Take the test, and score your answers to determine your pricing smarts.
- Part one of five parts For the last several years, business managers have been seriously attempting to get at the core of value.
Several wholesaler associations made understanding value a primary focus, so they explored and reviewed the determinants of value in an attempt to better understand them.
Unfortunately, many of these efforts have gone to waste. Association members drop their heads when asked about their progress defining and managing value. Their search has left them no more enlightened about the tenets of value than when they began.
With their efforts exhausted, many associations have turned to e-commerce as an educational platform. However, with many B2B dot-coms turning to toast, the technology chase may be less fruitful than the value chase.
We have reviewed the value exploratory endeavors of several associations; despite the efforts of many well-educated association employees, their direct members and academic associates, we feel most of them simply missed the boat before they ever started.
We don't put ourselves in the role of industry clairvoyants on value determination. Nonetheless, we have found that most searches for value fail for two reasons: 1) The search uses incremental thinking from "experienced" insiders instead of new, more radical approaches. 2) The value research seldom reaches the bottom line because distributor managers can't capture it with poor pricing habits.
The purpose of this five-part series is to help distributors capture value in better pricing habits. It will explore how to seize value for greater earnings by using modern pricing methods.
If interested, refer to our series, which ran April-July in Electrical Wholesaling regarding the theory of services as the next frontier of wholesaling value. The service-exploration, service-marketing, and service-pricing view of wholesaling is the radical thinking needed in redesigning the wholesale firm.
Although pricing is probably the least understood and most underestimated marketing discipline, it often gets the least managerial attention. Because of high volume transactions, numerous segments, and thin EBIT (earnings before interest, taxes) margins, pricing is one of the most powerful wholesaler functions. To determine your and your firm's ability to maximize pricing gain, take this pricing IQ test.
1. Wholesaler's cost structures are primarily: A) Variable Costs
B) Fixed Costs
C) Step Variable
D) Step Variable, leaning toward variable
E) Cost structures don't matter in pricing
The correct answer is D. If you answered C and A, you are close. If you answered E, you are in trouble for the remainder of this test. If you answered B, and many do, then digest the following. Cost definitions are relative, not absolute. There is never any 100% fixed or variable cost. However, wholesaler fixed assets, as a percent of total assets are 50% to 60% less than the corresponding balance sheet ratio of industry manufacturers. If you're not convinced, take a 15-year look at wholesaler industry operating expenses. They are 20% to 25% of sales and have not appreciably gone down, although distributors have grown. Operating expenses represent the cost to service, and services are step-variable costs. "Fixed costs" in distribution are actually an excess capacity of service provision. You can add volume and contribute to excess capacity, but eventually the service will be loaded to capacity. When service capacity is reached, you either invest in the service (the cost step turns vertical) or you let service quality fall and watch sales volume go down as customers find a better service quality/value ratio. The pricing mode, in a step-variable or variable-cost firm, is to maximize gross margin percent as much as possible.
2. Velocity pricing is: A) Pricing based on the sales velocity of an entire product line
B) Pricing based on the sales velocity of an SKU
C) Pricing as fast as possible
D) None of the above
The correct answer is B. Velocity pricing is pricing based on the rate or sales velocity of individual SKUs. The original idea was to rank items by their usage and those with the largest sales got the lowest margin. The thought behind the logic is that customers notice prices of the fast-moving items but are blind to the prices of slower items. Many wholesalers use this logic in their pricing but may not know the terminology.
3. Velocity pricing: A) Works because it replicates demand patterns
B) Doesn't really work because it segments by product
C) Works if all customers are the same
D) A and B
E) B and C
The correct answer is E. Velocity pricing is good for accountants and operations people who really don't know marketing. A fundamental part of marketing is that you cannot segment by product, and velocity pricing uses a product definition before a market-driven definition. Customers don't use the same products at the same rates and product (velocity) pricing assumes this is true. The idea is to segment accounts by application, type of business, etc., before you attempt velocity-based pricing. Of course, if all customers are the same, then segmentation is not needed and velocity pricing would work; hence, C is a correct statement.
