The price waterfall: from list price to pocket price, with a distributor example

A price waterfall shows how a list price shrinks into the money you actually keep. It starts at the list price, takes off the discounts that appear on the invoice, then the costs that come after it, such as rebates, early payment discounts and free freight. What is left is the pocket price. For distributors the waterfall is the clearest way to see margin that leaks between the quote and the bank.

A distributor price waterfall

A contractor buys 6205-2RS bearings. List price is $18.56. The account sits on a price level 10% below list, the order qualifies for a 2% quantity break, the customer pays early for a 2% discount, earns a 3% year-end rebate, and the order ships free.

The invoice says $16.37. The business keeps $15.10. Against a landed cost of $11.60, the margin on the invoice looks like 29.1%, and the margin in the pocket is 23.2%.

None of the reductions below the invoice line is unusual on its own. Together they take almost six points of margin that no report built on invoice data will show.

The layers of a waterfall

Every waterfall has two halves, split at the invoice.

• On the invoice

  Price level discounts, quantity breaks, promotions and one-off rep discounts.

• After the invoice

  Rebates, early payment discounts, freight you pay, returns and allowances.

On-invoice discounts are easy to see and usually controlled. Off-invoice items are where waterfalls earn their keep, because they are booked in different places, often months later, and rarely tied back to the quote line that caused them.

How to build a price waterfall

1. Pull the transactions

   A year of invoice lines with list price, invoice price, quantity and customer.

2. Add the off-invoice costs

   Rebates, early payment discounts, outbound freight and returns, per customer.

3. Spread them to lines

   Allocate each cost to the invoice lines it relates to, by value or by volume.

4. Chart and compare

   One waterfall per customer, segment or rep, side by side.

The allocation step is where most waterfalls go wrong. A 3% annual rebate belongs on every line the customer bought that year, not on the month it was paid. Freight belongs on the orders it shipped, and a single small order with free freight can sink the pocket margin of that line entirely.

What a waterfall reveals

• Customers who look profitable but are not. Two accounts with the same invoice margin can sit 6 points apart in pocket margin once rebates and freight land.
• Discounts nobody approved: off-invoice items agreed by a rep and never written into the price.
• Price bands that are too wide, with the same item sold to similar customers at very different pocket prices, the pattern known as pocket price dispersion.
• Rebates that pay for nothing, such as volume rebates on accounts whose volume never changed.

Pocket price dispersion

Plot the pocket price of one item against order size for every sale in a year, and you will rarely see a neat line. It is common to find the same bearing sold to similar customers, in similar volumes, at pocket prices far apart. That spread is not strategy. It is the sum of individual decisions nobody compared.

Narrowing the band, by bringing the lowest prices up toward the middle for customers who do not justify them, is often the fastest margin gain a distributor can find. It needs no new customers and no list price change.

Where waterfalls stop helping

A waterfall is a look back. It tells you where last year's margin went, in a report that takes days to build and is out of date by the time it is presented. The leak it shows happened on thousands of quote lines that were priced without it.

The fix is to bring the waterfall forward to the moment of pricing. A pricing engine that knows the customer's rebate, payment terms and freight terms can price each quote line to a pocket margin target, so the 23% you want is the 23% you get, not a 29% that becomes 23% after the year closes.