- Created: Monday, 24 September 2012 14:53
- Published: Monday, 24 September 2012 14:53
By Aaron Smith
Is your pricing strategy on solid footing, or are you leaving money on the table? Many aggregates industry executives look too narrowly at pricing decisions and don’t simultaneously consider how pricing changes in one plant or quarry could affect many different markets.
This is akin to playing chess without planning more than one turn ahead. A move may seem shrewd at the time, but the subsequent countermoves can leave you cornered and weakened by your decision to set prices too low.
The most common traditional pricing models with these limitations are based on Next Best Alternative (NBA) techniques. This model sets your delivered price at (or near) your competitors’ delivered price, or the delivered cost of the least expensive ton of idle capacity. This strategy is effective when all the competing plants are serving a single geographic market, you are the low-cost supplier, you face aggressive competitors who price at their marginal cost, and there is significant excess capacity. In most cases, however, this tact is incomplete because:
- It fails to consider cross-market supply impacts.
- It often ignores capacity considerations beyond the least expensive capacity.
- It fails to adequately address opportunity costs (yours and your competitors).
Some executives also consider capacity that is “out of the market” and evaluate how a reduction in volume might enable higher pricing by “pulling” the supply curve to the left. This technique determines the volume where profit is maximized even though some share would be lost, but still fails to address cross-market impacts or opportunity costs.
Six Steps to Resetting Your Pricing Model
A more advanced approach builds on traditional pricing models by also considering how volume and pricing changes in one market can impact adjacent markets; and how these changes impact a broader constellation of connected markets across your network universe.
We call this our Network-Based Best Alternative (NBBA) technique, which is especially relevant in aggregates markets because they are capital intensive, have high transportation costs, steep supply curves, and frequently include multiple plants that serve different regions. L.E.K. Consulting’s techniques identify how a set of simultaneous, coordinated price/supply moves throughout your network can have a synergistic effect – far outperforming what can be done in a market-by-market approach.
The six-step NBBA process follows:
- Research both the supply and demand dynamics at a very granular level, similar to what is needed for NBA. Often this information already exists.
- Gain a deep understanding of customer purchase behaviors, alternatives, requirements, etc.
- Construct the NBBA pricing model.
- Run the model, interpret the findings, and socialize the results with senior executives, the sales force and other key stakeholders.
- Develop detailed account plans to facilitate making the recommended (and potentially difficult) pricing actions.
- Monitor pricing levels against targets and update the model to ensure decision making is evolving with changes in the market.
Case Study: Ripple Effect of New Reserves
A leading aggregates provider was facing significant quarry reserve depletion. Several new sources had been identified and valued based on their cost to supply the markets served by the depleting quarries. Utilizing NBBA, we identified highly valuable sources that had been originally discounted based on their inability to directly replace the depleting quarries.
However, these new sources were able to indirectly replace the depleting quarries by shifting the supply across the network of quarries. While many of the existing quarries served less profitable markets, the system-wide benefit was higher than acquiring direct replacements for the depleting quarries.
The key to this solution was to optimize pricing (based on NBBA) based on the new supply structure. As a result of this project, the company gained a higher value set of options to fill its reserve gap and achieved much higher margins than if company executives used more direct replacements for the depleting reserves.
Increase Your Margins
To remove pricing blind spots, executives should adopt a strategy that simulates multiple sequences of pricing decisions across all markets and all competitors. This approach should include an analysis of the full, system-wide impact of winning and losing each account at various pricing levels.
To continue my chess analogy, this approach will enable you to look many moves ahead and position yourself to outplay competitors who are taking a more narrow view of the market. This expanded view can help you enhance margins and position your company to achieve the maximum benefits in a growing market.
Prices are quantified as the annual average free on-board plant prices, usually at the first point of sale or captive use, as reported by aggregates-producing companies. This value does not include transportation from the plant or yard to the consumer. It does, however, include all costs of mining, processing, in-plant transportation, overhead costs and profit.
In 2010, the most current year for which data is available, 825 operations responding to the annual survey reported the dollar value of their crushed stone production for the current and previous year. The average unit value for operations reporting production and value was $10.02 per metric ton in 2010. This was a slight decrease compared with the average unit value of $10.16 per ton in 2009. The annual reports of the top U.S. producing companies reported a 2- to 4-percent price decrease in 2010, compared with prices in 2009.
For those operations that reported production only, the unit values of total production or specific end uses were estimated based on what other operations in the same state reported. The average unit value for specific end uses within a state was used in the estimation of value for operations reporting specific end uses. The state average was used in the estimation for operations reporting total production but not total value.
The 2010 average price of sand and gravel decreased 3 percent to $7.31 per metric ton compared with that of 2009. By use, the prices varied from a high of $11.61 per ton for roofing granules to a low of $4.47 per ton for fill.
The largest increases in price were recorded for plaster and gunite sands (19.2 percent), golf course maintenance (2.9 percent), and filtration (1.2 percent). The largest decreases were for roofing granules (43 percent), asphaltic concrete (11.3 percent), road stabilization, cement (9.1 percent), and concrete aggregate (7.7 percent).