Pricing: One of wholesalers’ highest ROI activities

BY RICH SCHMITT
Management specialist

This month I will wrap-up my principles of pricing discussion. I know this three-part series is a lot of information to digest. Not every principle will apply to every wholesaler, but most wholesalers will be able to select suggestions that apply to their situation and can improve their performance. I urge you to pick a few suggestions and begin the process. 

Following are the last -- but certainly not least -- principles of pricing.

Sales must commit to the delivery of gross margin dollars

Emotionally, and from a compensation standpoint, sales must first be committed to delivering a quota of gross margin dollars. Frankly, I have seen only a couple of wholesalers who have attempted this approach, but it does bring clarity to the sales team’s requests for pricing concessions. 

The expense budgets are developed assuming that the sales team will generate a budgeted level of gross margin dollars. After the budgets are set, the sales team then spends a huge amount of time negotiating each deal’s pricing. Unfortunately, the negotiation is with their management (not their customers) regarding pricing concessions. Management may ultimately approve some of the concessions. 

The problem is that sales might wrongly assume they are “off the hook” for delivering their budgeted gross margin dollars. This cannot be the case unless you are willing to link each and every pricing concession to an immediate and proportionate reduction in expense dollars. (Maybe the solution is to have the salesperson who just gave away a big chunk of margin on a sale be the one who has to tell Gerty in accounting that the company can’t afford her anymore.) Seriously, in most cases, business continues to operate and spend under the assumption that the promised gross margin dollars will be delivered through other sales. Salespeople should never be absolved of their commitment to deliver the budgeted gross margin dollars to the company. Every concession is accompanied by an iou to recover the lost gm dollars from the same or other customers.

Price changes are not only tied to supplier cost changes

Customers expect you to reduce pricing to the market in the absence of a supplier cost change. Similarly, you should feel free to adjust your pricing in the absence of a supplier cost change. Pricing changes should be considered and, as appropriate, implemented whenever:

• The market goes up
• The market goes down
• A line/category or product is not performing
• Your pricing on benchmark items is not competitive
• You’re not getting price complaints from customers -- move it up
• On a set schedule review pricing, competition and profits; adjust as appropriate
• The owner has a birthday -- not really -- but I bet a price increase would be great present for the owner. 

The point is:  The wholesaler is obligated to provide the contractor with a reliable way to determine his costs but is not obligated to hold his price as a constant. If your contractors have convinced you to lock in their pricing for long periods, they have out-negotiated you.

Don’t let the exceptions drive or limit your thinking

Just because you can think of situations where a specific approach will not work doesn’t mean you shouldn’t use it in other situations. We had a client’s buyer who resisted electronic price updates because two vendors couldn’t be handled electronically. The other 600 vendors could have been updated either partially or fully using electronic tools with increased accuracy and at a reduced cost. I viewed the two vendors as an excuse -- not a reason -- to abandon the process. 

In another instance, we had a client’s sales manager who didn’t want to use price optimization because there were a handful of big customers who, he felt, would not accept the approach. He wanted to ignore the profit potential that the approach offered for the other 995 customers that they sold to. Again it seems like an excuse not a valid reason.

Do pricing quietly 

In other words, don’t announce to your team that you are now going to start managing your pricing. The announcement can lead to a backlash from your people and, after they tell all your customers (they will), a backlash from your customers. 

• Make your pricing changes quietly without fanfare
• Let your customers and salespeople be the open-minded judge of whether your pricing is fair.

                    ° If they don’t notice that you have made a change, your pricing is probably fair

                    ° If they notice the change but don’t object to your pricing, it is probably fair

                    ° If sales volumes remain at expected levels, your pricing is probably fair.

So don’t sensitize everyone to a price change. If they don’t discover it or react to it, then they perceive the new pricing is fair.

Prepare for price objections

You know objections will occur, so be ready to deal with them. Make sure your people have a practiced response to the customer when they are challenged. Force/encourage your people to practice their response and then to use it. Each challenge is an opportunity to tell your story. Failure to have a practiced response often results in a price reduction.

Do not show cost or gross margin on order entry screens

• I have never seen the sales team use cost or gross margin for good (raising the price) but have often seen it used for evil (dropping the price).
• They don’t need it. The sales team’s job is to determine what the customer will pay and feel fairly treated. The customer’s perception of fair pricing is not related to what the product costs or how much the wholesaler is making. Lazy salespeople use the computer, not the market, to set their pricing.
• Plus, since many people think that 20% or 25% is plenty for the wholesaler, any higher price is often suspect.
• It someone holds a gun to your head and you must show a cost, you must not show your vendor purchase order cost. At the very least, show a selling cost that includes all of your hidden costs like shipping, handling, warehousing and shrinkage.

