Take time to manage your pricing

BY RICH SCHMITT
Management specialist

Price objections are a way of life in the distribution business. I don’t know where this all started, but it is a curse that we all endure as we try to run profitable hard-goods wholesale businesses. There are no legitimate prices because everything has become negotiable.

Over the years our industry has created a real mess for itself. The worst part of it is that many in the industry have become resigned to the madness and no longer put up a fight for fair profits. As the old acronym SNAFU goes, “Situation Normal…All Fouled Up” (since dad was in the Navy, I know there are other, less socially acceptable ways to expand the acronym, but the meaning is basically the same).

What is also troubling is that some in our industry make excuses:

• “My stupid competition is the problem”
• “My sales team is out in the field and they tell me that this is where we need to be”
• “It’s just too much work to improve our pricing.”

I know this may sound like a broken record, but please allow me to share a few more thoughts on the topic.

We are talking about big money

Working with a client some time ago, we analyzed their transactional data using our Price Analyzer software and determined that in one year, the sales team had, on average, discounted pricing 5% across the board. Some transactions were actually at a higher price, some were at the customer’s price in the computer, some were moderately discounted and some were obscene. So for a $35-million company, $1,750,000 was given in discounts throughout the year. In a tough year, just keeping one of those points would have put this company into the black.

While, in total, it can be big money, for many companies the problem is one of “Death by 1,000 Papercuts” — each override or discount seems small at the time. A dollar here, $10 there, but spread over 750,000 transaction lines, it adds up quickly. Thus far, I have never shown an owner his year’s override dollar total without him gasping or indicating that it was far more than he ever suspected.

Now I will allow that the bid situations certainly required special pricing and that from time to time the base pricing needed work or that customers had legitimate pricing complaints about some products. Pricing is never perfect and when it is wrong, the company needs to get it fixed ASAP.

So, while some discounting was probably appropriate to remain competitive, my gut and the data tell me that there were some times where smart thinking could have held onto 1 or 11/2 of those percentage points. And at $350,000 per point, it would have been worth a fair amount of effort.

It is critical to know how much discounting is actually occurring in your company. Many companies have override reports that may or may not be reviewed. Some companies filter out the small overrides and then fail to review the total, resulting in that “death by papercuts” I mentioned above. You need to know the percentages and the raw dollars that are being given away in the process. Even better, require documentation for each and every override as a way to track the market and to introduce some accountability to the pricing process.

Significant discounting is normally caused by one of two pricing problems

1. Flawed Computer Pricing — The customer pricing that was in the computer system was incorrect and maybe even ridiculous. In other words, not properly set for the market, product and customer. When this happens, the sales team is forced to establish the price for every sale. This wastes time, requires each salesperson to have significant pricing savvy and often results in overshooting the mark (gives away more than is really necessary to make the sale).

A ridiculous computer price also teaches customers to distrust all pricing and request/demand special pricing on every order.

2. Unwarranted discounting by your team – Many concessions are made without a legitimate market situation. The sales team got hoodwinked or was lazy or didn’t care. Pricing isn’t easy but the first goal is to not do it stupidly.

Here are some tactics that will help:

• Never give a discount that the customer doesn’t ask for. This seems pretty simple, but a surprising number of salespeople discount a customer’s price even before they tell the customer his computer price. So the computer price for a widget is $1.00 and the salesperson quietly overrides the price to $.80 while entering the order. The customer didn’t complain because he never heard the normal $1.00 price. Sometimes the money is given away so fast the customer doesn’t know it happened and cannot appreciate the gesture.
• Don’t make anonymous donations to customers. I think these are proper for charities but you want to get full credit and appreciation for every extra service and price concession that you provide to a customer. You are creating a bank account of customer assets that you may need to draw from if there is a problem.
• Only have price wars with real competitors. Many times, salespeople find themselves competing against a make-believe competitor. One that they have invented in their mind or one that a customer has created for them. I don’t believe in ghosts or imagined competitors. So the challenge is to find out who you are really competing against, what their game is and the highest price that will win the business.
• Don’t allow historical pricing and costing to shape your current pricing. A surprising number of companies use all the great customer history data in the computer to their disadvantage. It’s the old adage of driving a car looking out the rearview mirror. The fact that a customer paid $50 for a product two years ago has nothing to do with the right price today. If he happens to remember an old price, it is easy to sincerely say that a lot of water has flowed under the bridge since then and you will give him a competitive price in today’s market. The fact that the last cost in the system is $25 has nothing to do with the current cost and proper selling price. Don’t allow your people to see the data if they use it this way.
• Don’t show the salesperson the cost or GM percentage. I have heard a story where the owner collaborated with his programmer and showed a lowered GM percentage on the order entry screen. The widget price was $1.00, the GM% showed as 18% even though the actual GM% was 32%. The price was the same either way. Guess what, the amount of discounting dropped. The only conclusion was that seeing the percentage radically changed how the salespeople operated. The customer thought that the $1.00 price was acceptable in either case since he never got to see the GM%. (Before you complain, sales compensation was based upon the raw sales dollars not the gross margin so the inaccurate GM numbers didn’t cheat any salespeople out of their commission. In fact, since the sales force didn’t discount as much, they actually made more money in the process.)
• Don’t show the customer your cost or GM percentage. I just wanted to throw this in since there have been instances where salespeople routinely shared the company’s costs and gross margins with their customers.

