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Better Margin Management
Improve net profit through margin management
This case study shows how a small distributor shifted its strategy to focus on growing margins through enhanced pricing management across its three core areas of pricing: Pricing matrix for stock items, Spot buy business (non-stock), and Bid and contract business. This is one of several case studies from the book, Price for Success, A Practical Guide for Improving Margins in Wholesale Distribution, a resource guide on pricing for distributors interested in driving higher margins.
By Anthony Pericle, Advanous
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Company
Acme Supply Company (company name changed)
is a small, regionally based distributor of industrial, construction, safety and
janitorial supplies. With revenues under $15 million, Acme serves its clients
with a direct sales team of five outside sales representatives and
four-and-a-half internal representatives.
Overview
Acme’s guiding strategy for profitability
and long-term success had been to focus its time and resources on driving
top-line revenues through its direct salesforce. Acme’s president was involved
in the company’s sales and pricing activities and managed the company’s pricing
matrix. However, Acme sales representatives had authority to deviate from the
company’s flexible pricing matrix to win business, and the president realized
that growing revenues to drive improved profitability was "extremely
tough."
He decided to attend a presentation given by a profit planning consulting group. What he quickly learned was that a focus on growing margins could have a far greater and more immediate impact on the company’s bottom line than continuing to drive sales, cost cutting and inventory-management activities.
Acme shifted its strategy to focus on growing margins through enhanced pricing management across its three core areas of pricing:
- Pricing matrix for stock items
- Spot buy business (non-stock)
- Bid and contract business
The
Solution
Acme’s
president decided to take pricing control away from the salesforce and lead the
development and enforcement of pricing strategies himself because, "I have more
to gain and lose by the success of the program than anyone
else."
He decided to use velocity as the driving factor in determining pricing across the company’s range of SKUs. As an initial step, he began examining individual SKUs to determine the frequency at which these items were sold every year. Based on the velocity of each SKU, Acme applied a rank of 1 to 13, which categorized whether items should be priced more or less competitively. The items with a higher velocity were subsequently priced more competitively with lower margins; the lower-velocity items were priced less competitively with higher margins.
Acme’s president decided to apply the 80/20 rule to his business. He researched the competition and established competitive market pricing for the 20% of items that made up 80% of the company’s business. For the remaining 80% of the items, he decided to set more aggressive pricing for higher margins. According to Acme’s president, he followed a pricing strategy similar to that used by The Home Depot in its retail stores: Price competitively on light bulbs but drive higher margins on the odd items.
Pricing
Matrix
The company
president built a new pricing matrix that presented a single price point rather
than several price options within defined matrix categories, believing that
multiple price options gave sales representatives an opportunity to migrate to
the lowest price. To help ensure success with the new pricing plan, Acme spent a
significant amount of effort educating its sales representatives that the new
pricing was competitive and market acceptable. Additionally, Acme tracked sales
representative performance to measure acceptance of the new price
plan.
Spot Buy
Business
To improve
pricing for Acme’s "spot buy" business, the president created a one-page matrix
based on revenue volumes ($0-$99, $100-$199, $200-$299, etc.) and applied a
target margin percentage within each range. Acme’s sales representatives were
given a limited ability to fluctuate on margin within certain ranges, but any
proposed deals where gross margins were less than a given minimum percent
required approval from the president. He manages this process by reviewing
margins on spot buy items on a daily basis.
Contract
Business
The
bidding side of Acme’s business remains an area of concern for the company. Bid
pricing is still largely created by taking a "gut feel" approach. Acme
management feels that its customers have the upper hand in this side of the
business and are in a strong position to "drive the prices they
want."
Results
With the pricing changes made through its
velocity-based approach, Acme was able to increase margins by 3% in the
matrix-based business.
Additionally, Acme’s margins in the stock-buy portion of the business resulted in dramatic margin gains. The company was pleasantly surprised to discover that customers were delighted that their orders for lower volume and less frequently purchased items were being fulfilled—even though Acme was placing higher margins on these less-competitive products. Acme also found the new pricing strategy helped to reinforce the perception by Acme’s own Associates that Acme could compete effectively in the marketplace.
Throughout this process, Acme’s president also learned that he now had the ability to manage margin at his desk with results that have helped improve the company’s bottom line by over 70% percent.
According to the president, many of his distribution colleagues and competitors continue to focus on improving inventory turns and operational efficiencies while missing the opportunity to dramatically improve net profit through margin management. "I’m embarrassed that it took me as long as it did to understand and embrace the idea of better margin management," he says.
© 2004 NAW/DREF. Reprinted with permission. This case study is from the book Price for Success, A Practical Guide for Improving Margins in Wholesale Distribution, published by the National Association of Wholesaler-Distributors Distribution Research and Education Foundation. Price for Success presents strategies, tactics, and case studies to help executives, sales managers, and pricing managers build a pricing foundation for improved margin management and long-term profitability. The authors take a commonsense approach to pricing by sharing methodologies and best practices that have proved successful in the marketplace. For more information on the book or to order, go to NAW Publications at http://www.nawpubs.org/.
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