Make sure that your team understands the need for profit

Most employees think that the wholesaler is making tons of money and their sympathies are often with the poor struggling contractor. When your team has a sense of urgency about making money for the company, it does make a big difference.

You must first convince your team that your pricing is fair

If your team doesn’t think your pricing is fair, how are they going to convince your customers that your pricing is fair? When your team sees that some of your pricing is in excess of 35% and views that as immoral, you can bet they will have a tough time standing tall when challenged. Some salespeople drop offer reduced pricing without an objection or a fight feeling guilty about gouging their customers. I think this is due to the fact that few salespeople understand the significant selling, warehousing, delivery and financial costs associated with delivering a product to the customer.

Discounts are gross margin points

We have found it helpful to remind everyone involved in offering or allowing discounts that each discount point is a point of margin. So a 10% discount gives away 10 points of margin.

Pricing concessions must be made in the smallest possible denominations

When a customer demands a pricing concession, the situation should be diffused with:

• The smallest percentage possible.  Not 5s, 10s and 20s, but 1s, 2s and 2.5s.
• Applied to the smallest number of skus possible

                    ° Customer level override on a single sku -- 1/2" copper 90° elbow

                    ° Customer level override on a single group -- copper elbows

                    ° Customer level override on a single product line -- copper fittings

                    ° Customer level override on a single vendor

                    ° Move customer to a different customer-type

                    ° Create custom pricing for customer because no customer-type is low enough.

Manufacturer’s list price sheets are designed with only one purpose in mind...

...To make the manufacturer money. The manufacturer doesn’t mind if the wholesaler makes money, but make no mistake, their singular, self-centered, selfish purpose is to make themselves money. Wholesalers must, whenever humanly possible, disconnect themselves from using manufacturer’s list price sheets and a single discount.

Many customers don’t really care about seeing the manufacturer’s sheet

They just need a pricing reference to do their jobs:

• To create pricing and quotations to their customers
• To determine if their wholesaler supplier is competitive and fair.

There are several ways to provide this information to the customer while moving away from manufacturer’s sheets:

• General printed catalogs
• Net-priced print catalogs
• Web catalogs and order entry systems
• Electronic feeds or interfaces to the contractor’s computer system

Customers will tell you when your pricing is too high but not when it is too low

When your pricing is perceived to be unfair, your loyal customers will tell you. It is easier for them to work with you to adjust pricing than to switch to another supplier. Very few customers will tell you when you are too low, so when you are not hearing some price complaints your pricing just might be too low.

Price optimization is the process where you establish the company’s “normal” price for every stocked, nonstock and special order product that you sell

Some thoughts on the optimization process:

• Within pricing, the highest roi activities, in priority order, are:

                    ° Stratification of the products within the line or category based upon their price sensitivity 

                      then setting the gross margin on each group within the line.

                    ° Creation of customer-type pricing that addresses the price sensitivities of different types of

                      customers. I think the most important adjustments are based upon what the customer does

                      as opposed to his size. We have found that a customer’s pricing issues are most directly

                      related to what he does since that dictates the products that he uses the most. For

                      example, residential new construction (rnc) plumbers may be sensitized to small copper

                      pricing while large mechanical plumbers are sensitized to large copper, and visa versa. So

                     while you may use a 1/2” copper  90 as an “A” benchmark item to the rnc guy, you don’t

                     always have to offer that same aggressive pricing to the mechanical guy. So you might offer

                     a slightly higher price for that fitting to the mechanical.

                    ° Creation of geographical pricing that addresses the competitiveness or lack of

                      competitiveness in a market. In some markets you may need to adjust your pricing down to

                     be considered fair, while in other markets you may be able to charge a little more and still be

                     considered fair.

• Price by product line or category.  Manage the pricing on each product line or product category. You will find that focusing on a group of reasonably similar products and their relative price sensitivity, brings great clarity to the process. 
• Use six gradations (A-F) in every product line/category. Through the years we have found that less than six gradations is too coarse and results in suboptimal profits. More than six levels quickly become too confusing since it is difficult to describe the characteristics of a “J” versus a “T” product. Six levels seem to be the right balance of profit generation and complexity.
• Pricing codes (A-F) are not the same as inventory management codes even though the same letters are used. Your inventory classification codes are for inventory management so, typically, they cannot be used to represent your customer’s price sensitivity.
• Pricing sensitivity codes should have the same meaning consistently throughout all your product lines and categories. In other words, “A” indicates that a product has certain characteristics:

                    ° It is highly price sensitive

                    ° It is a benchmark product used by customers to check your pricing on the product line and                        sometimes for the company

                    ° It is advertised and “specialed”

                    ° The price is well known by the trade customers who use it routinely

                    ° The price is expressed as a dollar/cents number not a percentage

                    ° In most full-line plumbing/hvac companies, there are less than 100 total “A” items

