Authors: Amadeus Petzke, Arun Rajamani, Adam Rothman and Marcus van der Vegte

Pricing of standard chemicals is complex. Differences in supplier prices are larger than the laws of supply and demand would account for, and volatility is higher for a variety of reasons. By understanding and mastering this complexity, chemical companies can improve margins by up to 3 percentage points, as the authors explain. Although specific to the chemicals industry, this article provides pricing best practices applicable across multiple sectors. Amadeus Petzke is a Partner and Associate Director in Berlin, Arun Rajamani is a Partner in Singapur, Adam Rothman is a Managing Director and Partner in Chicago, and Marcus van der Vegte is a Managing Director and Partner in Düsseldorf.

The Pricing Advisor, July 2021

It seems obvious that the prices of standard chemicals would be dictated by the market. After all, that’s how most sales teams at major chemicals companies have long operated. But pricing of standard chemicals is more complex, and less predictable, than that, even when there is limited differentiation between suppliers. Differences in supplier prices are larger than the laws of supply and demand would account for, and volatility is higher for a variety of reasons. By understanding and mastering this complexity, chemical companies can improve margins by up to 3 percentage points.

To achieve these gains, sales teams must rethink and revise their pricing strategies, both in the short-term, to make up for the current structural decline in demand, and for the future, as standard chemicals become increasingly commoditized and companies struggle to stay profitable.

Here’s how.

Beyond Supply and Demand

Every sales team knows just how volatile both chemical prices and margins can be.

In 2018, for example, the price of MDI, the most common isocyanate, increased by more than 25% in less than six months.

Chemicals prices are of course subject in large part to shifts in the balance between supply and demand, and to changes in underlying commodity prices like crude oil and natural gas. They may rise due to supply constraints on the part of a competitor facing production problems, for example, and fall when demand declines, as it has for many standard chemicals during the COVID-19 pandemic. Yet other factors can affect prices as well. Price arbitrage between regions can result in opportunistic flows of material, for example, affecting the regional balance between supply and demand and causing short-term price volatility.

Our research shows, however, that sales teams struggle to respond adequately to changes in market conditions, and prioritize maintaining volume over boosting overall profitability. So, for example, they overreact in downward price scenarios, lowering prices too much too quickly, and are too slow to react when prices are on the rise, raising their own prices too little too late.

And they often fail to take individual customer circumstances into account when negotiating deals. The inevitable result: lower margins.

Pricing excellence—and better margins— require a far more proactive approach, taking a holistic view of the customer’s total cost of ownership and being very surgical in pricing each product in light of each customer’s willingness to pay. Done right, the opportunity to monetize these factors is substantial. To that end, sales teams should consider pulling the following five levers to unlock their full pricing potential.

Better Pricing Basics

Chemicals companies still have a lot of value to be gained by returning to the basics of pricing, especially when selling to mid-sized and long-tail customers. Many sales teams have yet to master such practices as, enforcing contract compliance with respect to committed volumes and rebates, limiting value leakage through overly generous terms and conditions, and passing through surcharges for options such as special packaging, non-standard delivery, rush orders, change orders, additional technical services, and others.

In many cases, this is because many companies’ price systems are outdated or incomplete, giving the sales force plenty of room to deviate from the rules. Discounts for early payment, for example, don’t always reflect today’s low interest rates, and transportation charges aren’t typically based on the proximity of the customer to the next nearest competitor rather than on the chemical company’s own transportation costs.

Value can also suffer when pricing systems provide little transparency into the many possible product variations, changing raw material prices, and the cost to serve customers, making quick, accurate and profit- able pricing a challenge. In this regard, advanced analytics and widely available pricing software solutions can be game changers.

Value Pricing

The value of any chemical product and related services differs for every customer. Most companies offer special product grades and qualities that are difficult to compare across suppliers and create unique value for customers. Purer grades, for example, can lower customers’ processing costs or increase the value of the customer’s end product. Yet many companies fail to capture the full value of their products because they do not fully understand their customers’ end-to-end economics. The goal of value pricing is to understand each customer’s needs and to price products accordingly.

Different customers also require different services. Some require unique logistics handling when limited in their storage capacity. Others may depend on suppliers’ technical support services if they do not have their own formulation capabilities. To capture the value of services, sales teams should segment customers based on their need for value-added services and their willingness to pay for them, and then adapt pricing for each segment.

Most important, value pricing should be carried out in partnership with customers. Companies should work with customers to determine the sweet spot of value creation for both. This could be accomplished, for example, by selling chemicals on a price- per-outcome basis, working with customers to determine if the combination of chemicals and accompanying services fully met their value expectations. The result would be a win-win for both.

