Unleashing the Potential of Your Portfolio Company through Pricing. Private equity (PE) firms are no strangers to growing the value of their portfolio companies. Besides providing capital, they utilize several strategies from operational transformation and cost-reduction measures to talent upgrades and introduction of efficiency-boosting tools.
Yet, there’s one area – pricing – that offers the highest EBITDA margin which one would think many PE owners will focus on. Surprisingly, they seem to be hesitant about going down that route. Why is that?
Pricing: The High-Returns Way Companies Are Wary Of Taking
To increase the value of their portfolio companies, private equity leaders often start work by raising efficiencies through cost reduction. An option that’s perceived as having a much lower risk on the business.
PE operators cite several reasons why they traditionally put pricing on the backburner when it comes to creating value. Two of their notable concerns are customer defections and competitive responses.
They are worried that customers would defect and competitors would adjust their pricing pattern to capture that defection and overall, gain control of the market.
While these fears are not totally unfounded, they only come to fruition when pricing is not handled by experts. Most times, the management of a company and even PE operators have no solid background in pricing that would enable them to capture full pricing opportunities.
Failed cases of pricing usually happen when companies embark on a pricing strategy based on cost-plus estimates and skewed counsel from the sales team.
In contrast, when pricing improvements are executed in the appropriate pockets of opportunities, the chances of losing customers are greatly reduced and the result is considerably higher profit margins.
But this happy result can only be achieved when companies reprioritize and start investing more in effective pricing programs just like they’ve been doing for cost-saving and procurement measures.
Pricing Power: The Fastest Way for PEs to Create Sustainable Value
It’s a given that if PEs continue to invest less in pricing capabilities, they would keep missing out on an effective way to create longer-lasting value for their portfolio companies.
When PEs make pricing power a priority, research has shown that it can create significant value in the portfolio company. As small as a 1% increase in price (with volume staying constant) has been known to produce an 8% increase in the operating profits of S&P 1500 companies.
This profit increase from pricing is 3X greater than what is obtained from a 1% increase in volume and nearly 50% greater than the result from a 1% reduction in variable costs (e.g. direct labor and costs of materials).
Another analysis of thousands of PE investments confirmed that pricing is the greatest leverage any company could use to maximize their investment returns.
The analysis revealed that a higher pricing power typically increases EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) by 10 to 12X.
On the other hand, when fixed and variable costs are reduced, PEs record an unimpressive 2 to 5X EBITDA on their investments.
Pricing Mistakes to Watch Out For In Your Portfolio Company
Yes, it’s true that pricing is a better route for PEs to increase the bottom line and competitive advantage of their holdings.
Nonetheless, the journey has its fair share of business-sinking pitfalls, PEs need to look out for before they can successfully claim the price (pun definitely intended). Some of them are:
1. Keeping Prices the Same for a Long Time
It’s always advisable to let customers’ and even the company’s sales forces get used to regular price adjustments when there are changes in the marketplace.
Make everyone aware that the value proposition of products also changes along with market situations.
2. Adjusting Prices without Thoroughly Considering Competitors’ Reactions
Before any pricing strategy is implemented, not only should the pricing team forecast possible price changes from competitors, they also must objectively assess competitors’ product/service quality.
3. Committing Insufficient Resources to Pricing Programs
It’s not enough to resort to basic pricing procedures when working on pricing for your portfolio company.
Just like the management would go all out – using highly sophisticated technologies and procedures – when tracking and controlling costs, the same investment and effort need to be committed to pricing.
The necessary expertise and tools that would ensure your portfolio company achieve the desired goals need to be brought on board.
A Resilient portfolio company has sound Pricing strategies & tools.
Have a look here at examples of companies that went successfully on that path
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Unleashing the Potential of Your Portfolio Company through Pricing
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