Pricing is among the most direct and potentially lucrative value-creation levers private equity portfolio companies have at their disposal.
Based on information from D&B Hoovers and an analysis by McKinsey & Company, a 1.0% pricing improvement translates to a 6.0% increase in EBITDA for the typical midsize U.S. company.
Meanwhile, an equivalent improvement in variable costs, fixed costs, or volume translates to EBITDA increases of 3.8, 1.1 and 2.1%, respectively.
Pricing improvement has an outsized impact on profitability compared to other common tools for margin expansion and companies with a track record of successful pricing innovation tend to trade at higher multiples.
Yet despite these benefits, pricing strategy remains an underutilized means of value creation across private equity. While slashing fixed costs or expanding sales volume often remain top priorities throughout the hold, research indicates PE professionals and portfolio company operators often hesitate to dedicate a similar focus to pricing.
To better understand this disconnect, McKinsey surveyed 106 PE operating and investing partners and portfolio company CFOs/COOs across Europe and the U.S. Participants were asked to cite their top three obstacles to promoting margin expansion through pricing.
- 63% of survey respondents cited risk of competitive response.
- 48% cited weak commercial capabilities.
- 47% cited the risk of customers deciding not to purchase.
Note that two of the top three most-commonly cited obstacles were driven by fear — many respondents assume any benefit in altering price would be outweighed by the risk of existing or future customer loss.
However, such risk is often vastly overestimated.
In their summary of the survey results, the McKinsey authors state, “From experience, we know that when pricing improvements are implemented in the right pockets of opportunity, the risk of customer loss is widely overestimated and investments in pricing capabilities typically have a high and quick return.”
Insufficient data may be one reason many operators lack confidence in their company’s ability to identify such pockets. A Bain & Company global survey of more than 1,700 B2B business leaders found only 15% believe they possess “effective tools and dashboards to set and monitor prices.”
Sponsors and operators who establish pricing improvement as a strategic priority from the outset of investment create greater urgency around identifying and building the capabilities required to fuel a smarter pricing strategy.
The sooner a portfolio company can increase visibility into pricing and execute quick-win initiatives, the more runway they allow themselves to hone deeper and more dynamic modes of pricing value creation.
However, pricing improvement executed at any point of a hold can enhance enterprise value. While towering purchase multiples have limited the return on many of private equity’s most common financial engineering strategies, pricing represents a bold opportunity for margin expansion.
Falcon provides C-suite talent solutions for middle-market private equity firms across North America. Follow us on LinkedIn.