Principles to consider in pricing

BY RICH SCHMITT
Management specialist

In past columns I have discussed pricing in a variety of ways and have gotten many requests for additional information on the topic.  Frankly, I consider this interest as a positive sign for the industry since pricing seems to have taken a lower priority for wholesalers than I think is prudent.

Thus far, in my consulting, I have not encountered a wholesaler in our industry who couldn’t improve their profits through better price management. Even the great wholesalers can get a little better. For wholesalers who want to improve their price management, the question is often, “Where do I start and what do I do?” 

The answer, of course, depends on many factors that are unique to each company. This column starts a list of principles that I feel are applicable to pricing in this industry and next month’s column continues this list. (Sorry to split the topic, but it is a significant and important subject that I do not want to oversimplify.) Of course, your situation is unique but most wholesalers will be able to adapt my list to fit their situation and needs. The important thing to remember is: While you may not want to use some of the techniques I discuss, you should be aware of them since your competition just might be using some of these techniques against you.

So here is my first installment of thoughts regarding pricing.

Pricing management is the highest return on investment activity in wholesaling

It is often the simplest, easiest and most direct way to improve your profits.  When I am involved in turning a company around, after stopping spending (bleeding), price management is quite often the next activity on the list.  Consider that there are typically four approaches to increasing your bottom-line profits:

• Sell more -- Great idea! You should always be working to sell more. In a soft market this may be tough to accomplish, but you must always be working to gain or hold your share of the market. In any market, your competition will probably not willingly sign up to your growth plan so you should anticipate their resistance. Further, there is often a delay as you energize your sales and marketing team. In the end, only a small percentage of the additional sales actually falls through to the gm line on the income statement.  (If you are a 25% gm wholesaler, only $0.25 of every dollar of additional sales becomes gross margin. If there are any expense increases associated with the additional sales, an even smaller percentage of the added sales will hit your bottom line.)
• Reduce expenses -- Again, great idea! Keeping expenses under control is always a high priority. Unfortunately, headcount is the expense item that is most often attacked. The termination expenses, implementation delays and impact on morale associated with a force reduction tend to reduce and delay the benefits to the company. Further, it takes substantial expense cuts to produce a significant bottom line impact. (If your expenses run 23% as a percentage of sales, you must reduce total expenses by 4.35% to yield a 1-point bottom-line improvement.) Of course, your headcount and other expenses must always be aggressively controlled so your total expenses, as a percentage of sales, stay in budget. In a soft market, it is crucial that spending be adjusted just as quickly as sales are receding.
• Buy better -- Your team should always be working to ensure that you have cost parity with the other wholesalers in your market and that your unique strengths in a market are reflected in your deal with your suppliers. These often take time to negotiate but good buy-side deals can drop directly to the bottom line (if they are not immediately released into the market as price decreases).

The stupid pricing trick I have seen way too often goes something like this:

1. The buyer gets a great price (your cost) from the supplier.
2. That cost is entered into the computer.
3. The same gm% is applied to the reduced cost to calculate a new selling price.
4. The gross margin percentage remains the same but since it is applied to a lower cost, the gm dollars take a hit.
5. The buyer did a great job but the company made less money.  This was certainly not anyone’s intent.  
6. Frankly, this story happens much too often in our industry through inattention to pricing. Many wholesalers, who do not have pricing managers, stupidly fritter away their buy-side advantages. So in practice, buying better must be aggressively protected through vigilant control on the pricing side.
7. Manage your pricing for higher gross margins. If you do this with your existing people so there are no expense increases, 100% of the additional gross margin falls directly through to your bottom line. As that cooking guy says, “bam!”

When you improve your pricing, the effect is immediate.  When you raise the price on a product, you generate the added profits the very next time you sell that product. “Bam!”

You need a pricing manager

I recommend that every $20M+ company have a dedicated pricing manager. Smaller companies may not be able to justify a dedicated person however they must certainly assign someone who, as their Number 1 responsibility, fills the pricing management role. In other words, if that person gets busy and something must slip, it must never, ever be pricing management that takes the back seat.