• Some product lines or categories have no “A” (Benchmark) items because none of the items have the characteristics of an “A.” Said another way, “A”s have very specific characteristics, they are not “A”s simply because they are the most price sensitive products in a line.
• The optimizing codes have different gross margin values for each line or category.  “A”s in copper fittings have different gross margin percentages than “A”s in hvac equipment.  An “A” in copper fittings will have a lower gross margin percentage than a “B”, “C”, etc. within copper fittings.
• Analyze before you act. Good pricing involves a tremendous amount of analysis. You have to understand the situation, competition, customers, costs and markets in order to create optimal pricing. 
• Model all pricing before you implement. After you understand the situation, you will create proposed pricing that will be modeled using historical sales volumes, and ideally sales forecasts. You will apply the proposed pricing to those volumes to forecast/calculate the profit performance of the proposed pricing prior to installing it in your computer system. Modeling several different possible scenarios can help to understand when specific market conditions might make the proposed pricing less effective or even unacceptable.
• Never install pricing that makes you less money. While this may seem like a “no-brainer” this must be a fundamental rule within your company. You keep reworking and remodeling pricing proposals until they are forecast to make more money than the status-quo.
• Analyze your changes after the fact to determine if your change produced the desired result and that your modeling and analysis tools are dialed-in. This is not a perfect science, but when your results do not reflect your forecast you must go back and understand why.  If the forecasting model was wrong it must be adjusted so future modeling is more accurate.
• Pricing should not shock the market. As you make changes and evolve your pricing, you must try to make changes gently. Rapid and abrupt changes in pricing are viewed by customers with the same fondness they have for rapid and abrupt changes in an airplane’s altitude. Going from sea level to 10,000 feet in one minute would terrify most of us but climbing to that altitude over 10 minutes wouldn’t wake most babies. The result is the same. One approach is hardly noticed and the other fills a lot of burp-bags.
• Promotions are critical to pricing. As I discussed in my first column in the series, the fairness of your pricing is based on the customer’s perception of your pricing. You must use promotional activities to shape the customer’s perception and to remind them of your competitiveness.
• Price changes for “A” items must be communicated broadly to the concerned customers. A client once complained that he had gotten aggressive on some of his “A” products and nobody seemed to care. I asked how his customers were informed of the great new pricing. He immediately began a process to remind his customers, along with many other messages, that his pricing on the benchmark items was very competitive. I would not recommend that you create a list of “A” product pricing and distribute it to the world. The idea is to, in an almost matter-of-fact manner, continuously demonstrate to your customers that you have fair pricing.
• Use the cost of next acquisition for all price calculations unless you enjoy a buying advantage that your competitors do not enjoy.  (Do not corrupt the market pricing when your buyers do a good job of negotiating.) Never use average cost for price calculations. Whenever possible use a fully burdened cost that includes the vendor’s cost, inbound shipping and handling as well as any carrying costs that apply to the product. The fully burdened cost will encourage you to set pricing that is high enough to be fair to your company or to understand which products cannot earn their keep.
• When you make a pricing mistake, fix it and move on. If you are doing a proper job of pricing, you will make mistakes like setting a price too high.  When you do make a mistake, simply tell the customer that you’re sorry and that you will get it fixed asap. Frankly, if you are not occasionally setting a price too high, you are probably leaving some money on the table.

Pricing is never done

The market is in a constant state of change so your pricing must also be constantly changing. Pricing on major lines should be reviewed and, as appropriate, changed on a weekly or monthly basis. On all other lines, pricing should be reviewed at least once per quarter. The review should focus on a group of questions:

• Where do customers think we have unfair pricing?
• Is our pricing really wrong?  What data do we have? What data do we need?
• Is our pricing right but the customers perceive it to be wrong?  How do we demonstrate that our pricing is, in fact, fair?
• Where are there opportunities to make a little more money?

This completes my Principles of Pricing series.  I know these three columns on pricing have been a long tough slog. There have been many elements to discuss because pricing, done well, is not a simple process. 

I firmly believe pricing is, done well, the highest return on investment activity in all of wholesaling. That means, if you do pricing with intelligence, every minute that you spend properly managing your pricing should return added gross margin to your company. I am convinced and I hope you are now convinced that pricing will be one of the keys to surviving and, maybe even, prospering in the rough seas that are looming on the horizon.

Rich Schmitt is president of Schmitt Consulting Group Inc., a management consulting firm focused on improving the profitability of distribution and manufacturing clients. Rich is also the co-owner of Schmitt ProfitTools Inc. (SPI), a business producing print, CD-ROM, web and palm-based catalogs as well as pricing management and analysis software for wholesalers.