Fundamentals of Pricing

Raymond Hill - Wednesday, August 26, 2015
This month we are sharing a quick reminder about making money on the items you sell. You have to do so many things right to get the nod from your customers and make the sale but often the “follow-through” of the selling process is to make sure that you charge enough so that it was worth your effort. Some things to consider as you price items:
  • The objective is fair pricing – Fair means the wholesaler made acceptable profits and the customer felt that he was fairly treated in the transaction. There is often a range of prices that the customer will view as fair. The optimal price for the wholesaler is to sell at the high end of that “fair” range as opposed to the low end of the range. Gouging is never the objective since that will leave a bad taste in the mouth of your customers. With that said, if the customer thinks the fair price for an item is in a range of $9-$10, then why not charge $9.95?
  • 80% of wholesalers make less money than they could – This percentage is a made-up number pulled from a bodily orifice, much like the pricing in our industry. We have no idea what the real number is, but we know from experience that many, if not most, wholesalers routinely leave money on the table. By “leave money on the table” we mean that a higher price than what was actually charged would have been considered fair and acceptable by the customer. Often fear of not getting the sale and ignorance of where the market is for an item, drive the sale to this lower-than-optimal pricing level. Both can be addressed with training and marketing effort.
  • The market price is seldom, if ever, found in your computer system – The market price is defined by, you guessed it, the market. It is not determined by your cost, your break-even point, your desired target margin, your crystal ball or the opinion of your buyers or sales team. The “market” is defined by the customer’s willingness to buy the item at a specific price. That specific price is shaped by your company’s sales and marketing efforts, your competition and your customers’ interest in pricing. The price you pay your supplier is a factor in the market price but not always the driver. If you have done a poor job of negotiating your costs, most of your customers will not be concerned about that if the market price is at a level that generates unacceptable profits for your company. If you have done a stellar job of negotiating your costs, your customers will expect to pay market prices and be unaware that your company is making outrageous profits — unless your sales person tells them (see the next point).
  • Most of the sales input you get about pricing is an opinion that is seldom connected to real numbers or data – Sales is a tough job but most sales people do not know the market price on most of the items that they sell. Most do not even take the time to ask. As the old saying goes, opinions are like ear-holes; everybody has a couple. That’s okay but that’s not how your company should determine market pricing. Many companies do not offer their sales team any alternative to “opinion” pricing since the customers’ pricing in the computer system has no connection, what so ever, to the market. The computer pricing is often the opinion of some corporate pricing person who is even more isolated from the market. So the sales person uses his/her own opinion over the pricing person’s opinion. The solution is to create thoughtful, market-based pricing in the computer system and then insist that the sales team use that system pricing.
  • The market price is in dollars, not percentages – Some of the most comical pricing conversations that we have had over the years arise out of the industry’s confusion about pricing. An item’s market price is in dollars and cents not a gross margin or, even worse, cost markup percentage. When we go to the grocery store, neither we nor the grocery store communicate the price as a percentage.
It is often based upon competitive comparisons done both by the consumer and the store.  Grocery stores spend a lot of time “shopping” their competition to gather data about their market. Pricing is not as simple in our industry but most wholesalers do nothing because good price management is difficult. For them, price setting is like shooting at a target in the dark…occasionally they hit the market price but not often.  Good wholesalers put in the time and effort to understand their market.  Note: We are not attorneys but you should never discuss pricing with a competitor and as you consider gathering competitive data from competition, you should discuss your approach with your attorney to make sure you don’t do something that will cause legal problems for your company.
  • Your sales person does not need access to the cost or GM% for items, remove them from their order entry computer screen — You should expect crying and tantrums but the computer’s cost and GM% do not influence the acceptable price as defined by the specific customer. Further, we have seen systematic reductions of any gross margin above what the sales person feels is “fair.”  In some very flawed situations, the sales person’s “fair” gross margin was below the break-even for the wholesaler.
  • While you are removing order entry screen features, remove the ability to set the margin for an entire order – This feature simplifies destructive pricing behavior by your team, allowing them to, with a simple 2-digit entry, trash the price on every item on the order.  If your software only allows margin trashing by line item on an order, some energetically misguided folks will traverse the entire order dumping the margin on each item.
  • Using historical pricing from historical transactions does not really provide much insight into the true market price for a product – If you look at your sales transactions for an item and find that you routinely sell it, in quantity, for $1.00, this tells you only that you are at, or probably below, the market price for that item.  You can always sell an item for a price below market.  As we have said before, there is no magic in selling dollar bills for 95 cents. No selling is involved. No marketing is involved. Even worse, a regular pattern of selling below market may, over time, drive the market to this new lower level. If a wholesaler sells at stupid margins, customers would be stupid to not take advantage of them.
  • Silk purses are not created from sows’ ears – Market pricing, in our experience, cannot be calculated using a magic formula applied to below-market transactions. You can determine what the customer paid, but not what they would have happily paid.  We spend a lot of time looking at sales data and would love to see the math behind a program that can tell you the market price for an item that is sold at 20 different prices over the course of a year.  To repeat, just because you sell a product at $1.00 has no relationship to the market and the potential for an item.  You can assume that $1.00 is at or below the market but that’s about it.  Let’s try a boating analogy:  You cannot determine the depth of water you are in using a 2’ length of rope tied to a weight.  You only can confirm that the water is at least 2’ deep.  To infer anything beyond that might result in a bent prop.
  • Customers are focused on a small number of items that you should also focus on – These items are like speed traps. When your price is over the limit you get a ticket from your customer.  Get enough tickets and you get your license to sell to that customer revoked.  You need to understand where the speed traps are and what the limits are.   In pricing, outside these pricing traps, you can probably do a little better. This is of course where the analogy ends.  We would never suggest driving over the posted speed limits — even when the rental company comps you a nice Camaro and you are cruising a wide-open 4-lane with no traffic on a clear day — because “pricing” can apparently be monitored from small aircraft with great precision.
  • Get a pricing manager – Someone who will accept the challenge and take pride in helping the company make more money.  If you are over $20M in sales you need a full-time one to get on top of it and then to stay on top of it.
  • You are never done – The market is ever-changing. Your products are constantly evolving.  Costs continue to move up or down. Customers continue to come and go. Competitors covet your customers. Until all these things stop changing, you need to change too in order to remain competitive and to make the highest possible profits.
We have found no shortcut to managing pricing thoughtfully.  It’s hard work but we know of no higher ROI activity you can invest in.  Or if you’d prefer, we’d be interested in buying some dollars.