Since the January launch of its pricing initiative, Grainger has seen significant declines in profitability. While this margin trend is expected to reverse in 2019, its existence may signal that the pricing process Grainger is pursuing is less than optimal. This article, part 2 in a series, analyzes the challenges Grainger faces in implementing its pricing approach and provides additional lessons for other distributors looking to improve their pricing strategies.
Part 1 of this series analyzed the results of Grainger’s initiative thus far and how the
company has managed some of the risks that this strategy has presented.
The phased implementation of Grainger’s web pricing strategy initially focused on price cuts on about 400,000, mostly slower-moving, SKUs where list prices seemed most misaligned. For many of these products, the demand curve in the non-contracted segment is likely made up by a wide variety of customers across different markets. These customers may vary a great deal in how they use the product, what services they value, what competitive options they have and so forth. This means wide variety in the underlying demand dynamics.
We know at least two things to be true:
- In many cases, demand prior to the pricing initiative was high enough for customers to justify paying high list prices. If Grainger had not seen significant sales at or around list price, dropping these list prices would have been largely a non-event and doing so would not materially impact their margin rate. Their margin rate has been taking a hit, however. According to analyst conference presentations in June, Grainger projects a 210-basis point gross profit decline in the overall U.S. segment in 2017, mostly from overall (and mainly self-driven) price deflation of 4 percent to 5 percent. This gross profit decline guidance is at an aggregated level that rolls up both midsized and large accounts. Some would call this a massive financial hit.
- In other cases, Grainger’s value proposition was not strong enough to justify the high list price. Management admitted that inflated prices posed a barrier to volume growth in the non-contracted segment of their business, and that large contracted customers also tried to avoid paying these often inflated prices.
Even with limited understanding of the relevant markets that Grainger’s strategies impact, there is very good reason to suspect that demand in the non-contracted business segment may, in many cases, be all over the place, particularly when it comes to the most impacted subset of slower-moving SKUs. These willingness-to-pay distributions have very high standard deviations and have shapes that bear very little resemblance to typical bell curves.
Grainger’s strategy fails to adequately address this variation in demand patterns. The segmentation in the non-contracted part of the business remains somewhat myopic in that it seems to focus almost entirely on product attributes. Although we have not analyzed in detail or reverse-engineered Grainger’s web-price structure, based on publicly available information, the web pricing strategy seems to largely perpetuate the practice of using a single price per SKU across most non-contracted customers/selling situations (similar to the previous practice of having a single list price per SKU).
Important customer dimensions and attributes may not get sufficient consideration in Grainger’s segmentation/price management practices when it comes to managing non-contracted web prices. When this happens, willingness to pay will vary widely within most price segments.
In practice, this will likely continue to be a major problem. Such suboptimal, overly simplistic price structures make it impossible to set truly optimal price points in the context of specific transactions in specific markets. The problem (as is frequently the case in pricing) comes down to the ability of the business to effectively manage volume versus margin.
On the one hand, Grainger is unnecessarily missing out on margin-rate opportunities in many selling situations, where customers were historically willing to pay higher (i.e., closer to list) prices and would presumably be willing to pay higher price premiums going forward. These unnecessary drops may be widespread, as evidenced by the dropping margin rates Grainger has reported. With a more sophisticated, less product-myopic segmentation scheme to manage non-contracted prices, the distributor could hold onto much of this price premium/margin – both in the short and in the long runs.
On the other hand, lowering prices puts Grainger in a better position to pick up more share and volume in the non-contracted segment of their business. However, this volume pickup has limited potential in the short run, and therefore, it is not enough to pay for the margin-basis-point drops in the short run. Given the myriad selling situations and customer types involved, quite frequently even the new lower web prices will prove to be too high.
In the product-myopic web price structure, it remains impossible for Grainger to come anywhere close to realizing its full volume potential from non-contracted business. With a more sophisticated, less product-myopic segmentation scheme, Grainger could be more targeted in varying the magnitude of the price drops (including even more aggressive discounting in some situations) in ways that could help capture more of the profitably attainable volume in the non-contracted business segment in both in the short and long run.