Watch for the red flags

Red flag 1 — Sledge hammer discounts. These are instances where the salesperson sees that the customer seems to have heartburn and hits the situation with the biggest hammer that they are permitted to use. They don’t take time to determine if the heartburn is related to the price, if it’s a bargaining tactic or due to the double-bean, extra spicy burrito the guy had for lunch. The big hammer almost always gets the sale, but often creates big collateral damage:

• The company’s profits are gone.
• The customer wonders why he has been paying so much for all these years when such a massive discount was offered with so little effort.

Often, simply asking a couple of questions can help the salesperson understand the highest price that will make the customer happy enough to buy from you.

Red flag 2 — Even percentage discounts or gross margins. Over the years, as we have looked at the individual transactions, we noticed that many of the concessions resulted in even numbered GM percentages. (In fact, as we noticed the pattern we added code to our Price Analyzer that detects and reveals instances where the salesperson looked at the customer’s sale price and entered an even GM percentage override into the computer.)

Red flag 3 — Discounts and gross margin percentages in multiples of 5. We noted that many of the GM percentage overrides or discounts were 10%, 15%, 20% or 25%. We have found in practice that there are many instances where a 12% or 13% discount would have worked just as well (with the customer) as the 15% that was given.

I don’t want to get off into a rant but I find these last two types of overrides to be quite offensive. Why, you might ask.

• Because seldom, if ever, does a customer tell your team that he needs 25% gross margin pricing on a product. Very few of your team understand what gross margin is and even fewer of your customers have a clue about what gross margin is.
• If, perchance, they did understand gross margin, they sure as heck wouldn’t tell your team that they needed xx% gross margin pricing.
• In my 20 years of consulting, with an emphasis on pricing, I can count on one hand — really, three fingers — the number of instances where customers have demanded pricing in terms of gross margin. I am not sure that they understood what they were requesting but they used the words gross margin in only three instances.
• So the gross margin percentage or discount that gets entered probably tells you what the salesperson thinks is a fair gross margin percentage or discount for the product and maybe for the company overall. (As an aside, each member of your team probably has his own personal “fair gross margin” number in his head. It typically has little or no relationship to the market, the company budget or the competition. It is just a number that he thinks is right. It may vary based upon the company’s niche but as I poll people in our industry, it is typically in the low to mid 20s. Sadly, the fair gross margin threshold for some salespeople happens to be below the break-even point for the company.)
• Even gross margin percentage pricing is not related to hitting a target price put forward by the customer since that customer’s price seldom resolves to an even GM percentage. So when the customer says, “I buy that widget for two bucks down the street,” your guy will enter $1.99 and the GM percentage will calculated to some number that is seldom an even percentage.
• Further, 10, 15, 20 and 25 discounts are massive drops in margin especially when you consider that each discount point gives away a point of gross margin.
• Most companies and salespeople don’t understand that each discount point gives away a point of gross margin.
• These major jumps may indicate how casually some salespeople view discounting. They give away the company’s money in a way they never would if it was their money. This is a huge problem.

Red flag 4 — Discounts to the wrong customers. Some salespeople have become discount addicts. They discount to customers based upon their mood more than a verified market situation. When you see a faucet cartridge discounted to a cash customer, you have a problem. In fact, discounts to any cash customer are suspect since these are often high-cost transactions in the first place. Again, the sales team sees a high gross margin and gives away the money.

Red flag 5 — Robin Hood attitude. Discounting authority is granted for one reason: To address competitive situations. It is not provided to allow the sales team to use in making friends with customers. If you find that some of your sales team has no customer skills beyond price dropping, they are buying the customer’s friendship and that is a bad approach.

So, in short, here’s my punch list:

• Take time to manage pricing.
• Work hard to give away a little less. Every dollar not given away should hit your bottom line.
• Start with properly managed computer pricing so your sales team has a realistic starting point for any negotiations.
• Don’t show GM percentages.
• Don’t allow people to see costs.
• Require accountability when discounts are required. (Why, who was the competitor, etc. Provide documentation whenever possible.)

For more on pricing, e-mail at rich@go-spi.com.