Finance’s Role in Pricing

Finance should NOT set prices.

Finance cares a lot about pricing because they focus on profitability. They need to project how profitable the company will be and price is a major component for them. Absolutely, they care about pricing. But finance should NOT set prices.

Here’s the problem: Finance people do not know the value of their products. If they set prices, the only strategy they can use is use cost plus. Anybody who knows anything about pricing knows this is the wrong answer if the goal is to maximize profit.

However, finance people can play an important role in pricing. Here are several ways.

Margin guidance: Finance knows what investors or owners expect in terms of overall margin. They can provide this guidance to the pricing people who then can assure that their blended margin, across all of their products, achieves that margin goal.

Margin floor: Some companies set a margin floor, meaning they won’t accept any business at a margin below that floor. I’m not a huge fan of margin floors because sometimes companies are willing to take a piece of business at a loss in order to capture other business at a profit. However, one of the roles of finance is to mitigate risk for the company and margin floors help them in that capacity.

Price monitoring: Here is where finance and pricing people can and should work closely together. Finance constantly collects and analyzes data about the business. The two groups should think through what information around pricing will help them understand the health of the business. For example, monitoring average discounts by product could provide an indication that market conditions have changed. The win/loss ratio is another indicator of changes in the market. There are many KPIs or measurements that both finance and pricing people should monitor.

Pricing committee participation: Many companies have a pricing committee where representatives from different parts of the company periodically discuss and improve pricing practices. Finance should absolutely be one of those participants. As price methodology changes are suggested, finance plays a critical role in projecting the financial impacts of those changes.

Price leadership: In a rare but powerful role, finance can take the lead on pricing. In this role, finance directs and monitors all pricing activities within the company. They take the lead in finding and fixing all the profit leaks, including the product lines, sales and even accounting. This is an ideal role for finance for several reasons:

  • It is vital to the success of the company.
  • Nobody else in the company takes on this role.
  • Finance often has enough power to strongly influence all departments.
  • Finance already works closely with every department in the company.

An engaged and informed finance department can help a company be much more successful with pricing. It’s just that finance should NOT set prices. They don’t know the value.