Allow me to lay out an argument for taking all but a few pricing issues away from outside sales and putting it squarely where it belongs: in the hands of management.
1. It’s impossible for a salesperson to know the market price on everything you sell.
Most distributors sell tens of thousands of products to a thousand customers. Unless all your sellers are named Albert (as in genius Albert Einstein, Albert Switzer or Albert King), the chance they actually know the right price for everything you sell is zero, zippo, nada. Why do I say this? First, research indicates sellers generally can remember the pricing of about 10 of your top 50 items sold and most of the time their prices fluctuate by 10% from the true price. Second, most remember the lowest price of the item because large customers attract more attention.
2. Salespeople are closest to the customer and know the commercial situation.
Again, salespeople can’t be trusted to know the “normal” price of products beyond the top 10 or so sold in their territories. They can be counted on, however, to negotiate pricing on large orders, especially when they are receiving feedback from the customer, though that feedback needs to be solidly based on some real situation. Further, salespeople are bombarded with misinformation on pricing. Telling a salesperson their price was high is an easy let-down for the customer. It takes guts to straight up tell the seller, “We think your service is a little sketchy on this new technology so we gave the order to your competitor.” Most customers choose to be polite and say it was a pricing issue.
3. Cost-up pricing is a sketchy concept.
When I ask salespeople to give me competitive pricing information on an account, I often hear stories about how they are “called on by a lot of people so I give them cost plus 18% pricing.” At first glance, the statement makes sense. Lots of competitors, so the sales guy takes just a bit off the normal gross margin level. However, once we think further, the concept breaks down. Here are a couple of things to consider:
• What makes us think the competitor has the same cost? In an age of tiered distribution and special stock prices, there is a very good chance the competitor doesn’t have the same price level on everything sold.
• If a distributor has exclusive or nearly exclusive product lines, how could the competitor have the same price? Even if our first assumption is incorrect, the exclusive products need to be priced differently.
• Do stock and instant availability make a difference to the customer? If the other guy gets his product from a location two days away and the customer needs quick delivery, does the cost-up strategy really work?
4. The real margin gains come from the “long tail” of products.
This is an extension of the “bread, milk and Busch Light” pricing practiced by C-stores. They have learned their customers have extreme price sensitivity to a small subset of the products they purchase. Simply stated, customers know what the price should be for these three basic “food groups,” yet don’t necessarily know how much a small jar of mustard costs (and they charge accordingly).
For distributors, it’s a bit more complicated. Instead of just a few items, the customer may, with the help of their computer, understand the approximate cost of 50-100 items. However, for most there exists a long stream of other items they seldom purchase. Allow me an example from the electrical world. A distributor may have an OEM who purchases $100,000 in automation equipment but rarely purchases products for the export market. While they are experts with their normal and domestically centered product purchases, each export machine is a one-off, which requires a great deal of distributor involvement. In these cases, they also expect to pay more.
Distributor salespeople mostly overlook this opportunity to make added margins. Instead, they use cost-up pricing with exactly the same margin as the often-purchased products.
5. When Matrix pricing is used, salespeople incorrectly categorize their customers.
For those unfamiliar with the term, Matrix Pricing operates under a couple of time tested premises:
1. Customers who purchase large volumes leverage their purchases for larger discounts.
2. Due to the nature of their business, some customer types receive larger discounts.
Typical distributors break customers down using a system that looks something like the one in the chart.
Applying the criteria above, it makes sense to offer each of these customer types a different discount. Since size also makes a difference, the different sizes within each customer type also demand additional discounting based on the buying power of the customer. The premises are solid and provide a strong starting point for distributor pricing. But, implementation and practice are problems.
Closer examination of most distributor Matrix Pricing files shows a steady migration of customers to a size group larger than their sales justify. For instance, it’s common to see every “end user” with an active account classified as large. This translates into lost margin.
6. Management needs to control the Matrix.
Standard practice in our industry appears to be allowing salespeople to pick the size column for their customers. The ever-optimistic sales types see every customer on the verge of a major breakthrough. A few sellers feel it’s not fair to not share the better prices provided to larger customers with loyal customers who happen to be tiny. Others see migration of customers to the next larger category as a sales strategy; lower prices mean easier selling. It also means lower gross margin for the distributor.
The major argument on large versus small customers is tied to potential. A customer doing almost no business with the distributor could have massive potential. Salespeople argue that without the proper price levels they will never have the opportunity to make a sale. There is some validity to the argument. However, this judgement call should be weighed carefully by management. Let’s look at an example.
Early in my career, we had a nearly exclusive product line. Our company was the only local source for the product. A contractor with massive potential purchased only this product from our organization with their purchases consisting of mostly repair parts. After repeated tries, we could not break into the customer, but the flow of orders for these few items continued. While going through the argument, the sales team lobbied for “large contractor” status for the customer. They were, after all, a large company who happened to be a contractor. However, to our business, they were a small contractor. We adjusted them accordingly and the business continued to flow. The only difference was a 10% boost to our gross margin.
7. Salespeople hate to negotiate price increases.
Our industry overflows with special pricing agreements (SPAs). Periodically, the manufacturer pushes out a price increase, typically giving the distributor a 30-day notification. This notification is designed to give the distributor team a window to alert and notify the customer of the impending increase.
For some reason, distributor sellers hesitate in taking the price increase to their customers. Extending further, I would say many argue for absorbing the price increase until they feel more comfortable about the customer response. Reciting recent issues, they push the customer price increase under the carpet for an indefinite time. We have seen price increases put on hold for two or three years with several price increases absorbed to the point the customer’s business is no longer profitable.
8. Management must closely monitor and control SPA agreements.
Not only should management monitor these agreements, there needs to be a plan for instituting (and enforcing) the necessary price increases. I know of a couple of distributors who “suspend” commissions until price levels are reset at the customer end. Strangely, they don’t have a great many laggards in the communicating price increases to customer department.
I don’t mean to be mean, rude or preachy, but this stuff is important.
Distribution is a low-percentage industry. In some lines of trade, distributors operate at 2%. The typical electrical wholesaler is 3.3%, and the median automation distributor is just a shade under 3.2%. The industry is under constant margin pressure and doesn’t have much extra margin to give away needlessly. The small gains in margin made by following these steps could be the boost that keeps us all in business.
Frank Hurtte is founder of River Heights Consulting, Davenport, IA, a firm specializing in “knowledge based distribution.” He has 28 years of distribution industry experience and a lifetime in sales. During his career, Frank has gone through nearly every aspect of the wholesale business. You may have met Frank in one of his previous lives — he worked in sales management for Allen-Bradley and at several senior executive posts with Van Meter Industrial. He is the author of The Distributor’s Fee Based Services Manifesto and the newly released Plan on Breaking Through: Customer-based Strategic Planning for Sellers. You can contact him at [email protected] or 563-514-1104.