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How Should Manufacturers and Wholesale Distributors Announce Price Increases?

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Price increases in industry are a fact of life. Most manufacturing companies and wholesale distributors see rising costs on a regular basis and feel the need to respond with price increases to maintain margins. But, how do you best communicate the increase to your customer base?

Depending on the customer profile there may be several approaches employed. Larger accounts may require a personal meeting to announce the increase and explain the impact on the account. Customers that order infrequently, say once a year for a small quantity, may not warrant an announcement at all. They may just see the increase at the time of the next order.

However you approach a price increase announcement it is likely that you will want to draft a letter explaining the increase. Over the years our pricing consultants have seen numerous letters announcing increases many of which we feel are ineffective.

Here are some recommended steps to building an effective price announcement letter. See if your announcements follow this pattern.

  • Create a “value sandwich”. Before actually stating the increase in the letter deliver a summary of the value that your company delivers. Explain recent initiatives that contribute to delivered value like a CRM program for example. Then, after you state the actual price increase, close with a brief summary of delivered value again.
  • Keep the actual explanation of the increase short and to the point. Avoid vague language and uncertainty. Simply state the increase amount if possible and the effective date.
  • Focus on your relationship with the customer. You desire to continue be a long term partner with this account and the increase will help to insure continued product quality and service.

How you handle price increase announcements can make or break the results. Well thought-out  price announcements have a higher acceptance rate with customers. Spend the time and attention to the details to ensure that you get the most out of your increases.

Wholesale Distributor Price Performance Visibility on the Front Lines

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How important is price performance to your company? How important is price performance to your sales team?

Most manufacturing companies and wholesale distributors are focused on managing revenue and costs as the key profit drivers to their business. Typically, price performance gets mixed into margin somehow and fails to get the attention it truly deserves. If you are serious about managing pricing better, then the results of day-to-day pricing actions need to be visible. And, specifically, visible at the sales level.

While our pricing consultants see more companies compensating sales reps on profit margin it stops short of addressing pricing directly. If you consider the basic profit equation where profit equals sales unit volume times price minus cost, you can quickly see that sales teams rarely have the authority to control costs. However, they can control or at least influence sales unit volume and price.

So, why not reward their efforts based on sales volume and price performance? Using basic invoice data, it’s relatively easy to measure price performance. Simply use a historical price for each item to each account multiplied by the number of units sold and compare it to the same items to the same account going forward. Determine the difference in actual price realization and you will have a basis for measuring price performance.

As the old saying goes…”What gets measured gets managed”. Using a price performance measurement provides a metric to address performance with sales reps and reinforce the need for price performance improvement.

When Does It Make Sense to Set Prices at a Margin Loss?

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Does it ever make sense to price at a loss? Over the last 16 years in business we have seen nearly every company sell at least some items at a negative margin. Manufacturing companies and wholesale distributors typically have thousands of items and at least hundreds of customers. Sure, with this level of price complexity some transactions are bound to slip through at a loss. Costs may vary and prices may be adjusted on a customer by customer basis that leads to items sold at a negative margin. In many cases, a manufacturer or wholesale distributor may not even know they are selling at a loss or realize the extent of margin loss sales.

Other companies are fully aware of their negative margin business and choose to continue the practice for a variety of reasons. Here are just a few.

  • The manufacturing company that uses negative margin business to support overhead and maintain a level of productivity or capacity.
  • The wholesale distributor that must infrequently purchase incidental volume items in order to serve existing accounts. The distributor is unable to buy at a lower price and is squeezed by the market price thus resulting in a margin squeeze.
  • Where profit margin is measured on an account basis. Some items are intentionally priced at a loss to serve the broader needs of the customer but the overall profit margin of a specific account is positive.
  • As a competitive weapon. This one is particularly dangerous as it could trigger a price war.
  • Just to get business at a new account. We’ll increase prices later on additional items sold.
  • Costs are temporarily high on an individual item as production machinery may require updating.

These are just a few of the reasons we have seen in industry. Some may have an argument while others fall well short.  So, what can happen when we sell at a loss besides the hit to profitability?