Earning Primary Supplier Role with customers is the strategic objective

Pricing must always be supportive of this objective. The Primary Supplier role means the wholesaler gets the first call, the first stop and the last look.  To earn that role there are four requirements:

• The customer must know you are a reliable, reliable, reliable provider of the product
  • Branches -- convenient to the contractors’ shops and the job site
  • Delivery as promised -- On time and correct
  • Convenient and easy to do business with
• You must have the products the customer uses, needs and wants
  • Brands the customer uses -- You must stock the brands he likes and is familiar with to be his primary supplier.                   
  • Quality the customer buys -- If you sell heavy duty widgets and the customer uses economy widgets you can either work to convert the customer (sometimes tough to do with the typical stubborn plumber) or stock the economy widgets that he’s already sold on.
  • Quantity -- If the customer buys a product in cases, their primary supplier for that product will always have cases of the product in stock.
  • One-stop shop -- The smart contractors know that they gain efficiencies from having one or two wholesalers who can supply all the materials for their work. Ideally, you want to be their one and only.
• Never out of bread-and-butter items -- Contractors don’t want to have to call ahead to see if you have a box of 1/2” copper 90s in stock. The wholesaler they choose as their primary supplier is one who they can always count on to have those critical bread-and-butter skus in stock, without fail, rain or shine. (They have little tolerance for wholesalers who do stock out of these crucial products. And they remember it for a long time when a wholesaler lets them down.)
  • Must know you have it -- You must ensure customers know what you have for sale or they might be using someone else as their primary supplier.  You cannot assume that your customers and salespeople know and remember all the products you stock. You must constantly be working to keep everyone informed of your offering.
• Customers must like you -- Contractors, when possible, have a primary supplier who they like and who likes them.
• Customers must feel that you offer fair and competitive pricing -- Not always lowest but always fair and competitive. You can, of course, take the simple approach: Offer the lowest price in the market on every product but many wholesalers (now former wholesalers) before you have proven that this is not a viable long-term strategy.  Providing fair and competitive pricing and making money requires determined price management activities.

Advanced pricing management techniques do not work

effectively when your base offering stinks

When you are not reliable, when you don’t have the right products and when customers don’t like you, your only redeeming feature is your “whorendously” low pricing.  If you find that you are not able to earn the role of “primary supplier” with customers in your market, it might be that you are just not worthy. Contractors typically won’t feel comfortable telling you that your company stinks but they will tell you that you need to lower your price. (It’s not as offensive and the real message is, “You stink, but if you can get your price to this outrageously low level, I will be forced to tolerate your incompetence and buy from you.”)

Manage and control every product’s pricing --  All products’ prices are managed. Period. You never allow anyone to casually price any product. You might allow your people to sell at list price when a product doesn’t have a managed price but there may even be some products where the list price isn’t high enough to generate fair profit for the wholesaler. So manage the pricing for every stocked, non-stock, special order and bid & quoted product for every type of customer you serve.

Of course it is a huge job but it is like eating an elephant, you do it one bite at a time. You should start with your important products and customer types but then, over time, go on to pervasively manage every product to every customer. Wholesalers spend a lot of time worrying about their high-velocity products which is certainly appropriate. They often spend very little time managing their low-velocity products assuming that the profit opportunity is insignificant. This is absolutely not the case.  These ignored products are gross margin opportunities that must be exploited. You must search out these ignored products in the nooks and crannies of your inventory and raise the pricing.  When you consider that these skus may actually be a major percentage of your total skus, the opportunity for increased profit can be significant.

Pricing fairness is perception-based

Fair and competitive pricing is the goal in price management.

• Fair as perceived by the customer
• Providing fair profitability for the wholesaler
• Fair and sellable as perceived by your team. With fair pricing you are sending your team into battle armed with pricing that will not embarrass them and not get them shot out of the saddle.

Being perceived as high-priced is never a good

reputation with your trade customers

Many contractors will simply not allow a “high-price” wholesaler to become their primary supplier. They just cannot emotionally allow a wholesaler to take advantage of them day-in and day-out. If high-priced is your reputation, you need to begin working on changing that reputation immediately through pricing actions and through price perception promotional activities. If you provide superior service and support you must get your customers to value and ultimately pay for that level of service and support. I recommend you try to get your sales team and customers to understand that you are the highest value wholesaler in your market as opposed to the highest priced.

Optimize the price on every product you sell

The optimal price for a product is the highest price that a customer will pay while feeling that the price is fair and competitive.

Most customers use a few “Benchmark” items to

determine and test the price competitiveness of their local wholesalers

For years, a 1/2” copper 90 has been a benchmark item. Trade plumbers have tracked their price for that fitting, often to the penny. Upon hearing your current price for that fitting, they have been able to determine whether your current fittings pricing is fair and competitive. If you are competitive on that fitting -- and maybe a couple others -- you are in the running to be the primary supplier for copper fittings, and maybe pvc and malleable fittings too. Your good or bad pricing perception created by benchmark products splashes onto other products in the line, onto other lines and onto the company as a whole. It is critical that you understand where the market price is on your benchmark products and provide fair pricing to your customers.

There are very few benchmark products

Retail studies have determined that buyers can remember the precise price for a very small number of items. (In the range of 5 to 10 skus.)  While the list of skus may vary from customer to customer, in our experience, a full-line wholesaler normally has a total of 100 or less benchmark items.