Predicting Prices

Numerous use cases have demonstrated that the power of analytical data models for predicting demand can beat the experience of even the best sales professionals, while offering numerous operational bene- fits. An algorithm-based model we built for a major petrochemical player, for example, improved its demand forecasting accuracy by 35%.

Superior demand forecasting can also enhance companies’ ability to forecast

prices as well. Accurate insight into where prices for a particular chemical will be in the next six months or a year allows companies to make better commercial decisions. If prices are expected to rise, for example, companies can profit by selling more on the spot market; alternatively, they can reduce risk and increase volume by selling through longer term contracts when prices are expected to decline.

We supported an HMDA sales team in developing advanced forecasting capabilities embedded in day-to-day price decision support tools. These tools consider multiple drivers of price volatility such as raw materials costs and industry utilization.

Sales reps quickly began using the tools to find the optimum between offered contract durations and price, resulting in 1.5% higher margins.

By providing insight into operational issues such as how much inventory to hold in anticipation of future demand, when to slow down production, and even when to schedule planned maintenance given market conditions, demand forecasting can also aid sales teams in accounting for changes in their companies’ supply.

Data-Driven Pricing

Imagine the value to be gained if your sales teams could predict the probability of success of a range of customer-specific price quotes, taking into account the complexity of the product and service offering, the buying power of the customer, and the

real-time dynamics of the market for that product. That’s the goal of dynamic pricing—to extract maximum value by deter- mining the right price for any customer at any point in time.

Dynamic pricing tools that leverage artificial intelligence—so-called “deal-scoring”—can adjust price levels continuously. While deal-scoring tools are not entirely new, they are only now being adopted by leading-edge sales organizations. At their best, these tools recommend to the sales person a “best price” that maximizes mar- gins given everything that is known about

the customer, the current order book and inventory, and market dynamics, while factoring in hundreds of market variables such as the price of oil, currency exchange rates, and even the weather.

By incorporating data on recent successes in the market, these tools can take into account, for example, whether a regular customer is committing to buying higher or lower volumes than expected, and then adjust prices accordingly. The most advanced dynamic pricing tools are self-learning and evaluate purchasing decisions by individual customers, an especially valuable feature given the high volatility of market prices for standard chemicals.

For example, we helped a petrochemicals player implement an Artificial Intelligence- based pricing system that sales reps use to determine the optimal quote and win-probability. As a result, prices went up between 1% and 3% across the product portfolio.

As valuable as they can be, calibrating these tools to each company’s specific pricing history and market dynamics takes considerable expertise—and an often-substantial change management effort to encourage sales people to trust them.

Innovative Pricing Mechanisms

Chemicals pricing has changed very little in the past 30 years. While both longer-term contracts with price formulas linked to regularly updated market indices and sales tied to spot prices remain standard practice, it’s time for chemical companies to enhance their pricing mechanisms, drawing inspiration from other industries. As difficult as it may be to implement new pricing mechanisms in a traditional B2B business, companies with leading positions in particular markets are especially well positioned to do so.

Auctions, for example, already widely used in industries such as online advertising, are a powerful way to maximize prices. They can be particularly effective in pricing products for small and mid-sized customers, in both long and short markets, and to maximize the value of off-spec materials.

Chemicals companies should also consider using forward pricing for deliveries in the future, as the mining industry does. Forward pricing would allow chemical players to leverage their superior knowledge of the market to boost value.

Market leaders in standard chemicals have the power to play a key role in transforming the industry’s sales practices, and smaller competitors will surely follow their lead.

Now is the right time to act: A variety of new online sales channels, owned both by chemical companies and by third parties, have arisen to facilitate new types of trans- actions and to take chemicals sales beyond the traditional face-to-face sales channel.

The Bionic Sales Force

As valuable as these levers can be, implementing them poses significant challenges for conventional sales teams. In effect, they must become “bionic,” seamlessly combining the capabilities of experienced sales experts with tools incorporating artificial intelligence and machine learning.

The primary barrier no longer lies with the technology itself. Rather, it is finding the right model for the commercial organization, one that blends human capabilities with new technologies to fully unleash their combined power. To get there, sales leaders need to answer three questions: What does the target bionic sales organization look like? What new technical capabilities are required? And what is the practical path for traditional organizations to take when con- verting their organizations to the new model?

The greatest challenge: how to manage the shift in the roles and responsibilities of account managers and sales people, from carrying out their traditional jobs to becoming data-enabled, commercially savvy professionals who combine the best of man and machine to optimize the price point of every product for every customer.

The transformation will be disruptive, and companies will need to pay careful attention to how they reskill and motivate every member of their sales teams. But the added value in the form of higher margins will make it all worthwhile.

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