  • Competitors may react with their own price pressure often times causing industry participants to follow into a margin death spiral. This doesn’t always happen but the potential is real.
  • Buyers come to expect the low prices and it becomes very difficult to move them away from that expectation especially when it means increasing price double digits to get into the black.
  • Depending on the sales team compensation scheme, reps may continue to get paid commissions on negative margin sales while the company takes a hit on both the margin loss and commission payments…a double whammy for the firm. And, it becomes difficult to get the reps motivated to increase the price.
  • As price is used to help close the sale, reps are less likely to take the extra time to sell value and realize higher margins or know when to walk away from the sale. Again, depending on compensation plans, we find this particularly difficult for some sales reps to embrace as they will be paid regardless of the outcome.

As our pricing consultants are “pricing purists” and focused on helping our clients lift margin, we most often will argue against negative margin business. Taking the time to find acceptable margin business is time well spent. Yes, it takes longer to sell your value and it takes a little longer to find profitable business but the result in the end is significant.

Many companies struggle on the issue of negative margin transactions. What are your thoughts on this topic? I would like to hear from you and your perspectives. You may email me at rzuponcic@pricepointpartners.com.

Let Your Customer Increase Your Prices

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Many of our clients who operate within complicated pricing environments have transactions that result in negative gross margin. There may be several reasons for these money losers but one thing for sure is that these transactions quickly drain the bottom line. Often times, manufacturing companies and wholesale distributors are not fully aware of the extent of the loss.

So, regardless of the cause, how do we correct these losers when it comes time to have the discussion with the customer?

Several approaches can be employed. But, why not let the customer suggest a price increase?

We know that one way of correcting negative margin transactions is to stop selling these items altogether. As soon as you stop selling an item at a loss you are already putting more money to the bottom line.

Consider a discussion with your customer that starts with a statement about discontinuing the sale of the item to the customer. For example, “Our company is unable to continue the sale of item XXX to your firm.”

What is the buyer likely to do next?

They will likely ask why we are discontinuing the sale of the item. This is our opportunity to share with the buyer that we are losing money on the sale of each unit. And, any data that you can share with the customer that supports your loss is helpful.

In many cases our pricing consultants find that the buyer will help find a way to correct the situation which often includes offering a higher price. Assuming that you are a valued supplier to the customer, the last thing the buyer wants is to find a replacement supplier.

Other options may arise that includes lower performing but acceptable products that may be lower priced.

The key is to engage the buyer in the problem which will help to engage them in the solution. If the buyer concludes that a price increase is appropriate then they have ownership of the solution. And, if in the end, the sale of the item is discontinued to the account you are money ahead anyway.

The Wholesale Distributor Sales Team Pricing Challenge

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Most wholesale distributors and many manufacturing companies task the sales team with setting or adjusting prices on a customer by customer basis. In most cases, a centralized pricing system where a pricing structure is maintained for field use does not exist. Instead, many distributors rely upon the skill, experience and judgment of the individual reps for pricing management.

The challenge is that even though each rep has unique insights into the marketplace and customer needs, each rep may be applying their skill and experience differently with differing results. And, no mechanism typically exists that allows reps to share their experience across the organization.

Capturing the experience of a team of sales reps is no easy task. However, by beginning with historical pricing data, analysis can be performed that provides visibility to company wide price performance. Visit this page on pricing analysis to learn how to begin analyzing historical pricing data.

What Is Market Based Pricing for Wholesale Distributors and Manufacturers?

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There are a number of methods that wholesale distributors and manufacturing companies use to set prices. One of the most popular is a cost plus approach where a desired margin is applied to an item to arrive at a price point. This approach supports profit margin attainment but comes up short in considering market or customer willingness to pay.

Other approaches gauge prices to competitors. This is potentially one of the most dangerous methods as we may not fully understand the competitors pricing strategy. This can lead to inappropriate price reactions that can unknowingly create price wars. Most price wars are started unintentionally.

