Pricing for value

March 2, 2014
Long-time wholesale distribution consultant says most companies are proficient at operations and logistics, but not pricing

To start his “Pricing for Value” presentation, Brent R Grover assumed the podium and said, “Hi, I’m Brent Grover, and I’m a recovering distributor.”

Grover, the managing partner and founder of Evergreen Consulting LLC, ran wholesale distribution businesses for many years and then returned to being a consultant.

Based on his extensive experience, wholesale distributors are not very proficient at pricing—or at least not proficient enough.

He cited General Electric CEO Jeffrey Immelt’s quote from 2006: “When it comes to the prices we pay, we study them, we map them, we work on them. But with the prices we charge, we are too sloppy.”

Grover worked with 100 distributors on pricing projects and ultimately wrote a book, Strategic Pricing for Distributors.

He said many wholesale distributors in the heavy-duty industry should take the advice in the old Wayne Gretzky adage: He didn’t go where the puck was; he went to where it was going.

“The hard part for wholesale distributors nowadays is that things in our business world have changed so fast and continue to change at a rapid pace,” he said. “It’s hard to know which puck to pursue if somebody throws nine or 10 pucks on the ice.

“So thinking about pricing is really something that has always been there to work on, but the time has come to give it serious consideration, because if you’re like most distributors today compared to five to 10 years ago, you’re much better now at running the operations end of the business. You probably have a good computer system and enough people who know how to use it. You’re probably good at the logistics end, and it’s becoming more and more difficult to be distinctive based on logistics alone because most of the people who continue to succeed are pretty good at the logistics side, and there’s not a whole lot of difference from the customer vantage point between a wholesale distributor with excellent logistics and companies that are mediocre.

“As well as most of you in the nuts and bolts of the business—and that will include receivables—we’re also good at managing the ups and downs of the business, having gone through the recession. The most important thing is managing margin.”

He used the example of the car-shopping experience.

The typical customer has spent 14 hours online before walking into a dealership. The customer not only knows the models and features, but also exactly what the car’s true market value is.

Brent Grover Evergreen Consulting LLC

“Less of the conversation today is about what you will pay for the car,” he said. “The pricing band—the difference between the lowest price typically paid and highest price paid—for the typical vehicle has shrunk from over $1500 to $190. Sellers are using iPads to compute the new car price, trade-in value, down payment, and monthly payment.”

According to a global pricing study by Simon-Kucher & Partners in 2011—which studied 500 companies from all over the world in different industries—price wars continue.

The study showed that 46% of companies think they’re in a price war, but 83% of companies blame competitors for starting it.

“So you might want to possibly consider that your sales people are either starting the war or keeping it going,” Grover said.

In terms of pricing weakness, 71% blame the competition and 36% blame the customers.

“Many blame the products,” he said. “How many times have you heard, in your own office, people say that your products are commodities, and the reason you don’t get good margins on your products is the fault of the products themselves?”

Pricing know-how

Grover said there are three fundamental causes of pricing weakness:

•  Insufficient monitoring.

“When they do, it’s after the fact. You get monthly reports, and it’s ‘All hands on deck’ and ‘We’re going to really make an effort to raise prices.’ And that might be one of the management initiatives of raising prices across the board because markets have slipped. In the old days of wholesale distribution, the owner would be in the office flipping through invoices before they went out. They’re looking at decisions sales people and customers have already made. All they can say to sales people is, ‘Don’t do that again.’ ”

•  Lack of pricing know-how.

“It starts with the sales force. Most of us are very much in the habit of giving sales people a lot of latitude. You might call it ‘empowering them.’ You give them too much wiggle room on price. You start with cost, you give them a price list that typically has unrealistically high prices. All he can do is learn from other sales people in the company—the people who trained them—that ‘This is a 20% item,’ or ‘This is a 30% item.’ That anecdotal type of pricing information is not know-how about pricing. It’s not knowledge about market pricing. It’s mostly pricing in a reactionary way.”

•  Poor strategies.

