The complexity and length of sales cycles in the B2B business carry a big risk — the uncontrolled erosion of profit margins. Between the list price and the final pocket price, a large gap can develop leading to a significantly reduced margin. The problem is that the loss of margin is not only the result of the final negotiation in the closing phase, it is composed of various, often minor, concessions made over a longer period of time. This is why it is generally called the “price waterfall.” The actual price waterfall models vary with industries and reflect the different effects contributing to the loss of margin, but their principle is the same.
The problem with the price waterfall is that it is not transparent. There are many types of concessions which are not detected by cost calculations because they are buried in the overhead. Typical hidden concessions are free training, modifications, handling, and extended payment terms. The price waterfall happens over the whole length of the sales cycle through concessions mostly made by sales people.
What is making the price waterfall so difficult to handle, and hence dangerous, is the complexity of the B2B sales cycle due to highly customized offers, multiple decision makers (the buying center) and the length of the sales process. Let’s start with the product.
In many businesses, products are tailored to the customers need. Often this doesn’t mean configuration only, but significant design changes as well. But even if a standard product or a bundle of standard products is sold, it may be combined with a lot of extra services and special conditions. The first could be training or service support. The latter may involve long term contracts with on-time and on-site deliveries, special packaging, or other services enhancing the value to the customer. Some of these extra services are not easy to calculate and they are often not included in the cost calculation because process costs are not always monitored.
Buying decisions in B2B markets usually involve buying centers made up by decision makers, gate keepers and influencers. Each member of the buying center focuses on different aspects of the purchase decision and represents different interests, personal and business-wise. The character of the sales process is such that the sales person will not meet with the members of the buying center in joint meetings. Most interactions will happen with its individual members at different points over the whole sales cycle. And here the price waterfall comes in again.
Each contact will look for his own concessions, and to please him the sales person will at least give something, some minor modifications, free support or other extras. These may each be a little thing, but in total they sum up over time.
And then there comes the first time the sales person gets asked for a “rough price” for the solution. This is a dangerous moment. In order not to jeopardize the opportunity, the temptation is high for stating a too-low price at this point. Even though this price may not be binding, it will set the reference for all future negotiations. From here it will only go further down the waterfall – with no return.
Delays provide another reason for concessions. It is quite typical to be asked for the final price because the customer intends to make his decision. And then? Nothing happens. The project gets delayed until after some time the customer calls and says, “We are ready for making our decision now. What will the final price be? Can we have another discount?” In order to secure the business, the vendor will make even more concessions, which, in larger projects, may be followed by a final negotiation with high-level decision makers on both sides. The price will not go up in this meeting, and if too many little concessions have been made during the long chain of interactions in the course of the sales cycle, profit margins are eroded significantly.
Through managing the price waterfall, a company can significantly improve its profit margin. What’s needed is transparency, awareness, and skills. Every interaction in which even minor concessions have been made must be recorded. The cost of any concession has to be calculated and to be known by everybody involved. Sales people must be trained to defend the value positions and to be aware of the cost of each concession they make.
The better the sales cycle is managed, the easier it will be to keep the price waterfall under control.
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