There’s a lot of talk about whether or not the U.S. is looking at an economic recession in the near future and the impact a market downturn could have on distributors’ profitability in the process. But the truth is, distributors should be examining their pricing strategy no matter how well or poorly the economy is performing, says Al Bates, principal at Distribution Performance Project. “Whether it’s a good market or a bad market, you’ve got to get control of your pricing,” he says.
With 30 years of insight into distribution financial performance benchmarking, Bates will address how distributors have best managed past recessions, and what they can do now to mitigate any economic uncertainty, when he speaks at MDM’s April Pricing and Profitability conference.
MDM spoke with several industry experts slotted to speak at the April 15-17 event in Denver for insights into key issues they will address: the need to develop a centralized pricing plan, factors that influence pricing and how to gain control of them, where to find savings, and the benefits of putting in the effort to create a true pricing and profitability strategy.
Centralized Pricing Plan
Threatened by a down market, distributors will often panic and lower prices in an effort to avoid as much loss of volume as possible. But such a strategy tends to make things worse rather than better, according to Bates. Instead, he recommends focusing on creating a centralized strategy that does not give away pricing authority to the sales team. “It’s time for more centralization of pricing: We’re all going to march down the party line and not down 25 different lines,” says Bates, who will present his session, Avoid Mistakes of the Past to Stay Profitable in a Sales Downturn, on April 17.
Brad Johnson agrees that a key component of success, especially for distributors with multiple locations, is to establish a centralized category management and regional procurement team where the pricing decision-making is made by the people charged with negotiating the contracts. “Then, the people in the marketplace, whether it be regionalized or local, execute to those agreements,” says Johnson, president of consulting firm Building Products Distribution – Supply Chain Analytics. “Even if it’s not a centralized team, it has to be a centralized process so that everybody is following it and you execute against that.” Johnson will present this message during an April 15 pre-conference workshop, Strategic Purchasing that Drives Profits.
Factors That Influence Pricing
There’s nothing more powerful than, “Buy low and sell high,” says Bruce Merrifield, partner at WayPoint Analytics. The problem is, often distributors will simply raise prices by a percent or two and call it a financial management plan, he says. “They’re thinking, ‘I can keep everything I’m doing the same, but just sneak up the prices here and there and I’m going to make more money,’” he says. But this practice is a distraction from the ultimate goal of service value innovation and productivity, he warns.
The buy low, sell high mentality is really nothing more than “zero-sum thinking,” Merrifield adds. “It’s, ‘I would like to win and I would like you to lose. And I’m not going to change what I’m doing.’”
While Amazon is busy changing prices multiple times a day, other distributors are stuck in the mindset that they need to keep prices the same for an indefinite period of time, even if items aren’t selling, says Merrifield, who will present the April 16 session, New Paradigms for Pricing Efficiency & Profitability. He recalls a company that was keeping the same prices for “dust collector” products that hadn’t sold in three or four years. Merrifield proposed raising prices 10% for items that hadn’t sold in a year, 20% for two-year old items, and a 30% hike for three or more years on the shelves. At first, they balked, but he pointed out while customers may call out the high price, the distributor can just as easily explain that they could be charging even more, due to the carrying costs of keeping such a rare item in stock.
When one customer did reference their price being higher than the competitors, Merrifield found out the competitor didn’t actually have the product in stock. “I said, ‘That’s a Marx brothers joke.’ You know:
‘Hey Groucho, how much for the chicken?’
‘You gotta be crazy. Down the street, they sell it for 50 cents.’
‘Well, why don’t you buy it there?’
‘Well, they don’t have any.’
‘In that case, next time it’ll be, chickens, 20 cents!’”
Distributors make these “sacred assumptions” about pricing all the time, without any data to back them up, says Merrifield.
In his April 16 presentation, Case Study: Air Hydro Power’s Profitability Journey, Matt Ott, co-owner of Air Hydro Power in Louisville, KY, plans to highlight the total cultural change his company underwent on its pricing strategy. “It used to be very fragmented and uncontrollable and basically chaos. Now it’s a controlled environment,” says Ott.
Ott will touch on how the pricing program implemented by his company opened his eyes to price-influencing factors, such as specific product visibility per SKU. “The analogy that we always use is if you’re going to get gasoline, you see that everybody is charging $2.15. That’s very visible. But when you walk into the store and you start picking up snacks, that’s not as visible,” says Ott. “That’s when the strategic pricing kicks in.”
How to Gain Control and Find Savings
One area for distributors to consider to re-gain control of their pricing model is how to handle customers who cherry-pick products and circumvent existing pricing in the process, Merrifield says. Distributors should feel empowered to put parameters in place to handle such disruptions, including making the customer a house account with strict minimum orders at list price. They may threaten to not buy from you again, Merrifield notes, but because you have the cherry-picked product they need, they will come back for it. Instituting a strict minimum order of $300, for example, could lead to them buying $200 of “vanilla” items to get the $100 cherry they need.
