Pricing and profitability analysis do not depend on the market. Action them effectively and the impact flows straight to EBITDA, faster and with more certainty than revenue growth alone.
Pricing and profitability analysis allow portfolio companies to grow EBITDA quickly, with low execution risk, delivering results early in the investor’s hold period. There are still risks, but they are relatively manageable. Poorly managed pricing changes can alienate profitable customers, while rumours of a cost reduction can be a significant distraction.
As these rapid levers work through the business, revenue initiatives can build their own momentum through customers and the competitive marketplace, converting to exit value at a scale that pricing alone cannot match.
I set out four cases below. Two on pricing, two on profitability analysis. Different sectors, different tools, but one consistent finding. The value almost never sits where management expected it.
Pricing Optimisation: the myth of managed discounting
The portfolio company in question was a builders’ merchant, where B2B customers mostly bought at one of 20 store counters. Staff had discretion to apply discounts to list prices at transaction level, to retain clients and maximise margin. Leadership was confident that this discretion was exercised skilfully by the colleagues who were “closest to the customer.”
But the EPOS data told a different story. Pricing variability across the estate, and even within a single store, was significant, so we drilled down, focusing on our most recognisable commodity, bags of cement.
Combining EPOS data with CRM data showed three counter staff in one store exhibiting three deliberate but distinct pricing behaviours. For all customers, one consistently discounted to a round price plus VAT, one discounted to a round price including VAT and the third applied a round number percentage discount. With individual customers accepting different prices on different days, maybe precision pricing was not the holy grail management had assumed. Maybe customers were less price-sensitive than expected. Could availability of a credit account or dependable deliveries be important, too?
We presented this finding to management, who responded that it was impossible. Local staff were the unassailable experts in margin and customer retention, given their local knowledge. But presented with the transaction level data, they were converted. They could see that loyalty was not solely driven by price and that we could apply a more strategic approach to discounting, without triggering a mass exodus. We could focus our discounting on the biggest clients, who were buying from multiple outlets for multiple construction sites. Their purchasing offices had the sophistication to respond to keener pricing by directing more of their purchasing our way. Using a Pareto analysis of customer expenditure, we assigned four discount levels according to historic sales, maintaining local flexibility for new customers and other exceptional cases.
Pricing was transformed from a mysterious art to a science, yielding two percentage points of additional margin almost immediately. Any loyalty uplift from keener pricing for the largest clients would take time to manifest (and we never tried to isolate this impact because of noise from other market changes).
Pricing Optimisation: when beating the competition costs more than it earns
The subject operating company was a JV retailer selling office supplies in the UK, mainly to small businesses. The US-based JV partner was advocating for a “lowest price in the market” strategy, which had proven highly successful in driving loyalty in the US, where they operated ”category killer” stores, with a huge footprint and market-beating range breadth.
In the UK, the main competitor was operating stores with 2/3 of the range in half the footprint, prompting the UK partner to question this approach. We knew that our range generated extra footfall and/or bigger baskets but was this enough, with lower percentage margins and higher rent per store?
We started with the top line, counting how many bags were carried out of our own and nearby competitor stores as a sales proxy. We gathered the bag count observations on the same day, to eliminate for the impact of weather, weekly and seasonal trade cycles, etc. Factoring in a pricing basket comparison, this allowed us to impute a sales multiplier for each competitor store, compared to our own store group.
We then applied our knowledge of rents, gross margins, staff structures and wage levels, plus other P&L lines to calculate competitor profitability. The finding was clear enough not to be a measurement error. Our gross margin per store was a little higher but not by enough to cover the higher rent. If “lowest price in the market” led to a price war, we would be in trouble.
The arithmetic convinced the JV partner to shift the UK company to “match the market”, retaining lowest-price position on a handful of known value items (KVIs) to influence price-perception, namely reams and cases of copier paper and a handful of the most-purchased own label consumables.
Direct Product Profitability: a million pounds a month in a kitchen cupboard
At a major DIY retailer, a direct product profitability analysis across the main categories revealed that fitted kitchens were losing approximately £1M per month. The category was inherently challenging as a kitchen order comprises hundreds of individual components with variable availability, and high customer service costs to manage the resulting disappointment. But these masked the two quickest fixes to address the losses.
