Strange Inheritances

By Frank Hurtte

Late last night I found myself channel surfing in my hotel room. Between infomercials, old Walton's reruns and the cooking channel, I stumbled onto a new program called "Strange Inheritance". The premise of the show is something like this: Great Uncle Ralph dies and leaves his favorite niece a roadside Alligator Farm in rural Florida. The recipient of this wondrous bit of good fortune suddenly finds themselves a predicament. Pardon the pun but it's the old "knee deep in alligator thing" except the person struggling didn't create the mess. Instead they inherited it.

Distributors often find themselves in similar situations. Examples are many. The last guy hired some duffus to work in the south territory and now you are left with a mess. The computer is load with 20 years of bad data and sales metrics won't work until all the garbage is scrubbed and corrected. Or, territories laid out inefficiently with salespeople crisscrossing the state in a haphazard manner racking up massive sales expenses.

Experience with dozens of distributors indicates, the most common strange inheritance comes in the form of poorly managed pricing process. Unlike the story of weird Uncle Ralph, this mess is often created by none other than our own previous decisions. The result is poor gross margin performance, sluggish bottom lines and, worse yet, customer issues. Let's work through this short list in reverse order.

How can poor pricing process impact customers?

Nobody complains about your prices being too low, correct? Maybe. However, they will question your integrity when they get different prices from your company depending on who they call. And, when quantity breaks are poorly administered, they will wonder what the real price should be.

Further, if you hold prices for a very long time, absorbing price increases from suppliers over a several years, eventually price levels will need to be adjusted. Typically, this results in extraordinary emergency price increases; the kind that come after you realize you have been losing money for the past year. Distributors often report seven or eight percent increases became necessary just to stay in a break even mode. This practice nearly always puts your whole book of business at risk at the customer.

Price process impacts profitability and gross margin

Everyone understands the connection between gross margin and profitability from a macro level: more margin equals great profits. What they fail to understand is the relationship in an industry with very thin bottom line returns. For the typical distributor (regardless of line of trade), the bottom line is razor thin; hovering in the 2dž percent range. Allow me to break this down into the simplest terms. For every $100 dollars in sales the distributor gets to keep something just over a couple of bucks. When the gross margin falls by a percentage the two dollars can become something far less. Conversely increasing the gross margin by two points, not percent (moving from 25 percent to 27 percent), has a major impact on the bottom line.

Each time a salesperson decides to offer a special discount of just a couple percent, profitability is hammered. Holding the line on price increases in an attempt to avoid hard conversations with the customer equates to a direct hit to the bottom line.

You've inherited a mess, now what?

Whether you inherited the issue of poor pricing policy from others or your evil twin took control of your body and created the whole situation, you've got to fix it. Rest easy, you can fix the situation. It will take some time and a little planning but you will see steady process along the way. Join me as we review six time tested procedures to improve your pricing situation.

  1. Make good use of manufacturers' price increases.
    Periodically every manufacturer publishes price increases. In many industries the increases come near the end of the calendar year. Others come irregularly in relation to commodity price movements; things like copper, steel, oil, plastic or other raw materials. When these happen it's not unusual for the company to publish some kind of justification but rarely is an actual increase percentage noted. We like to see distributors add a little extra for the "home team". For instance a manufacturer's price increase comes in at two percent and the distributor provides the customer with a three percent price increase.

    If you want to get advanced and have the proper discipline, prices for items not purchased in the past six months might be increased by an even larger percentage. Again referring to our two percent increase from the supplier, a two percent price increase might become a four percent increase on items not purchased for six months or more. Items never before purchased should be set at the "normal market price" we'll talk about that later.

  2. Review all special pricing agreements.
    Customers, especially those with professional purchasing types, negotiate prices based on high volume purchases and future growth. Somehow the promised volumes don't happen. When this occurs, distributors should put the opportunity to good use by reopening the negotiations. Price need play a part in the negotiation. If the customer pushes to maintain the old price, this presents the perfect opportunity for a quid pro quo trade for additional purchases. The new products should be fairly priced and hopefully at an improved margin.