Value based pricing, on the other hand, does a great job of factoring the economic benefits of each selling situation in order to capture the most value in the form of pricing. While it is often the preferred method of strategic pricing, it has limited application in complex pricing environments that contain a large number of SKUs, customers and markets.

Market based pricing is directly applicable to these complex pricing environments commonly experienced by wholesale distributors and manufacturing companies. Market based pricing uses historical pricing data from your business to determine what the market or customer is willing to pay. Think of your sales data as marketing research. It essentially is a collection of “win” data that reveals what customers are willing to pay. When we analyze this data it begins to tell a story on each SKU, customer and market combination with real evidence of what prices will be acceptable at a point in time.

For example, we have 20 similar customers in a specific market buying the same item and they are each paying $30 per unit. Then, we have two additional customers that are paying only $18 per unit. The 20 customers paying $30 per unit provides evidence that this segment of buyers is willing to pay the higher amount. Logic would then dictate that the two customers paying only $18 per unit would be willing to pay $30.

Most wholesale distributors and manufacturers don’t realize the power that they possess in their historical pricing data. Using this data to make market based pricing decisions is a sure fire way to improve profit margins and sales close rates.

Wholesale Distributor Pricing ‘Must Haves’

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With the majority of distributors placing pricing power in the hands of the sales teams it is most important to provide the necessary structure to support price performance. Sales teams are in a unique situation to impact financial performance. Consider the three profit drivers: sales unit volume, price and cost. Sales teams can impact unit volume and price assuming that they have the authority to either set or adjust prices.

With this level of power consider how we are managing the sales force to achieve the highest price performance. Here are three key management tools to measure and control sales team pricing performance.

  •  Include a price performance requirement in the sales team job description. Raise the level of awareness on the importance of better pricing by stating it in job descriptions. Reps will know it is a key measure. And, after all, what gets measured gets managed.
  • Set price performance goals. Set a goal for each rep to achieve that is focused on price level attainment. Create a modest price increase goal that requires action by the rep. This too will raise the overall level of awareness of pricing performance.
  • Measure price performance. Create routine price performance measurements and reporting that provides feedback to the sales rep. Monthly, quarterly and annual reports send a strong message on the importance of strategic pricing.

These are the most fundamental tools to better pricing management through the sales team. However, we find few companies that take these important steps.

Wholesale Distributors and Pricing Strategy Complexity

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Wholesale distributors inherently operate within a complex pricing environment. Pricing complexity is simply defined as a high number of SKUs, customers and markets or channels. Consider the firm with 10,000 SKU items, 1,000 customers and five different markets or channels. The number of possible price combinations is 50 million. While it is unlikely that 50 million prices will actually be required in commerce it points to the potential complexity that exists in a wholesale distributor environment. Wholesale distributor pricing strategies can become complex as well.

Many manufacturing companies face similar challenges with pricing complexity. However, two different situations exist that create complexity. The first is the firm that has a large number stock-keeping units. Like distributors, these environments are complex due to the large number of products, customers and markets.

Alternatively, made-to-order manufacturers have a different but just as challenging situation making it difficult to compare products and their price points.

When sales reps are tasked with setting or adjusting prices it is easy to see the challenges in arriving at the best price for every selling situation. Now consider additional factors like competitive pressure at your largest customer and the risk of missing the pricing target increases significantly.

When we put the front line sales team in the position to influence prices without sufficient price guidance we are basically sending them to battle without sufficient weapons. Most often, sales reps will retreat on price in order to close the sale and result in leaving money on the table. Or, in fewer cases, unknowingly overprice the deal and lose the sale altogether.

What if each sales rep could leverage the collective pricing experience of the entire sales team?  Here in lies the solution for managing complex pricing environments. Faced with a new pricing event, we want to compare it to similar situations from the past. A wholesale distributor pricing strategy will focus on managing complex pricing environments using invoice pricing data to identify optimal price points from historical transactions. The objective is to put pricing power in the hands of the sales team that increases sales close rates and lifts profit margins.