The DPP itself highlighted a surprising cost of delivering interest free credit, where we had a permanent finance offer. Prima facie the financing cost should be tiny, and indeed it was. But alongside the financing cost there was a substantial administrative overhead particularly on small ticket purchases, where the transition to an interest-bearing loan provided no meaningful incentive for customers to pay off their loans without being chased repeatedly.
Transaction analysis identified the other fix, with appliances regularly being marked down or given away. Our specialist sales team was highly incentivised to meet sales targets and had no visibility of margins, so it had become commonplace throwing in a dishwasher, or offer a free upgrade to a better model. A customer spending £8,000 on a kitchen might be offered a £600 appliance, with no flag raised anywhere in the business.
This gave us a clear set of immediate interventions that moved kitchens to breakeven, namely: margin training for kitchen salespeople, monthly price overrides reporting, setting spend-hurdles for our credit offer, and switching credit from a permanent offer to a promotional offer mechanic and call to action.
Alongside we initiated longer-term work on range simplification, supplier availability and introducing a limited in-store stocked offer.
Activity-Based Costing: a superhero beats a dozen small brands
At a portfolio company producing children’s TV content and monetising the resulting brands through publishing home entertainment and ancillary consumer products licensing, aggregate EBITDA margin was high at over 80%, since our core TV production costs were capitalised. Buy-and-build was a core growth strategy with an expectation that we could acquire smaller shows and plug them into our licensing engine… until we ran a detailed profitability analysis.
Using time sheets, we mapped staff costs to activities and activities to brands. This revealed the true costs of producing each show and exploiting the resulting brand.
This divided our existing brands into three categories. Tier-one brands justified “full steam ahead” on content investment and licensing activity. Big multi-territory licensees. Big revenue per product line. Solid home entertainment. Broadcasters with consistent appetite for a new season. And by investing in additional style guides we could grow print-based categories like apparel licensing.
Investment in content and licensing on our tier two brands needed to be watched carefully as the home entertainment industry transitioned from VHS to DVD to digital. These just about covered production costs on home entertainment, made much less on TV distribution and only had ancillary licensing in a couple of key categories.
Our tail of smaller brands all highlighted a need for streamlining and simplification. Current revenues did not justify the cost of designing full style guides and approving all designs with multiple small licensees.
Rigorous scaling back delivered over $7M of annual EBITDA improvement, with the focus on programming investment identifying $3M annual capex savings. It also applied a new lens to our buy-and-build strategy. Before this work, the assumption was that all revenue was accretive. After the work, it was clear that scale mattered at the individual brand level, not in aggregate. Our acquisition criteria shifted towards brands with individual scale potential, and away from bolt-on properties that would grow our tail without improving our economics.
Operational Restructuring: the third “rapid and reliable” lever
This episode covers three ‘rapid and reliable’ levers: pricing, profit attribution, and operational restructuring. The first two are covered explicitly above. The third is implicit in several of the cases covered in this series.
Operational restructuring was the “sharp end” of both the profitability exercises detailed above. It was core to the convenience store acquisition integration covered in Episode 1 (shifting from impulse-distress, can-and-packet, stock room to top-up, fresh and max throughput). It was central to the TV rentals business run-off (where we needed an economically viable plan to maintain service levels as call-out densities fell) also in Episode 1. And it was central to the revenue model pivot at the e-sports leagues broadcaster in Episode 3.
The mechanism differs by situation, but the process is consistent. Identify the operating model needed to serve the business, and the current points of friction. Adapt the structure to ease the friction.
The pattern across all three levers
The value almost never sits where management expects it. In the builders merchant, customers were less price sensitive than expected. In stationery, the US operating model needed changes for a UK context. In fitted kitchens, the obvious challenges obscured the easiest ones to fix. And in kids’ TV, we demonstrated that how we grew scale was more important than the scale we grew.
That gap between assumption and reality is where the analysis earns its keep.