“Which is the one you focus on most? Profit, quality, or market share? Market share is really for Procter & Gamble, Ford, or General Motors, where they’re trying to get share away from competitors maybe to increase manufacturing efficiencies at the expense of competitors. But the other two apply to us. What do you try to get your sales people to go after? Volume or profit? The ultimate profit that comes back to the shareholders and company is not significantly different from a rapidly growing versus not-so-rapidly growing company.

“The most important thing is managing margins, so your people are incented to grow profit. For instance: Your sales people are on straight commission that is based on gross margin dollars generated. From their vantage point, where do they have the greatest incentive going into the marketplace? To build more sales volume with their customers to increase their income or trying to spend extra time with the customer and each transaction, trying to optimize the price with each transaction so it’s good for the shareholders of company and ultimately for them in commission?

“Think of a real estate agent. He put your house on the market for $320,000. The agent gets an offer for $300,000. The agent’s commission is about 6%, so that’s $18,000, which of course they will divide up with the agent for the buyer and split in half with the company they work for, so it’s a question of a commission check for $1500 or not. If they hold out for the listing price of $320,000, of course it’s marginally better for them to the extent of about $320. Is it worth it to them to do more open houses, more advertising, more showings, with the risk you will be dissatisfied with them and pull the listing when it expires? They’re going to pressure you to take $300,000.

“The same logic applies to people at a wholesale distribution business who are on straight commission. They’re really getting most of the focus on a straight commission plan to build volume, even though sometimes in our minds we think our interests are aligned with our sales people if they’re on straight commission and consequently they are going to do the right thing and try to get the highest price possible on each transaction. I would argue they are trying to get as many transactions as they can.”

Grover said most wholesale distributors don’t have a process in place for pricing.

“It’s ad hoc, getting back to cost-based pricing, which is mostly decided by sales people with no real marketing information in terms of what the market price is,” he said. “How would we know what the market price is for our products? If we sold toilet bowl plungers, we could go to Ace Hardware and price it out. We could go on the Internet. In our world, we really can’t do that. Even if you think you can do it on the Internet, I would say that manufacturers now have an Internet Minimum Advertised Price (IMAC). If their authorized dealers or distributors put the product on their website, they’re not allowed to advertise it for less than the IMAC price. So you can’t really go on the Internet.

“The only place to go to get market pricing information on our own products is to look at our own database in our own system. What does that system tell you? You organize your customers into segments—eight at the most. Group them by what’s important to them, when they buy, and then stratify them based on how much business they do with you, which is a proxy for their buying power. Big customers tend to get better deals than small customers because more competitors call on them, they typically have more people devoted to the buying function. There are exceptions, but larger customers tend to get a better deal than smaller customers.”

He said it should start with strategic goals: What is your pricing strategy? Are you focused on profit, not volume or share? Is a pricing process missing?

A consistent and systematic process is necessary—a detailed process for every single activity except price increases.

“The hard part of this is it’s the sales people’s job,” he said. “They’re responsible for implementing pricing. It’s a very tough job and they struggle with it more than anything else in their job. It’s tougher to quote prices for sales people than it is to find leads or make presentations to new accounts. Consider a young person with less than a year of experience. How would you find out how much to charge your customers for products? Most often you’d probably talk to other sales people and carry on with the same information your company already has.”

He said that in managing the margin, leaning too hard on the sales force can be counterproductive.

“You can’t keep whipping the sales people because it’s not their fault,” he said. “If they don’t have market pricing information and their incentive is mostly to build volume, is it their fault they aren’t able to get value from the customers? The only number you’ve given them is what you paid for the product.

“They don’t take too kindly to software and consultants. Getting them more complexity on their laptop or smartphone or tablet can be counterproductive.”

He said Simon-Kucher & Partners’ global study found that weak pricing cuts profits by 25%.

“A very small change in net income as a result of a very small change in margin percentage has a magnification effect on return and investment,” Grover said. “And the magnification effect is a very small increase in margin. Two-tenths of a point in margin would have an increase of about two percentage points on your return on investment. I like to think it’s bigger than that. A 1% increase in margin percentage would increase your return on investment by 10%.”

Fundamentals of weak pricing

He said weak pricing is caused by:

•  Fuzzy pricing structure and process. “Compared to your other processes—inventory replenishment, credit, opening new accounts, all the other things you do—the process for pricing is probably the weakest.”

