Companies look to smarter pricing; How IT can help

Computerworld - Not long ago, a major U.S. company embarked on an ambitious Six Sigma program to improve efficiency. The program was a big success, saving the company $250 million.

Problem was, the sales force, mindful of the cost reductions, increased customer discounts by $260 million, more than wiping out the savings.

"In many cases, there was no competitive action that required those price discounts," says Matt Johnson, managing director of the Mountain View, Calif., office of strategy and marketing consultancy Simon-Kucher & Partners LLC. "The salesmen had margin targets, and when costs went down, prices were systematically vacuumed down to a cost-plus markup."

Johnson says the company, which he won't name, employed the kinds of self-destructive pricing practices and philosophies that are common in industry today. He says that in recent years, IT has made it possible to price smarter, but a company's culture and management often stand in the way of its use of the technology.

As senior vice president for revenue integrity at Seton Healthcare Network in Austin, John Elver has a job title that suggests he won't let others give away the store. Indeed, aided by new price optimization and contract management software, he boosted annual revenue by almost $200 million by improving the sophistication of pricing at Seton's 21 medical facilities.

Previously, Seton had taken a crude approach to pricing. It would, for example, raise the prices of all its 60,000 items and services by 4% and then manually tweak the prices of a few selected items. Now Seton uses the Hospital Optimization System from PROS Revenue Management in Houston to model the effects of more fine-grained changes. The pricing models, which analyze some 70 million historical transactions and take into account the terms of complex contracts, can forecast customer demand and the associated revenue likely to result from various pricing decisions.

"Now we can say, for example, that we'll reduce prices for some items 35%, increase the others by 10% and still get a 4% average increase," Elver says. That mix of price changes might be far more effective in stimulating demand and boosting revenue than an across-the-board 4% increase would have been, he says.

Rolling out price optimization software required Seton to examine the ad hoc rules that hospital managers had carried in their heads over the years, like such-and-such an item ought to be priced at a certain multiple of some other item. Some of those rules of thumb were scrapped, some were codified into the models, and some new ones were developed, Elver says. "For the first time, we got an understanding of the absurdities in some of those rules," he says.