Escaping the Discount Trap

HBR’s fictionalized case studies present dilemmas faced by leaders in real companies and offer solutions from experts. This one is based on the Kellogg School of Management case “Tupelo Medical: Managing Price Erosion,” by Eric T. Anderson, Daniel Abraham, Gus Santaella, and Elizabeth L. Anderson. “Beautiful,” Cora Milano said, looking up at the soaring spires and Gothic arches of the immense charity hospital. Her colleague, Augusto Tolentino, barely paused. He was in a hurry to get to their meeting—and to make a point to Cora. The two worked together at Bosi e Faora, a São Paulo–based medical device manufacturer. Augusto was officially the head of operations, but his real job was as the right-hand man of the company’s diretor presidente, who had informally dubbed him “head of customer satisfaction.” Cora was the sales director. Augusto and Cora were on their way to see Sergio Lins, the purchasing director at the Santa Casa de Misericórdia hospital, a few hundred kilometers from the Brazilian capital. Like many of the company’s large customers, this philanthropically funded general hospital aimed to serve as many patients as inexpensively as possible. So Sergio was extremely frugal, always opting for minimum orders and negotiating relentlessly for low prices. Augusto had been preparing for the meeting for weeks, because he hoped to change the relationship—and to show Cora that the new solutions-based selling and pricing strategy that Bosi e Faora had recently adopted with great success for its specialized, wealthier hospitals could work with all kinds of customers. Augusto saw discounting as a sinkhole—just like the ones that opened up in roads all over Brazil during the rainy season, trapping cars and their drivers. In fact, they’d heard a news report about just such an incident earlier that day, and Augusto seized upon the metaphor to convince Cora. “That car is like our business,” he said. “For years, our sales reps have given bigger and bigger discounts to sell more products, and our prices and margins have dropped steadily. The whole company has fallen into the price sinkhole. And as you know, the diretor presidente’s goal is to increase margins by 3%. Solutions selling is the only way to do that.” But Cora wasn’t at all convinced that a solutions-selling strategy would work for institutions like the one they were about to visit. “I know we’ve persuaded some of our specialized hospitals to spend more on an array of products and services—those ‘touch points’ you love to talk about,” she said. “But general hospitals lack the resources. They don’t care about our touch points.” “Cora, with all due respect, we have to overcome that attitude if we want to increase margins.” “I’m just trying to be realistic,” she responded. “I talk to these people more than you do.” An Unacceptable Minimum The solutions-selling idea had originally come not from Augusto but a customer: a São Paulo cardiology hospital run by a charismatic doctor who took a keen interest in the medical device business. A year ago he’d complained to his sales rep about Bosi e Faora’s lack of engagement. “We are very engaged,” Augusto retorted when Cora relayed the message. “We’ll sell him anything he wants. Tell him to name the product, and we’ll provide it.” But the hospital director wasn’t talking only about products. He wanted Bosi e Faora to help him better serve his patients. He was looking for ideas. The rep had none. Neither did Cora. Out of frustration, the hospital director suggested one off the top of his head: “Bosi e Faora sells me beautiful, state-of-the-art blood-pressure cuffs,” he said to the rep. “Could you also sell me inexpensive ones that I can resell to my patients who need to check their blood pressure every day because they’re at risk for strokes and heart attacks? And could you make the cuffs electronic so that a nurse can see the data and call the patient if there’s a problem?” The wide-eyed rep relayed this idea to people back at headquarters as though he had discovered a tribe that spoke an unknown language. But the language wasn’t entirely unfamiliar to Augusto. He recognized that the customer wanted to move beyond a purely transactional sales relationship—“I’ll pay you this if you give me that”—and instead collaborate to solve patients’ problems. “For years, our sales reps have given bigger and bigger discounts to sell more products, and our prices and margins have dropped steadily.” The doctor’s suggestion prompted a series of significant changes at Bosi e Faora. The company already manufactured a wide range of automated, easy-to-use blood-pressure cuffs, including some that were quite inexpensive (though not very accurate), and it sold simple telemetry systems for remote blood-pressure monitoring. Combining the two concepts turned out to be fairly straightforward, and within a year Bosi e Faora implemented the hospital director’s idea on a small scale. Building on this success, Augusto proposed that Bosi e Faora expand the number of customer “touch points”—that is, opportunities to help hospitals and other medical practices improve patients’ health. The company gradually began to reposition itself as a provider of not only products but also services, such as training, and the sales reps became more adept at suggesting innovations such as cobranded informational materials. Still, profitability was not improving, in part because Augusto hadn’t dared to extend the new solutions approach beyond the specialized hospitals in the city of São Paulo to the charity and other private hospitals of São Paulo state; the latter group made up more than 60% of the company’s business. Device makers competed intensely for sales to those institutions by signing up as many customers as possible, using steep discounts to drive the competition away. Bosi e Faora’s sales reps, who were responsible for price negotiations, were rewarded for quantity, not margins—and they had considerable control over the final offer. In fact, for hospitals that employed no more than 10 doctors, the reps didn’t even have to obtain company approval for discounts. As a result, prices ranged widely: The price for Bosi