  3. Narrow the scope of future special pricing agreement.
    Distributors often error in setting the price for entire families of products. As a simplified example, imagine you are selling Wylie Coyote's ACME Anvil line. ACME produces anvils in sizes ranging from a few pounds all the way to the giant 5,000 pound roadrunner smasher. OEMs apply the anvils to their products, but rarely is does any OEM purchase more than a half dozen sizes.

    Typically distributors extended their best prices to the entire line up of ACME products. This point limits the opportunity to make additional revenues in those infrequent times when something outside the normal range was being purchased. Narrowing the scope of special pricing allows for margin improvement.

  4. Tie pricing to payment terms.
    It's one thing to provide low products at low gross margin when the customer pays like clockwork and something else again to offer low prices and extended terms. Most companies publish standard terms; typically 30 days net in most industries. Conversely, it has become the custom of many large companies to pay in 60, 90 and even 105 days. Review all quotations for statements of payment terms and again open up customer discussions on adders for payment outside your expected terms.

  5. Establish and enforce reasonable and real quantity pricing structure.
    Candid conversations with sellers and their customer service counterparts indicate customer facing staff often stresses over knowing exactly where to provide a quantity discount. For the customer who regularly purchases three parts at a time, an order of a half dozen may include an inquiry on quantity pricing breaks. Unless a policy is established and well documented, the decision becomes an uncomfortable judgment call.

    I recommend building quantity pricing around numbers that make sense. For example, full case quantities might be justified over broken case quantities. The same goes with bundles, bags and all kinds packaging right on up to pallet loads. Secondly, quantity pricing should contain "stretch numbers" if a customer's ongoing needs justify it, they should be able to push up to the next number. Otherwise, they pay a higher margin.

  6. Ask manufacturers for additional discounts when you provide extra customer service on their behalf.
    The practice of pushing back to supply partners for extra margin has been used, abused, bent, folded and otherwise mutilated. It's not something I typically recommend. As a matter of fact, I almost decided to not mention this point. However, there are instances when distributors find themselves providing extra services for their supply partners and these instances demand an increase in margin. Examples from the field include, incoming inspections after quality issues, excessive warranty processing, maintenance of just-in-case inventory due to factory delivery issues and a number of other services which extend far beyond the distributor's normal responsibility. Ask for additional margins in all of these cases.

An ounce of prevention is worth a pound of cure…

By now you've no doubt surmised, fixing inherited pricing issues takes more effort than just establishing a process today. Any real pricing process must contain the following: documentation, metrics and measures, and management tools. If you miss any of these three pieces, the process is doomed to failure.

Looking back at the whole inherited pricing problem, most would wonder how something like this could even happen in an age of high powered ERP systems and computerization. But it does. Most of these same folks have been schooled in matrix pricing and have heard industry experts talk about the importance of margin improvement. Yet the problem exists.

Distributor pricing is not hard. However, it is massive. Consider a distributor with 3,000 accounts and a line card containing 10,000 SKUs. This creates over 30 Million price permutations. Balancing that many data points is not humanly possible, regardless of your skills with spreadsheet. Clearly, some kind of additional resources are in order.

David Bauders and his Strategic Pricing Associates team has developed a real process for pricing. They attack the pricing problem from three directions:

  • Scientific analysis of data from your own customer history and invoices – this allows better understanding of the true market price and price sensitivity by each customer.
  • A well-documented plan implementation including training and ongoing employee education – customer facing employees learn how to avoid pitfalls and poor pricing habits. Procedures and best practices are laid out.
  • Metrics and Measures are provided for coaching and managing the process – recalling Pearson's law: "When performance is measured, performance improves. When performance is measured and reported back, the rate of improvement accelerates." Coaching and managing with real data can drive behavior.

The real proof of the process comes via the over 350 distributors who have applied the Strategic Pricing Associates process. Distributor report a typical improvement in margin of two full points. Imagine how two points could impact your bottom line. Why wait till that dark gloomy day when you find you have inherited something?