments) or collections strategy (identifying accounts or geographies more likely to be delinquent) we further optimize our approach to the business and our expected returns. Developing and testing of improved segmentation often involves changing processes or infrastructure that had been designed as ‘one size fits all.’ The data upon which the segmentation is developed will also be useful in estimating the effectiveness and profitability of the proposed segmentation approach – pilot testing or champion/challenger testing of the segmentation will further improve your estimates and will help speed adoption. Pilot testing also provides the opportunity to identify and resolve unforeseen systems limitations or process issues before a wider rollout. Regionalizing your originations or collections strategy not only allows you to customize your approach to the business as conditions worsen, but also when conditions improve you will be able to capitalize on them on a regional basis earlier than competitors operating with broader or national segmentation.

As mentioned before, the importance of managing change in any pricing or business optimization effort cannot be understated. Deliberate planning of change management efforts, to include assignment of responsibilities and a stakeholder analysis, will help ensure understanding and adoption of the desired business process change. The stakeholder analysis facilitates the identification and inclusion of all relevant stakeholders at the outset, preventing the development of objections and obstacles late in the process. Another key component of the change management process is the development of the communication plan, which includes consistent and continuous messaging that is targeted to specific audiences, as well as communications of early successes and lessons learned.

Whether you have already completed a pricing optimization initiative or are in the process of considering one, your experience with this process improvement effort can be the prototype for a series of business improvement initiatives. The principles of executive sponsorship, controlling exceptions, aligning incentives, applying improved segmentation, and deliberately managing change will allow you to use analytics to drive business performance and improve profitability.

Tom Schwartz is an operations and analytics executive with experience as a leader and consultant across financial services, retail, manufacturing and distribution. His specialty is the use of analytics to drive business performance and increase profitability. Schwartz was most recently SVP of Operations Analytics at AmeriCredit where he championed a comprehensive pricing improvement program. He holds a M.S. in Operations Research from the Naval Postgraduate School and is a graduate of Wharton’s Advanced Risk Management Program. You can contact him at tomschwartz@uwmail.com.

Five key components of successful optimization:

1. Executive sponsorship
2. Ability to identify and control exceptions
3. Alignment of incentives with performance goals
4. Appropriate segmentation
5. Deliberately managing change