During the recession, Mahoning Supply, an imaginary industrial distributor with $50 million in annual sales, faced an all-too-familiar problem. Year-to-year sales were off, and the company was in danger of breaching its bank loan covenants. The bank was worried that projected cash flow would barely cover the required 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, these moves weren’t enough to solve the problem. 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 also perhaps the advantage) of being new not only to the company but to the distribution business.
George could not understand why his 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 reviewing orders and changing prices on the computer.
The Pricing Guessing Game
George also found that his reps knew vendor product costs but had little or no market selling price information. They had some feedback from a handful of their own customers, of course, as well as their general impression (right or wrong) of competitive margins 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. If the price list was used at all, it was only a starting point for discounting. When quoting, the sales reps would apply an arbitrary percentage to come up with a selling price. They often 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 was.
George hired a pricing consultant to do a statistical analysis of all transactions for the previous 12 months. It took less than three weeks for the consultant and George’s team to segment the customers, organize them by size, group the product lines, and set them up to analyze price sensitivity. The consultant’s analytical software determined a market-driven pricing for each customer and item.
The last step created pricing look-up tables based on the margin matrices for every product line and customer segment. The recommended pricing for each customer was reviewed and approved by the sales team. 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 by item for their customers. 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.
Mahoning’s information system professionals plugged the margin matrices and pricing look-up tables into the company’s ERP system. Most of the thousands of “special contract price and cost records” were eliminated as market-driven pricing made most of those hard to maintain records obsolete.
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.
Despite the fears of some sales reps, there was 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 a growth rate in gross margin dollars of almost $80,000 per month (approximately $4 million monthly sales at 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.
Strategic pricing freed up time for the sales reps to introduce new products and concepts and build customer relationships. In time, 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 matrices and pricing look-up tables in the ERP system, the inside sales staff was 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 the common problem of sales reps being 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 by using a pricing consultant to do a statistical analysis.
Reach out to our team of consultants today. We’d love to hear from you!
This article was adapted from “Strategic Pricing for Distributors.”