Price sensitivity is loosely-coupled to velocity, hits and sales in dollars or units

When a customer buys a lot of a product, it may increase his sensitivity to the price. Over the years, however, we have found numerous examples of fast-moving products with moderate to surprisingly low price sensitivity. Each of these discoveries was a profit opportunity for the wholesaler. Taking time to identify and capitalize on these opportunities means additional gross margins for the wholesaler.

Benchmark items do not travel in herds

We have never encountered large homogenous groupings of benchmark items. In other words, copper fittings are not all benchmark items. Even copper elbows are not all benchmark items. In many markets, only one copper elbow is a benchmark item. So your process might be to ask your team, “Where are we getting pricing pressure?” If they respond, “Copper fittings,” your response is, “It can’t be all of them, which ones?” If the response is, “Elbows,”  your response is, “It can’t be all elbows, which elbow?”

Benchmark items normally have a specific dollar and cents price

As you work to determine and understand the benchmark products for your market, you will find that contractors know their day-in/day-out price for their personal list of benchmark items with a great level of precision. By precision I mean they may know their price within 1 percentage point or less of the total price. When a salesperson tells you that Widget X is a benchmark product, ask what the price is. If it is a true benchmark product, he is often being hounded by his customers to hit a specific price point. If he doesn’t know the price of the product, that product is probably not a benchmark item or he is not paying attention.

Non-benchmark products’ fair pricing is often a range that can span many points of gross margin

The optimal price is at the high end of that range but always remains within the customer’s perceived range of fair pricing.  If a customer will pay $9 to $10 for a specific product and feel that he has been fairly treated, your optimal price might be set at $9.95 versus $9.00. If that product costs $5, the $.95 in additional gross margin yields an increase of 5 gross margin points! 

Extremely price-insensitive products’ fair pricing range may span 30, 40, 50 or more points of gross margin

Again the goal is to understand the range and then to position your pricing toward the top of that range.

Some customers have hot-button prices for products

When a customer’s fair price for a product is a single dollar and cents number, it is often difficult -- sometimes impossible -- to sell that customer at a price that differs from his single price. Typically each customer has a handful of products that he remembers with this level of precision. In many cases, your properly priced benchmark items will address their “hot-buttons.”

When a customer has “hot-buttons” that are not on your benchmark list, addressing these “hot-buttons” individually can create a positive price impression with that customer without dumping entire lines or groups thus preserving more of your profits.  In other words, “hot-buttons” can establish the pricing on the single sku but you should never allow a “hot-button” to drive the discount on a line or group of products.

Your Optimal price can also be used to drive your unit volumes

When your pricing is high on a product, you may not be the primary supplier. Thus you only sell that product when other wholesalers are out of stock or when the job site is right across the street from your branch and the closest competing branch is 10 miles away. 

Several years ago a client boasted that he made more than 35% on all his copper fittings. At the time most wholesalers were selling copper fittings in the mid-20s, so we were skeptical. As we dug into the situation, we found that he was correct -- but we also found that he sold very few fittings at those prices because his pricing was not considered to be fair in his market. So his margin percentages were great on a very small number of sales thus producing a small number of gm dollars. We recommended several pricing adjustments with the backup documentation. As he adjusted his prices into the market, his copper fittings unit volumes went up, his gm percentages went down but, most important, his gm dollars went up as some customers started to use him as their primary supplier for copper fittings.

Price is not related to cost

Pricing is related to what the customer is willing to pay not what you have to pay your supplier. Sales managers and sales people who set their pricing by looking at the costs in the computer are looking in the wrong direction.

One of the critical roles for sales is to assess and understand their market. Too many salespeople use the same over-simplistic (maybe lazy) approach as the contractor, they hear about 1 or 2 low-ball prices in the market and assume they must drop all their pricing to that level. They head to the computer and set the pricing on an entire line so their pricing matches the low-ball price they encountered.

A dedicated pricing manager can help prevent this sort of margin-dumping reaction to competitive situations.

Stay tuned next month for more thoughts on pricing. Your assignment this month is to start building a list of benchmark items in your market and to begin the process of identifying who will be your pricing manager. Remember, pricing management is a strategic activity not a clerical activity. If your pricing management has devolved into updating the costs in the computer, you need to evolve the position into one that can help your company make more money. 

If you are interested in reprints discussing pricing managers, identifying benchmark products or for information about our price analysis and price management software tools, e-mail me at Rich@go-spi.com.

PS: If you are attending ASA/Network ‘07, come to see us at our Schmitt ProfiTools booth #219 or at The Wholesaler/TMB Publishing booth #512. 

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.