How to Best Use Cost Plus Pricing Strategies

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The most effective way to capture the highest profit margin and achieve your revenue goals in B2B markets is to price products and services to value – that is, recognize and communicate the economic value they deliver to your customers. We have discussed this approach through many of our past newsletters.

Still, using a cost plus pricing methodology – applying a desired margin to a product cost to arrive at a selling price – also has merit when the approach is applied strategically. If used alone, a cost plus pricing methodology leaves gaping holes for margin and revenue leakage. However, our pricing consultants find that incorporating it into your broader pricing strategy can be a smart move, provided you limit its application to the management of low-margin business.

How should you use cost plus pricing?

Use it to set price and margin floors. Say a distributor has 30 different product groups, each with a desired target margin. Those target margins are the goal, but they won’t be attained in every instance. Discounted prices will erode margins on some transactions, causing price realization to often fall well below the target. That’s why margin floors – the absolute minimum margin levels you are willing to accept – are an essential element of your pricing strategy.

Ask yourself: How far below the target are you willing to go?

One of the keys to controlling margin leakage is to establish a margin floor for each product group within each market to prevent low- and negative-margin transactions. These limits essentially say that you will not, under any circumstance, sell below this level. Business that falls below the margin floor is unacceptable.

Of course, your margin floor will vary depending on the product group and its cost structure, price sensitivity, competitive environment and a host of other factors. When you are managing thousands of SKUs whose costs may be changing on a regular basis, it can be difficult to monitor every transaction. But setting margin floors using a cost plus approach helps keep your business profitable by preventing transactions from slipping below your threshold for minimum profit margin.

Pricing consultants often see a half-margin-point improvement by setting margin floors with a cost plus approach. That’s $100,000 in margin improvement on $20 million in revenue. While we recognize that this approach is simple, it is an effective tactic for grabbing some margin improvement quickly (assuming that your costs are accurate). It’s also relatively easy to sell to the sales team and customers because no one really expects you to sell at a loss or a ridiculously low margin.

Is Your Pricing in Line with Your Delivered Value?

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Does your offering hit the value target? Are your customers getting all they need at a price that results in solid value? These are questions that businesses ask our pricing consultants every day.

Value is all about the balance between the price of your offering and the benefits it delivers to customers. Perceived value is key. When an imbalance exists between delivered benefits and price, you have three options for re-establishing balance: (1) Lower the price to bring balance back in line, (2) Increase the benefits to be in line with the price, or (3) Adjust price and benefits together to achieve a value balance.

How do you know if you have a value imbalance? Our pricing consultants find that the most common way is to talk with your customers about value. Customers actually like to talk about their needs and what they value, so these are easy discussions to initiate. Most often, these discussions are conducted within the framework of market or pricing research. This type of research is different from customer satisfaction as it focuses on the potential gap between benefits offered and price.

Here are three key efforts that should be included in value-based research:

  • Gauge Perceptions - Perceptions are more important than reality. Never mind your offering’s actual price; ask customers how the offering impacts their business. What financial gain do customers realize from your offering? How does it help them increase revenues, reduce costs or reduce risk? These are the pillars of business value: At least one should be delivered in every offering.

 

  • Understand the NBA - And we don’t mean basketball. What is the Next Best Alternative to your offering? If the customer stopped using your offering, what would they use in its place? How does the alternative compare in benefits and value to your offering? Ask your customers: They will almost always be up front and honest about alternatives. Then you will know exactly how your value compares.

 

  • Talk Price - You can talk about price without talking about price. The word “value” is a great surrogate for price. Ask customers to rate the value of your offering on a numerical scale. If the rating is low, it is a strong indication that an imbalance between benefits and price exists. If the rating is very high, you may be leaving money on the table. Either way you will know the action you can take to remedy the situation. Remember that you can adjust benefits or price to bring value in line.

Having value discussions is critical in new product launches as well as in realigning existing offerings. Often, we find that opportunities for product versioning surfaces when we learn that different segments of users have different needs and value products differently.

Go ahead: Talk with your customers about value. They will thank you for it.