This article discusses influencing profit margins within organizations, by applying the price and margin waterfall. As in previously written articles on influencing margins, one way to do this is by applying different pricing strategies and adjusting different components of costs.
The price and margin waterfall models provide graphical insight into the structure of margins and offer additional insight into the evaluation of the various components that can affect margin. These can be both internal and external components.
The Waterfall methodology
The Waterfall is based on a graphical representation of the various components that lead to the margin. In the picture below is an example of a Waterfall. The Waterfall is often constructed from the two main components of the margin, namely the price and the margin itself. These are therefore referred to as the Price Waterfall and the Margin Waterfall.
Price Waterfall: it starts with the official sales price, then names various components that lead to the actual sales price. Think for example of currency differences, rebates and other discounts. This way you get a nice insight into where you can make adjustments to influence the sales price.
Margin Waterfall: this part of the waterfall provides detailed insight into how the various cost components affect the final margin. From the net selling price, it then provides insight into the cost of purchasing, production costs and inventory costs. Organizations that drive customer-level margins have insight into the cost components incurred at the customer level.
The Waterfall method is a powerful analytical tool for influencing margin at the customer level. It requires insight at the detailed level of financial figures. In addition to its advantages, this method also has limitations and challenges.
Limitations and Challenges
The application of price and margin models requires accurate and detailed insights into the construction of the cost price. Another element to consider is that it can simplify complex value chains.
It is also important to realize that the Waterfall method does not take into account external influences such as competitive dynamics and macroeconomic factors.
Practical application
For practical application, the advice is to conduct in-depth Waterfall-based analyses for a particular product or customer. It gives insight into the challenges within the organization when applying such a method. Simultaneously, it gives insight into the margins at the product or customer level and how these margins can be influenced.
Technological developments make it possible to set up and apply such methods. It requires proper application of technology and data to prevent such approaches from failing to produce the desired results.
Conclusion:
An in-depth knowledge of the elements of profit margins, combined with the practical application of price and margin waterfall models, enables organizations to substantially improve their profitability.
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