Are Grainger’s web prices more optimal?
Grainger’s new web prices may be optimal in more situations than its old list prices were in the non-contracted business segment. We are not quite convinced, given the degree of short term margin degradation, the inherent bias of hearing only about prices being too high (customers and salespeople never complain about them being too low or just right) and the fact that a variety of non-price factors likely also contributed to Grainger’s share/volume growth
challenges with midsize customers (some of these are being addressed concurrently by Grainger’s management).
Even if we assume that Grainger’s new web prices for non-contracted business are more frequently optimal, this change does not necessarily drive great improvement. Just like Grainger’s old list prices, the new web prices are still also likely to be suboptimal in most situations where they apply, because Grainger’s web-pricing scheme seems overly simplistic to effectively deal with the high variability of prevailing demand patterns in the non-contracted business segment. Price optimality in the non-contracted business segment may still well be a rarity – just a shade less rare, perhaps. Because of this, much of the benefit typically associated with price optimization projects may not be realized.
Grainger’s new web pricing strategy also may not do an adequate job of mitigating price transparency issues. Competition is likely to find ways to monitor Grainger’s web prices, despite recently added controls to reduce how widely available pricing information is on Grainger’s website. The continued high price transparency will still allow competitors to undercut Grainger on an account-by-account basis in specific selling situations. Although large-scale price wars may not erupt, these competitive dynamics will persist and further limit the potential for volume pickups to pay for reduced margin rates.
Did Grainger miss the boat?
It’s quite possible that Grainger considered several alternatives before settling on the fix that appeared most feasible in the short run. So why did it choose a solution with such an overly simplistic price structure?
It is common practice to operate list prices that are disconnected from the market range; many businesses do this, some quite successfully. It is also possible for prices shown on websites to reflect some type of a discount off list, even if existing customer contracts do not require those discounts. Surely, Grainger realizes that the demand patterns in the non-contracted segment of their business have a lot of variability. And surely, they understand that segmentation is a critical step in any price optimization project. This step cannot be skipped or cut short to the point of ignoring important factors driving demand patterns.
We suspect, however, that deciphering these demand patterns to develop an appropriate segmentation scheme (one that creates segments with more meaningful bell curves) may pose a formidable challenge, especially for a business of Grainger’s size and complexity. It would require relevant datasets, particularly on customer profiles, attributes and purchasing situations. It may also require updates to execution tools (e.g., reporting systems, data structures, ERPs, etc.).
In the absence of such a more refined segmentation scheme to guide discounting for the non-contracted part of their business, Grainger opted for simplification. Relative to a true price optimization strategy, Grainger’s current web pricing scheme may still leave a lot of money on the table – both in terms of volume/share and margin potential in the non-contracted segment of their business. In fact, the rationale behind Grainger’s current web pricing strategy may not be one of price optimization, but rather to make pricing a less frequent barrier to growth in the midsize segment, allowing non-price marketing efforts a chance to get traction.
Grainger’s web price structure may start to evolve over time, reflecting increasingly sophisticated segmentation. The company has a solid backbone when it comes to pricing analytics and technologies. It also has strong tools to perform the types of segmentation analyses needed to take its web prices to the next level. Even with just 2 percent of the highly fragmented U.S. midsize market, Grainger can likely generate more robust datasets on this segment of its business than most other players who actively serve this space.
As Grainger continues to focus on driving profitable growth in the midsize segment, the logical next step may be to take on these more in-depth pricing challenges. Until then, we are inclined to agree with the crowd’s wisdom: We remain skeptical that Grainger’s efforts to fix prices in the non-contracted segment of its business will yield benefits great enough to be in line with the aggressive targets management hopes to achieve.
Lee Nyari is managing partner of The Innovative Pricing Group, a consultancy offering strategic price management solutions for distributors. Lee is a seasoned distribution pricing executive with almost 20 years of experience leading strategic pricing projects. His deep distribution industry pricing background is coupled with engagement leadership roles at top-tier strategy consulting firms. Lee is a certified pricing professional, a certified public accountant, and he holds a full-time MBA in marketing strategy from Kellogg School of Management.