e Faora’s flagship wall-mounted blood-pressure monitoring system varied by almost 40% throughout Brazil. The overall trend was downward, and the price erosion led to a steady decline in margins. The company had recently tried to establish “acceptable minimum prices,” but customers and sales reps alike were unreceptive to the AMPs and now openly worked around them. Augusto even broached the idea of dropping some of the barely profitable hospitals, but the diretor presidente said no: He had become enamored with the early success in specialized hospitals, so he instructed Augusto to make solutions selling work for every customer. Augusto accepted the challenge. Years of Work Down the Drain? So here they were, ready to test the concept at a less wealthy general hospital. Sergio greeted Augusto and Cora in a courtyard that looked like something out of fifteenth-century Lisbon. The local Bosi e Faora sales rep, Roberto, was with him. Looking nervous, Roberto leaned close to Cora and whispered, gesturing at two men who were talking on their cell phones on the other side of the courtyard. She glanced at them and raised her eyebrows. Augusto was puzzled but kept his attention on Sergio, who had a disarmingly warm smile. In his office, Sergio talked soberly of the hospital’s persistent debt, the shifting philanthropic landscape, and other weighty matters. Eventually he brought up the company’s proposal, sent to him earlier, that the hospital expand its reach by creating a series of learning apps for patients’ mobile phones and a lending library of simple medical devices that could be used at home. Bosi e Faora would start by providing an app and equipment aimed at preeclampsia. The company’s research showed that for general hospitals, which saw large numbers of pregnant women, this serious and sometimes fatal condition, signaled by high blood pressure, was often caught too late, if at all. Patients would be able to borrow or lease a wristband-type blood-pressure device, use the app to learn about the condition, and even ask questions of experts on the hospital staff. “Too expensive,” Sergio said brusquely. “Surely after all these years in the health care business, you understand my situation. Look around you. We have too many patients and not enough resources.” Roberto nodded in agreement. Cora glanced at Augusto but remained silent. Clearly his colleagues weren’t going to help him, so Augusto jumped into the role of salesman. He passionately explained how Bosi e Faora wanted not just to sell to the hospital but also to partner with it. The company’s proposal for a package of services and products was ideally suited to the hospital’s needs, he argued. “You are just trying to upsell me…. We simply do not have enough cash for additional equipment.” Sergio waved a hand dismissively. “You are just trying to upsell me,” he said. “Where do you think you are? This is Brazil. We simply do not have enough cash for additional equipment. That’s why price is all-important.” “You are placing price above value,” Augusto said, shocking himself with his bluntness. Sergio, too, was taken aback, but Augusto decided to increase the pressure. He declared, “A business relationship must benefit both parties. If we can’t work with you on a more extensive basis to develop solutions for your patients, we might have to reconsider our relationship with you.” Sergio burst out laughing. “Your relationship with me has lasted for 15 years, and for very good reason. I’m your key customer in this area, and the other hospitals look to me for guidance. They know I have a good relationship with your company, and it’s because of my influence—my personal influence—that so many of them have contacted Roberto and placed orders. Without this hospital, you would lose many of your customers here. So you can’t possibly be serious about dropping me. “But if you are serious,” Sergio continued, “I must excuse myself. As Roberto knows, the two men who were in the courtyard earlier are salespeople from your closest competitor, Produtos Médicos. They’ve been selling to us on a low level for years, but they are making a big push to double that volume. They’ve been talking about some very interesting prices, tempting us with discounts. I’ve resisted, of course, because of my close ties with Bosi e Faora. But now—” What Would You Do? Some advice from the HBR.org community The right approach is to focus on creating value for the low-end, price-sensitive hospitals. Instead of selling a prespecified solution, discuss pain points where the company can help its customers. That is true solutions selling. Joey Mallari, project management office director, Novare Technologies, the Philippines Augusto must offer a solution aimed at minimizing Santa Casa’s costs while maximizing Bosi e Faora’s margins. For example, he might offer the hospital high-quality reusable equipment. Selling with conviction and a smile won’t hurt either. Yogesh Adke, management student, Indian Institute of Management, Indore The solution that Augusto is proposing may seem valuable at first, but perhaps the hospital is not focusing on preeclampsia. Augusto should have a more meaningful conversation with the client to better understand its actual needs and arrive at a valuable solution the hospital is willing to pay for. Melanie Gilbert, former software client lead for the Canadian federal government, IBM Canada Bosi e Faora must first consider whether Santa Casa’s influence in the region is worth the time investment. If so, Augusto might offer Sergio an exclusive long-term discount arrangement that shuts out competitors. Shravan Rungta, associate professor of marketing, N.L. Dalmia Institute of Management Studies and Research, Mumbai, India Should Bosi e Faora abandon “solutions selling” for some of its customers? The Experts Respond David Mok is the worldwide director of pricing for DePuy Synthes Spine, a Johnson & Johnson company. Price-only customers like Sergio Lins can be brutal. But Bosi e Faora shouldn’t abandon solutions selling, no matter how daunting the path forward might be. Many U.S. medical device companies face similar pricing battles. In the old days, a salesperson simply