Strategic pricing for distributors
Industrial Supply columnist Brent R. Grover explains how to turn a common problem into newfound profits
by Brent R. Grover
Mahoning Supply, an industrial distributor with $50 million in annual sales, faced an all-too-familiar problem. Year-to-year sales were off more than 20%, and the company had breached its bank loan covenants. The bank threatened to call Mahoning’s loan because projected cash flow would not cover payments. Management at this imaginary but not atypical distributor made two obvious moves: they laid off excess staff and tried to dump bloated inventory. Unfortunately, it was not enough to satisfy the bank. What to do?
Would you consider raising prices if your company were in Mahoning’s situation? That is exactly what Mahoning’s CEO, George, did! He had the disadvantage (and advantage) of being new not only to the company but to the distribution business. George could not understand why sales reps spent so much of their time managing prices, even on low-volume products at their smallest accounts. The reps were constantly on their phones quoting prices and negotiating with vendors for lower cost. They spent much of their office time auditing orders and changing prices on the computer.
The pricing guessing game
George also found that his reps had little or no market pricing information. They had some feedback from a handful of their own customers, of course, as well as their general impression (right or wrong) of what margins should be competitive on a few of the company’s product lines. The lowest “last bracket” prices in the Mahoning price book were too high – out of touch with reality – so if referred to at all, they were only a starting point for discounting. When quoting, the sales reps just wanted to know Mahoning’s cost for the item, and they would apply an arbitrary percentage to come up with a selling price. They mostly used the same margin percentage for all items in a product line. They also used the same margin percentage no matter what industry the customer was in, or how small or large the customer.
George hired an expert to help his staff do a statistical analysis of all transactions for the previous 12 months. It took less than three weeks for the analyst and his computer program to segment the customers, organize them by size, group the product lines and analyze price sensitivity. The program then calculated a margin index for each item. The last step produced pricing look-up tables for adjusting the margin indexes based on customer segment, buying power and item sensitivity. The result was recommended pricing for every item that customer bought. Below-market margins were to be brought up to market levels whenever possible, all at once or gradually depending in the situation.
The sales reps were taught how “strategic pricing” worked and were given margin goals for their customers, by item. Larger increases were sought on less sensitive items and for smaller customers. Smaller increases were recommended for more sensitive items and for larger customers. Most prices for larger customers were left alone, except for the least sensitive items. Prices under contract were not touched. The sales reps screened the proposed new prices and made decisions about trimming or postponing increases to selected items for some customers.
Mahoning’s information system professionals plugged the margin indexes and pricing look-up tables into the company’s ERP system. Most of the thousands of “special contract price and cost records” were cleaned out of the system. Strategic pricing made most of those hard-to-maintain records unnecessary.
Early results are in
After review by the sales reps, the new prices were applied to customer transactions. Margins on some low-profile items for small customers increased by several percentage points. Margins for other items increased by lesser amounts, or not at all. Mahoning did not reduce margins determined to be above market level because the goal was profitability, not perfection.
In spite of fears of some sales reps, there was almost no significant negative reaction from customers. The initial phase of the strategic pricing project resulted in an overall increase of 200 basis points, or a 2% increase in gross trading margin. The margin improvement translated into an immediate jump in gross margin dollars of almost $80,000 per month (approximately $4 million monthly sales @ 2%). Under Mahoning’s sales compensation plan, about 20% of the increased margin, or $16,000 per month, went to the sales reps. The balance went straight to the company’s bottom line: more than $60,000 per month, nearly $750,000 per year.
For Mahoning, at a $50 million annual sales rate, the $750,000 operating profit increase translated into 1.5% of sales. In terms of return on investment, a $750,000 leap in operating profit represented going from a $300,000 loss to a $450,000 pretax profit. As a group, the sales reps enjoyed almost $200,000 in additional annual commissions. The immediate improvement was enough to restore the bank’s confidence in the company.
Strategic pricing freed up time for the sales reps to introduce new products and concepts and build customer relationships. The reps learned to delegate most routine pricing activities to the support staff and, with better market pricing information, became more adept at negotiating deals with larger customers. Using the margin indexes and pricing look-up tables in the ERP system, the inside sales staff became empowered to quote market-driven prices to new customers and pricing on new items to existing customers.
George and his imaginary management team dealt with a serious challenge facing many wholesale distributors today. They responded to the threat in the usual ways – staff and inventory reductions – but also with a creative response to a common problem: sales reps overwhelmed with pricing tasks, yet starved of market pricing information. The data you need is already in your system. It’s up to you to turn the data into information, and the information into profits.
Brent R. Grover has written five books for the NAW Institute for Distribution Excellence and numerous articles about distribution management and is a regular contributor to Industrial Supply magazine. Reach him at (216) 360-4600 ext. 101 or brent@evergreen-consulting.com.
This article originally appeared in the July/August 2009 edition of Industrial Supply magazine. Copyright 2009, Direct Business Media, LLC.
INDUSTRIAL SUPPLY MAGAZINE
The November/December issue of Industrial Supply magazine features an in-depth cover story about Kimball Midwest. Plus, we're featuring articles by contributing writers Dirk Beveridge, Frank Hurtte, and Mike Marks, as well as interviews with numerous product and distribution industry experts.
