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Order the new MDM Special Report: Business Planning for Distributors
First Steps in Strategic Pricing
Break through the jam in your current pricing practices
MDM Audio Conferences recently featured consultant Mike Marks and attorney Gene Zelek in “Strategic Pricing: Create a Value-Based Approach.” The two told participants they must go beyond traditional pricing practices, segment customers and not be afraid to differentiate based on price. This article is based on that audio conference.
If you are implementing a pricing structure from scratch, and want to unfreeze an organization from its old habits, plan for at least 12 months of work to “make it stick.” Keep in mind: “It’s more than just coming up with a new price sheet and imposing it,” says Mike Marks, a principal in Indian River Consulting Group.
Here are a few thoughts to get you started.
Legal Hang-ups
One of the first things people think when the topic of value-based pricing comes up is that they can’t do it because legally they must give everybody the same price. That’s simply not true, says Gene Zelek, of Freeborn and Peters LLP, Chicago, IL.
Distributors do fall under the Robinson-Patman Act if they sell in interstate commerce, just as manufacturers are, even though few cases are ever brought against distributors. However, the law does not say you must treat everybody the same, Zelek says. “It says that you only have to treat competing customers alike.”
Start there. “If I’m selling to one customer who is an OEM and I’m selling to another customer who is an electrical contractor, they don’t compete,” he explains. “I can charge them different prices.”
If they do compete and are in the same geographic area, they must be treated alike unless there is a good reason to differentiate. “I can use value to say this customer brings me more value, and that’s not necessarily volume,” he says.
In addition, under the law, you are allowed to ask about competitive practices – “It’s just looking at what the other guy is doing,” Zelek says, “and if it makes sense to me I’ll do it.”
As long as there is no formal agreement “where competitors get together in a smoke-filled room,” following competitors’ actions is OK.
Common Pricing Flaws
What are the largest price management flaws hurting profit for distributors? The first: letting field salespeople set pricing in isolation.
Second: Distributors are too slow to pass on price increases.
“They immediately go to the last price the customer paid assuming they would pay that again, when in fact it should be something different.”
Zelek says there is often a disconnect at the sales rep level, “particularly if the sales reps are compensated in terms of volume, rather than in terms of profit.”
If you implement a value-based system focused more on profit, but reward salespeople based on “how many boxes they move,” he says, “it just doesn’t work because there is no incentive for them to implement it."
To break free from this ice jam, Mark says distributors should start to measure what is actually done right now.
“What is the distribution of pricing across multiple sales reps or multiple branches?” he says.
Moving forward, segment your customers, but not on their size – rather segment based on the importance of your products and services to them.
“The foundation of any rational pricing practice is based on customer segmentation and as an example, if I am a landscape contractor and I’m buying tons of shovels, I’m going to care what that shovel costs, but if I’m an electrical contractor that has one shovel in the truck, and I only replace it when it falls off on the freeway, I couldn’t care less,” Marks says. “I just want another shovel.”
The basic principle of value-based pricing starts with what a customer is buying, not with what a distributor is selling.
“Your margin should go up to the extent that the customer is not core to your business,” he says.
“Think about the electrician that needs to buy one shovel and wherever they can get a shovel they’re going to get it. … If the product is tertiary to the customer, it means it’s very small. They just don’t care. The other thing is that the product is slow-moving. In other words, if this product doesn’t sell very often, there should be higher margins.”
The core concept in pricing: “What’s the right price?” There isn’t a magic answer, Marks says. In pricing, build a process and measure changes in elasticity (the change in volume sold relative to price).
“A lot of this is about creating a pricing policy which is subordinate to a pricing strategy, and it’s been our experience that most folks don’t have that,” Marks says.
“When they have problems with pricing they just get a sharper pencil and that’s pretty much where it stops.”
Selling Your New Scheme
“Distributors have had a lot of revenue increases thanks to the rising increase in commodity prices we’ve had but many have failed to realize the margin opportunity because they were so slow in passing these costs on,” Marks says.
“Distributors have had a lot of revenue increases thanks to the rising increase in commodity prices we’ve had but many have failed to realize the margin opportunity because they were so slow in passing these costs on,” Marks says.
While price increases should always be communicated to your customers, it’s important to do it right.
Marks used the example of a wire manufacturer that did a good job of communicated with its customers by listing copper futures on its Web site.
“It was very effective,” Marks says. “Instead of trying to hide or pretend that there were going to be increases, they were trying to inform customers so they actually understood how the process went. People don’t like to be surprised.”
If you’ve done a good job of getting the customer to pay market, then it shouldn’t be difficult to move them up a notch.
“If it turns out you have been overcharging the customer, it’s pretty easy. If you’ve been undercharging them, that’s a different issue,” Marks says.
“The easiest way to bring them back up is to say, ‘By the way, just so you know, the next time you order this there’s going to be a price increase,’ and you lay out the case.” It’s best to over-communicate.
Will customers retaliate? Sure. Some will. “Quite legitimately a customer might say, ‘We’ve been buying from you for X price. Now you’re moving it up to X-plus. We need to put it out to bid.’ … Most people are unwilling to run that risk,” Marks says.
Zelek says some distributors are below-market due to the services it bundles with the products. “The distributor is giving away a lot of good stuff for free,” he says.
An example: A chemical company was providing consulting services to municipalities but the chemicals, chlorine, fluorine and so on were bought on bid.
“They were constantly getting low-balled,” Zelek says, because their costs were high thanks to the technical service they offered.
“For those municipalities that were doing this by bid, the company unbundled the service from the product, and they were competitive. If the municipalities wanted technical service they had to pay for it a la carte.”
An electrical distributor that was doing kitting for the industrial market charged a fee for the service.
On bids, they would allow a customer paying within certain terms to deduct part of that fee.
“In other words, if I’m doing the kitting I will build that into the price after I get it, but my original bid puts me on a level playing field with everybody else,” Marks says.
Other topics covered in this 90-minute audio conference:
Fundamentals of value-based pricing
Segmentation, velocity & life cycle pricing
Account-specific pricing
Power buyers & consolidation pressures
Lawful price signaling
Rebate management
Demand creation & pay-for-performance
Private label impacts
This audio conference covers pricing from both the manufacturer and distributor perspective. For more information on how to order the CD from this audio conference, go to www.mdm.com/conferences or call 1-888-742-5060.
Michael Marks is managing partner of Indian River Consulting Group, Melbourne, FL. He is also a Fellow of the NAW Institute for Distribution Excellence. Eugene Zelek Jr. is a partner in the Marketing Law Group of the Chicago law firm Freeborn and Peters and chairs its Antitrust and Trade Regulation Practice.
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