4. Sellers are: A) Qualified to price because they know the market
B) Unqualified to price because they don't measure the market with statistical validity
C) Qualified to price because they know cost
D) Unqualified to price because they don't know marketing analysis of pricing effects
E) Qualified to price because they've always done it
F) A, B, and C
G) B and D
The correct answer is B. We could write a book about this. (Actually, we have. The book debuts in 2001.) When a seller says they "know" the market, your pricing is in trouble. They probably "know" how to match a competitor's price, and they "know" the market of a handful of fast-moving commodities. Most distributor pricing, however, needs to have a good segment logic, valid statistical comparisons of like customers and careful analysis before pricing is maximized. If you have 30,000 SKUs, for how many can the average seller "know the market"? If you're not using your customer data history for pricing insight, then you are not using available information to really "know" the market.
5. Outside salesperson compensation systems: A) Encourage maximizing pricing gain if they are top-line driven
B) Encourage maximizing pricing gain if they are gross margin dollar (GM$) driven
C) Encourage maximizing pricing gain if they are gross margin percent (GM%) driven
D) Encourage maximizing pricing gain if they are gross margin and GM% driven
E) Encourage maximizing pricing gain if they are activity margin driven
F) D and E
The correct answer is F. If you answered A, sell the business before sellers "sell" it out from under you. B and C get top votes, but a single number is not a "balanced" control system. If you reward on GM%, sellers will turn down valid business. If you reward on GM$, sellers will cut price to reach the yearly bogey. If you balance GM% and GM$, the measures offset each other and strike a reasonable midpoint between sales, margins and profitability. If you have activity costing, then we recommend compensating on activity profits. Many sales managers reward on GM$ for sales performance and don't truly understand the cost of individual customers on operating expenses. Activity costing allocates operating expenses to customers, and maximizing activity margins maximizes EBIT.
6. Cost-plus pricing is: A) Good for fast-moving commodities
B) Good for all products as long as price is above cost
C) Bad for all except fast-moving commodities
D) Lacks variety because of cost-plus trial-and-error methods
E) Recognizes that customers care about industry costs
F) E, B, and C
G) A, C, and D
The correct answer is G. Cost-plus pricing is good for fast-moving commodities because it recognizes their price sensitivity and minimizes list-price changes. Cost-plus pricing is bad for just about anything else primarily because it lacks variety/flexibility due to the "two finger" pricing rule: one finger for 25% and one finger for 20%. If you cost-plus price most of your items, you make a base assumption that customers care about your costs. Customers actually care about your service value (they can get conduit, cable ties and switch plates anywhere) and product cost is only a part of the pricing equation.
7. Pricing is powerful because: A) A pricing dollar, without a cost of goods increase, is worth 30 to 40 top-line dollars
B) Price captures value created by the services we perform
C) Price positions the value of our services in relation to their quality
D) A, B, and C because our sellers told us so, and they are qualified to do it
E) A, B, and C because our sellers didn't tell us so, but still claim they can do it
The correct answer is E. We haven't yet found a seller who has said that they can get a 30-to-1 or 40-to-1 leverage on a $1 price increase versus increasing the sales of another widget. We also haven't found many sellers who realize price reflects service value, and price determines the perception of service quality. These are also valid reasons to further doubt the ability of the average seller to maximize pricing gain.
8. The system architecture for a matrix pricing system is: A) Accounts to geography
B) Accounts by size and geography
C) Accounts by segment, size and geography
D) Accounts by segment, geography, size, product group and SKU
E) None of the above
The correct answer is D. To have a functional, market- driven pricing system, you must map the data sets or its architecture. The best model we have found, once product costs and margins are archived, starts with accounts by segments, by geography, by size, by product group and then by SKU. We won't go into the architecture here, but we devote a substantial portion of our book on organizing and maintaining a pricing management system.
9. The best way to launch a price increase is to: A) Let the manufacturer do it
B) Apply a flat % across the board
C) Do it in small increments
D) Do it in small increments, by account, segment, size and geography, using sampling theory
E) Ask inside or outside sellers to do it
The correct answer is D. Pricing is most effective when using a properly designed system (see the previous answer). In addition, pricing research has shown that small incremental increases are less noticed by customers. And, we have used sampling theory to approximate the probability of getting a price increase to stick while minimizing risk. Of course, we couldn't resist asking E. If your answer to E is hardly ever, then you should think again about letting your sellers control price.
