What Is a Price Waterfall? A Guide to Increasing Profits & Fixing Your Price

In e-commerce, besides pricing, it is also immensely important to analyze the revenue and all of the transactions to identify imperfections, and so on… That’s where a price waterfall comes in handy.

A price waterfall is a process that helps you study the prices of goods at all stages of their transformation. Basically, a price waterfalls are used to identify margin leakage or any other shortcomings in the pricing system.

A price waterfall increases your business’s profits primarily because you eliminate mistakes and improve your pricing model.

Here we will consider the advantages of price waterfalls, why it is important, how to use this tool correctly and extract maximum profit.

Many companies offer their customers additional free services in addition to basic services or goods. This is done to stimulate the customers’ desire to return to the company again, or to help them form a positive opinion.

However, it is not always possible for a company to carefully calculate how much such free services will cost them. Sometimes, some details can be easily overlooked, and lost profits can no longer be returned. This is how profit leaks occur. In order to prevent leaks, a price waterfall is used.

Thus, a price waterfall is a comprehensive analysis of where, when, and how much money was spent. This helps you form a clearer picture of profitability, understand which levers should be used in the sales process and, of course, improve your pricing strategy.

What does a price waterfall consist of?

Firstly, the list price. This is the price at which it is recommended to sell a product. It can be assumed that this is the initial price after the purchase of the goods. This is the price on which the further analysis of the transformation of prices will be based.

Secondly, on-invoice deductions. These are the items that are visible to the buyer: all kinds of discounts, advertising credits, coupons, and so on. For better accuracy, each type of reduction should be analyzed separately. As you have already understood, the price waterfall consists of taking the original list price and then tracing all the changes that have occurred with that price.

Reducing the list price with on-invoice deductions results in the invoice price. This invoice price is, confusingly, referred to as a gross price or a net price in different contexts.

Next step, off-invoice deductions. These deductions are usually the main source of losses. These deductions include personnel costs, customer service costs, free samples, shipping costs, and so on. In this segment, it is easiest to miss various expenses, so here you also need to calculate each item separately.

After off-invoice deductions are accounted for, we have a net or net-net price. This is often referred to as the pocket price by pricing professionals because it is what companies actually “pocket” after all deductions are actually considered.

There are several advantages of a price waterfall analysis that will be beneficial for your business:

Diagnostics of several sites at the same time will allow you to determine your strengths and weaknesses, and it will be easier for you to decide what actions to take regarding your pricing policy.

A price waterfall will allow you to better understand your customer and comprehend how you represent the value of your product on the market.

Using a pricing waterfall helps you identify if both on- and off-invoice discounts are relevant and financially justified, because any discounts immediately affect the final cost of the product, and thus, your margin.

With a price waterfall analysis, the implicit and explicit elements of real product costs have nowhere to hide. This makes it the perfect starting point to optimize value chain operations and pricing policy.

Since you will have all the data about possible leaks, you will be able to calculate the optimal price and make the most profitable deals.

The main difficulties in a waterfall may concern the system itself, the people involved, and the reporting process.

Regarding the system, there may be insufficient data, or the program you are using may have insufficient analytical functions.

As for the people, there may be insufficiently competent employees involved, or there may not be a team lead who would manage the entire price waterfall process.

For reporting, high-quality monitoring is important, as there may be problems with data structuring and other reporting errors, which can negatively affect the price waterfall.

In order to create your price waterfall, you need to complete several steps:

Assemble a team. The team should consist of people with different specialties: that is, not only financiers and analysts, but also marketers, sales specialists, and IT specialists.

Perform data analysis. This is the most basic point. It’s not so important what program or software you use; the most important thing is the accuracy of the information provided for analysis. If some data turns out to be incorrect at the very beginning, then this can spoil the rest of the waterfall.

Add your own pricing factors. You have to include all the discounts: all the costs that you have. Then, you track how the price changes after each transformation. Each store may have its own items that need to be included in the price waterfall; the most important is not to miss anything.

The main goal of entrepreneurs when using a price waterfall is to identify money leaks and extract maximum profit from the business. In order for this strategy to bring as many benefits as possible, you need to use it systematically.

Use your pricing waterfall to thoroughly review your strategies and commercial policies to help your entire company achieve its goals.

It is essential to have a deeper understanding of the price waterfall and a focus on the pocket price or net price, as opposed to the invoice price, in order to optimize margin opportunities and make considerable improvements in sales and profitability.

Organizations can benefit from the price waterfall’s function of making clear the relative importance and attractiveness of the different channels, customers, segments, and products. As previously discussed, a pricing waterfall analysis allows companies to leverage existing sales transaction data to identify margin improvement opportunities and grow their profitability.

A pocket price waterfall reveals how a price erodes between a company's invoice figure and the actual amount paid by the customer: the transaction price. It tracks volume purchase discounts, early payment bonuses, and frequent customer incentives that squeeze a company's profits.

A waterfall chart depicts the initial cost, the factors that influence the price and how, and the final cost. It is a special bar chart that displays the entire process of price transformation.

A waterfall discount is a type of volume-based cash discount where the price per unit decreases as the volume of units sold increases. This type of discount encourages customers to buy in larger quantities to receive a lower price per unit.