“This customer turns into a $35,000 a year, 6%, 7%, 8% operating profit account, because you have the cherries,” he says. “What does that have to do with pricing? Pricing analysts, they don’t look at that at all. They’re just looking at items and saying, ‘Can I raise that price up a little here or there?’”
Johnson recommends ensuring supplier agreements address a variety of levers to reach optimal pricing, including negotiating for product marketing funds from the supplier and volume rebates. On the subject of rebates, he notes that suppliers can be sensitive to cost adjustments since invoices do sometimes get out into the public domain for competitors to see. To address this potential issue, he says distributors can create a system where they’re invoicing at one number and then receiving a monthly rebate from the supplier to offset the cost position. “For a distributor, that sort of increased profit from cost is huge, because all of that goes right to the bottom line,” says Johnson. “Especially if you have firm pricing in place in pricing to the customer.”
Line reviews can be an important part of a suppler buying agreement (SBA) as well, Johnson says. A roofer, for example, would bring in a range of roofing suppliers in separate meetings to hear their pitches on the geographies they cover, their pricing and service options, lead times, payment terms, volume rebates and more. “Balancing all of those things against each other, which supplier do I want to select? And it may not just be cost. There’re many dimensions you can select against. But it gives you a total custom ownership, a total way of looking at the entire package of what you want to buy,” he says.
Creating Sustainable Profitability
A common mistake distributors make, says Merrifield, is to ignore the size of an order relative to the cost to serve. Distributors can lose a lot of money on “small-dollar pick orders,” he says. Sustainable profit power comes from doing a customer profitability analysis to see which ones you make the most money on and why. Analyzing which type of customers like to buy specific types of products and then examining if you have the best sector sell rate and stock to meet the needs of that niche.
Reliably using profitability analytics allows distributors to start to recognize statistical patterns in their business, which clients are profitable and which ones aren’t. Merrifield calls it a five-why analysis. Why are the “super winners” super winners, and how can distributors leverage those efficient and effective buyers?
Taking the time to rank customers by sale — comparing margin dollars from two years ago to last year, for example — distributors will often find the profitability of their customer base as a whole will rise and fall with the economy. However, there are always outliers, Merrifield points out, and they may find they had three or four accounts that took off. Find out why business is going so well with those top accounts, he recommends.
Looking at the processes behind a P&L statement in a pragmatic way will not only allow distributors to better identify and replicate success, but also find areas where they may be leaking cash, says Janet Zelenka, past CFO and CIO at Essendant. “When I look at the balance sheet, the numbers sing to me,” she says.
In her April 17 presentation, A Distribution Treasure Hunt: Unlock Cash from Your Business, Zelenka will walk through the key elements of income statements and balance sheets, mapping the processes distribution companies have in place and providing pragmatic approaches to where they can uncover hidden profit potential. “They may not have been as systematic or taken a process-minded approach to solving where money may be going out the door when it doesn’t need to be,” she adds.
The Benefits of a Plan
Merrifield acknowledges examining existing pricing strategy, if there is any, is not an easy process. If all it took was a snap of the fingers, however, there would be no competitive edge for those who make the investment. Distributors can dream of magically raising their prices 3% or 4% without anyone noticing, but that’s not going to get them anywhere, he says. Instead, he recommends focusing on those top few customers, the ones who are “insanely profitable,” and taking their service to the next level. And it’s more than making sure to bring them a box of donuts on a regular basis.
In one example, Merrifield explains, a distribution CEO decided to visit the customer’s office himself. He chatted up the staff and followed his product throughout the business, talking with every single person directly or even indirectly affected by his company’s products. Ultimately, he spoke with the customer’s CEO and explained some observations he’d made to help the client grow productivity and get better use out of his products for themselves and their end customers. He ended up providing a lot of free labor and supplies for the customer totaling about $15,000 in sweat and materials — but, by suggesting new products and an upgraded replenishment system, he doubled the volume on his No. 1 account in the process, Merrifield says.
“That approach dwarfs — I mean dwarfs — sneaking up the prices 10 cents on an item that doesn’t sell,” he says.
So many distributors are focused on the selling process, that they don’t take the time to look into pricing strategy, says Johnson. But establishing a category management function will “clearly pay for itself” for those that do, he says.
This was the case for Ott, who, by ending his one-size-fits-all approach to pricing, saw a drastic improvement in bottom-line profit. “It raised our margin percentage by four full points,” he says. “It was absolutely worth the investment.”
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