10. List and discount pricing is: A) Inferior to cost-plus pricing
B) Superior to cost-plus pricing because lists can stay the same, but discounts vary
C) Superior to cost-plus pricing because customers like discounts better than net prices
D) Superior to cost-plus pricing because inside sellers maximize margin on list and discount mechanisms
E) Inferior to cost-plus pricing because the low-cost producer always wins
F) B, C, and D
The correct answer is F. List and discount matrix pricing is still the best mechanism for the majority of pricing situations. Varying discounts, rather than lists, minimizes pricing file upkeep. Discounts off of list have a psychological effect on customers that "rewards" them for increased purchases. And, finally, list and discount pricing gives inside sellers a mechanism for consistent pricing and maximizing of margin. If you answered E, then look at question No. 1. Distribution is largely a variable-cost business, and the "low cost producer" is a rarity since volume doesn't leverage fixed costs.
11. Inside sellers are known to: A) Increase margins over time
B) Decrease margins over time because they grow sloppy
C) Decrease margins over time because the fear of losing the order is greater than the risk of getting a better margin
D) Be very keen in their ability to price
The correct answer is C. As inside sellers develop account relationships, they fall prey to a behavioral phenomenon called Prospect Theory. The gist of Prospect Theory is that the fear of losing outweighs the thrill of winning. For inside sellers, the fear of losing an order to a customer with whom they have a working relationship outweighs the risk of getting extra margin. Generally, the fear of loss causes inside sellers to minimize margin to win the order and not suffer embarrassment. Many ways exist to combat this behavior, and we will cover them further in this series.
12. Pricing services: A) Can't be done because our sellers have never tried it
B) Can't be done because our competition hasn't tried it
C) Can be done, but only on higher value-added services
D) Needs to be done to avoid confusing services with commodity products
E) None of the above
F) C and D
The correct answer is F. Pricing services is generally done on Augmented and Potential services. Also, pricing services reminds the customer that they are purchasing your unique service value - not that of your commodity products.
13. A Corporate pricing manager: A) Is not possible because prices fluctuate too much
B) Is not a reality because there isn't enough for them to do
C) Is not a good use of operating expenses because they can't cover their salary expense
D) Is not done because wholesalers don't fully understand the complexity of pricing
The correct answer is D. Few wholesalers have pricing managers, but it's a viable and needed position. Our assumption is that wholesalers don't have a pricing manager because they don't know the complexity and power of the function and because they assume their sellers can price just fine.
14. Special-order items: A) Get a lower margin than stock items because they aren't stored long in inventory
B) Get a higher margin than stock items because warranty and return risk plus processing expense outweigh storage costs
C) Are price sensitive because customers ask for a quote on them
D) Aren't price sensitive since it isn't in the pricing system, and your customer wants the price so he can price the item to his customer
E) A and C
F) B and D
The correct answer is F. Nonstock items' cost of processing and warranty risk far outweighs any savings on storage cost. Also, many inside sellers assume that customers asking for a price on these items signals that it is being competitively bid. In reality, since the item is nonstock and not in the catalog, the customer merely wants a price so he can price it to the end user.
15. Small accounts are: A) Less price sensitive than large accounts
B) Difficult to raise price on to get positive activity margins
C) More price sensitive than large accounts
D) The most profitable accounts given their low cost to service
E) C and D
F) A and B
The correct answer is F. Small accounts, because of low purchase volume, are less price sensitive. Also, because of low volume, their activity margins are highly negative and you can almost never raise price enough to make activity margins positive. The key with small accounts is damage control. In other words, raise price as far as possible and eliminate service offerings they don't want or need. The result is an account that is less unprofitable.
16. Pricing gets: A) The same amount of managerial time as selling the product
B) The same amount of managerial time as sales promotions
C) Less time than any other part of the marketing mix
D) More time than selling, sales promotion, product or service management
The correct answer is C. Pricing inevitably gets less time than other functional areas. Managers spend their time creating value (or thinking they are creating it) and very little time in capturing their value through strategic pricing.
0 to 4 Correct Answers - You are in good company. There are more wholesalers here than you realize. Of course, this means that you can compete and still make money with not-so-good pricing habits. On the bright side, there are many improvements you can make, and we encourage you to do so.
5 to 8 Correct Answers - A reasonable score depending on where your incorrect answers were. You still have much to learn about the pricing discipline, but you have engendered some good knowledge or practices.
9 to 12 Correct Answers - You are probably in the top group of respondents. You have some very good practices or at the very least know what has to be done. There is still value to the questionnaire, and we encourage you to follow up on areas you are weak in.
13 to 16 Correct Answers - Congratulations! You are in the far-right tail of the distribution of respondents. Check areas that you may be weak in, but our guess is that you are the tops in pricing management - or an extremely good guesser.