told the medical director that prices would rise, say, 5% next year. The physician typically did not argue, because he knew the sales rep well and trusted the products. This type of “relationship selling” was routine. But the Affordable Care Act and the smaller reform initiatives that preceded it have ushered in the practice of measuring costs against health outcomes. Purchasing managers have become more influential, and medical directors now work with them closely when choosing supplies. Of course, Augusto Tolentino must discern who really has decision-making authority at the hospital he is visiting: Sergio Lins or the medical director. Purchasing managers often act as if they have the final say, but clinicians still wield a lot of power. That said, the health care industry, like any other, aims to minimize costs in the supply chain. Medical directors can no longer rubber-stamp price increases or order expensive devices that they happen to like. Device makers feel pressure to keep prices down, and transactional sales relationships have become the norm. The solutions approach discussed in this case goes by many other names. At my company, we use the terms “value-based pricing” or “key-account price planning,” which emphasize the value we bring to customers. Our sales reps, in particular, must identify the value proposition on a particular account and know precisely why each customer wants to buy from us. For some of our most important accounts, we’ve established cross-functional teams—pricing and marketing staff, as well as technical experts—charged with identifying and addressing each customer’s greatest needs. That’s not something you do at the last minute before a sales call. It takes structure and planning. In the long run, your value-selling strategy will help you climb out of the price-only sinkhole. Let’s say the team’s analysis shows that the customer’s main worry is losing money. Our first step might be to help the institution’s executives understand their costs (many, we find, are not sure where money is being spent). We might help them implement activity-based costing so that they can focus squarely on reducing the cost of caring for patients. Sales reps still interact directly with the customer, of course, but the work of the cross-functional teams helps them do their jobs better. As Augusto learned, some customers don’t care about your solution or your value—just the price. That’s when you think about trade-offs. If, say, you grant one hospital a big discount to avoid losing its $500,000 of business, you may end up eroding $2 million more when other customers find out (and they will—consultants are deft at uncovering price discrepancies). So, instead, you offer the customer products that fit its price range. In other words, don’t try to sell your Cadillacs to a discount-seeking buyer. But never lose sight of your value-selling strategy. In the long run, it will allow you to help your customers serve their patients, to improve your margins, and to climb out of the price-only sinkhole. Nandakumar Jairam, MD, is the chairman and group medical director of Columbia Asia Hospitals in India. I certainly understand why a hospital would be skeptical of Bosi e Faora’s solutions-selling strategy, given that the company doesn’t seem to be backing up its recommendations with scientific proof. Before planning to disseminate inexpensive blood-pressure monitors for home use, a medical device manufacturer should study whether patients are likely to participate in such a program, how much training of medical and support staff would be required, and whether the new practice would improve health outcomes. Before marketing the device, the company should run pilot studies, either on its own or in partnership with academic researchers, that set up the data-transmission process and monitor progress. The studies should be published for all to see. Cash-strapped hospitals like Santa Casa de Misericórdia are entitled to see proof of efficacy and cost-effectiveness before committing to a new “solution.” If hard evidence is lacking, the hospital should oppose the plan. Price is simply not the paramount issue. But Sergio Lins doesn’t seem to share my reservations about the lack of evidence for Bosi e Faora’s proposal. For him, it’s all about price. True, the cost of equipment is a crucial consideration, particularly in developing economies. In many countries, hospitals and medical practices are severely constrained by limited revenue streams, whether they originate from private or government insurance, or, as in many parts of India, patients’ own pockets. The best Indian hospitals have been so successful in driving down costs that even though their level of care is comparable with that of institutions in the developed world, they can offer radically lower rates. For example, a coronary artery bypass procedure that might cost $50,000 in the United States can be had for one-tenth that price in India. The medical device company must back up its recommendations with scientific research. Nevertheless, India’s better hospitals often are very willing to work with medical device manufacturers to implement a solution like the one proposed by Bosi e Faora. Examples abound. Diabetes patients, for instance, can now receive automated reminders to check their blood sugar and then send the results to a hospital by phone or over the internet. The technology is furnished by a device maker, which also provides training and ongoing education for patients and the hospital. Another manufacturer has started to work with a finance company to offer patients the opportunity to pay for their cardiac stents in small monthly installments. Programs like these not only give device manufacturers a chance to expand their business and improve their margins; they also allow hospitals to offer services that they cannot provide on their own. Many hospitals welcome such solutions, as long as they have been scientifically tested. If Bosi e Faora wants to pursue its new strategy, it must start backing it up with sound research. That’s a solution everyone can embrace.

Escaping the Discount Trap

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