•  Sales force prices autonomously. “In talking to people in your business, most agreed sales people have quite a bit of pricing autonomy. I’m thinking more of outside sales people than people at the counter, but it could be both, depending on how you operate.”

•  Too many people involved in pricing. “That’s pretty typical. You’ve got all people involved in pricing—the sales manager, purchasing department, the owner, the head financial person.”

•  Recommended sell prices not based on value. “If they’re based on cost and not on value received by the customer, then the results you’re going to get are pretty much what you have now. You’re not optimizing pricing because you’re basing too much on the cost of the product and not on value received.”

How can you get from cost-based pricing to market-based pricing? The only market-based pricing is what you have in the database already, which is what you’re charging customers for products they’re buying already.

Grover’s recommendations:

•  Measure customer operating profit and Cost to Serve (CTS).

“If you took all of your costs for a given year and divided by the number of orders—almost all warehouse orders—take the number of orders divided by the total amount of cost you incurred. If CTS is $75, you apply a $75 expense factor to each one of your customers, multiplying the numbers of orders by $75. That gives you a good starting point. That gives you a good idea of where you are and aren’t making money. The most important thing is pricing, but when you look at an unprofitable customer, one of the root causes of a lack of profitability is small order size, so take that into account. Just because there is an unprofitable customer on your books, that doesn’t mean you should immediately raise prices. And that’s the danger with the idea of an across-the-board price increase. You may be raising prices that are already at or above the market.”

•  Find and fix pricing outliers.

“You do that by doing an analysis of the customer base. Divide it into five to seven segments based on what’s important to them pricing-wise, stratify them based on how much business they do with you, and then you can start to apply some analysis. A computer can do it relatively easy. Microsoft Excel is good enough to do this. Look at what a customer buys often and not very often. You’ll have a much better idea of what’s sensitive to them.”

•  Build a value-driven matrix.

“Then your people can apply their judgment as to where your high-visibility products and low-visibility products are in your company and you can build a pricing matrix, which is based on value received, not cost.”

•  Put a manager in charge of pricing.

“Somebody has to be in charge. It does not mean it’s a full-time job for that employee. You have somebody in charge of inventory and credit. You have somebody in charge of the warehouse. It’s somewhat ironic there’s nobody at most wholesale distributors in charge of pricing.”

•  Track territory pricing versus potential.

“Many times the reason a territory is more or less profitable than another territory has a lot to do with the sales rep who is responsible for the pricing in that territory.”

•  Monitor results and take corrective action.

Grover said that a more consistent pricing scheme will account for 70% of the upside, while just 20% comes from non-margin profit plays (such as freight markup) and $10% from premiums on less visible items.

Grover said success hinges on a three-legged stool. Margin is not the only reason that customers are not profitable. Many times order size is a profound indicator of customer profitability. That’s why he urges them to do an analysis and look closely at the cost to serve elements that make one customer a higher cost to serve than another.

“Consider not paying a commission to your sales people,” he said. “Consider not paying incentive pay for money-losing orders. Consider freight as a profit center. Depending on who the customer is and how big the order is, you may be able to mark up freight or absorb freight based on objective criteria you can build into your system.

“If you’re allowing customers to use credit cards, one thing to do is not encourage sales people to encourage customer to use credit cards. Sometimes they encourage customers to use credit cards because it enables them to circumvent your own credit department and makes their job easier. It’s a ‘sales-prevention department’ in some cases, as far as they’re concerned.”

He said the heavy-duty market is not efficient.

“We do have lots of blind items in our business,” he said. “If we have a cost-based pricing scheme, we’re giving a lot of profit away. Pricing is not a black box, as some would say, where there is a secret ingredient—something I can’t tell you because I have the key, like the Wizard of Oz. It’s very transparent.” ♦

About the Author

Rick Weber | Associate Editor

Rick Weber has been an associate editor for Trailer/Body Builders since February 2000. A national award-winning sportswriter, he covered the Miami Dolphins for the Fort Myers News-Press following service with publications in California and Australia. He is a graduate of Penn State University.