Price / Margin Waterfalls: A Basic Introduction

I can’t think of a better topic for our first blog entry than a basic introduction to a standard Price / Margin Waterfall – the foundation for pricing analytics. Beginning with revenue and ending with profit, a waterfall is simply an income statement in graphical form designed to highlight “leakage” cost buckets (Freight, Logistics, etc) and their impacts on profitability. Cost buckets are separated by anchors (Base Price, Invoice Price, etc) that serve as intermediate points on the waterfall and are frequently used in various pricing analytics.

Waterfall designs will vary by industry but all feature some common elements. The first waterfall elements on the left are derived from an organization’s pricing setup. A common setup begins with a customer’s Base Price and then adds various on and off-invoice surcharges until reaching the Invoice Price a customer actually sees on an invoice. Another option is to begin with List Price, but that’s a complicated decision we’ll break down in the future. Breaking down the revenue data into several buckets and anchors instead of beginning simply with Invoice Price has several advantages, just one of which is allowing you to differentiate between changes in base price vs. changes in surcharges.

Following Invoice Price, cost to serve buckets such as sales adjustments, rebates, cash discounts, commissions, and customer freight are subtracted from Invoice Price to reach what many companies refer to as “Pocket Price” (i.e. the amount of cash placed in your metaphorical “pocket” after certain costs are paid). Many companies begin the waterfall design process with several of these cost buckets already being calculated in existing margin reports and simply have to add 2-3 new elements. It’s important to include as many costs as possible to give you the most accurate picture of your true profitability – but some constraint must be shown to avoid adding too many waterfall elements or trying to add costs that are impossible to allocate back to specific sales.

Some organizations will stop at Pocket Price for fear of exposing sensitive cost of goods sold (COGS) data, but in most cases COGS buckets are subtracted to reach a final Gross Margin anchor – representing the final profit you make after all costs are considered.

We’ll get into much more detail on the importance on designing a proper waterfall later, but for now that’s your basic introduction to price / margin waterfalls. In the meantime for more information contact us at info@nextlevelpricing.com.