(Hint: it involves tracking Mix.)
Revenue Growth Management goes far beyond pricing—it’s the art and science applied to growing the top line of the business. It’s also widely recognized that in mature categories like Grocery, Consumer Durables, etc. that it has the single biggest impact on profitability of any function in the core business (outside of a breakthrough innovation).
Given this, pretty much every company measures something like these:
- Net Revenue (NR) per a standard unit of measure (where the specific measure varies based on the most commonly generalizable measure in the business, e.g., per kilogram, per liter, per transaction, per equivalent store open at least 1 year, etc.)
- Market Share and/or Volume
- Gross Margin at Standard Cost (to avoid having cost shocks affect a measure of how much consumer surplus is captured).
These metrics are then compared to consumer price inflation, competitive industry benchmarks, etc. for target setting. Certainly, these metrics matter and if you had to pick only a few, these should be included. But, given the growing importance and business impact of the RGM function, what else should a CEO be formally tracking? Here’s my #1.
% of Net Revenue Growth/Unit of Measure from Rate vs. Mix.
Why should CEOs care?
Two reasons: a) this metric drills down on growth to reveal healthy vs unhealthy growth dynamics and b) can identify internal behaviors designed to hit a target vs truly grow the business. I’ll explain further and provide a few recommendations below:
Rate, defined as a change in price for an equivalent item, is the closest proxy to track against inflation… it indicates the share of the consumer surplus that your goods capture. If you are falling behind against the Consumer Price Index (CPI), it means your product is becoming less valuable to consumers relative to all the other goods they consume. Likewise, increases well above CPI usually come at the risk of declining consumption unless there has been an increased relevance for your product in shoppers’ lives (think a supply shortage or other shock).
Mix is the change in Net Revenue attributable to selling a growing mix of products. For example, if consumers are trading up from your mainstream items to your premium items, or attaching a secondary good to a core purchase, Net Revenue could increase without any increases in prices. This is typically the “healthier” indication of growth, as it theoretically comes without volume or market share declines.*
This metric is one of the best ways to avoid managers from gaming their targets by discounting their premium goods. “Mix” goes positive, while “rate” goes negative. This can happen, for example, if someone takes your high margin premium goods, and drops the price …. average gross margins should swell temporarily, while volume increases… making your business manager look like a genius on the surface while destroying the future prospects of the organization. This metric should help you flag those types of games and make them harder to get away with.
As a CEO, what’s the right balance of NR growth? The answer depends on your category and stage. Some “rules of thumb” below:
1) If you’re in the overwhelming majority of mature consumer goods categories I’d like to see a rate that is at or above inflation, and a positive mix trend… with approximately a 70/30 split of growth target between rate and mix. It suggests you’re continuously improving your core products to maintain their relevance in consumers’ lives while making new and better stuff to become more important to them over time.
2) If your product is brand new to the world, and you’re looking to penetrate early adopters (think high tech), you may wish to enter new products at a high premium, and slowly decrease the price to capture a larger share of the population over time while you layer in new premium products above it. Rate may even go negative, with volume gains driving most of the growth. Mix should be strongly positive (2% NR gains +) as well, otherwise the strategy will be short lived. That said, while this is theoretically a good idea, most high tech players end up wildly devaluing their categories by discounting too much and too quickly, leading to a zero-sum or net negative game, even when they “win”. Good luck slowing competitive price discounting once your competitors get a taste of it being allowed in their annual budgets. So, sure, this theoretically sounds good, but in practice, I’d tread really carefully trying to drive penetration pricing down over time. The reverse is generally healthier: mix goes negative, rate stays positive… as you fill in more of the portfolio and quickly grow the volumes. Try to be more like Tesla, and less like Flat Screen TVs, if that makes sense. Easier said than done.
3) If your product is on a managed decline (e.g. there are secular trends against the relevance of this product long term) and price taking is being designed to capture the most value you can from a limited customer base who will never be coming back, you’re likely starving the innovation pipeline and harvesting profits. (Think Tobacco in advanced economies). Here you want more from rate (like inflation plus 2%+) and less from mix (perhaps as low as 0%).
4) If your product is based on an economy of scale allowing you to offer the lowest possible price to consumers, or where there is high synergy for Sales and Marketing, then growth comes from an expanding share of wallet from loyal consumers who are coming to you for more and more goods and services. Think Amazon, Costco, most Google Products. These are “winner take most” businesses and, as long as a customer is loyal, layering in other products can capture lots of incremental growth. Here I’d push for pricing at the lower of inflation or your next best competitors’ efficiency gains, with a high focus on mix (again, 2%+ of NR growth).
Again, these are rough suggestions in terms of the proportion…my point is less the absolute numbers and more that this strategic discussion should happen.
* If you really want to get specific here, it’s not strictly speaking true that adding more products won’t cause market share declines. The problem is the “no rubber shelf” problem…. In theory, if increasing the number of facings of, e.g., slow turning premium goods comes at the expense of having enough distribution of your popular mainstream products, it could cause out of stocks in the mainstream and your sales could decline. I’m not getting into these “gotchas” in this blog, but if you spotted this, you’re right, and this is part of why I think RGM should be as close to the customer as possible to minimize mistakes.