When we study distributor transactional data, we see the same trends over and over again that reveal untapped profit potential.
While there are several reasons for why distributors struggle to reach their optimal profitability, one of the biggest culprits is an unstructured pricing strategy (if a strategy exists). This generally takes the form of broadly applied margins across product lines and SKUs. By doing this, distributors miss a golden opportunity to capture premiums in areas or for SKUs that aren’t as visible or sensitive to customers and cause little sales friction. We call these items “long-tail” products.
For most distributors, long-tail products make up about 60 percent of stock revenue, yet they cause around 40 percent of invoices to be less profitable. As you might imagine, these money-losing invoices prevent a distributor from reaching their profit potential which is generally 1.5x to 2x greater than their current results.
Correcting the “long tail” pricing problem is an easy step toward improving profitability, but it needs to be done carefully. In this article, we’ll explore how this can work for your company.
Understanding the Long Tail Problem
The fact is, many distributors price long-tail items using margins that aren’t terribly different than their highest-visibility products. Why does this happen? When selling thousands of items with no pricing guidance and cost-plus behavior, sales teams are left guessing about market price points. Often, when they guess, they aim low and leave money on the table. Even when companies have a pricing matrix in place, these products still tend to underperform when it comes to profitability, because:
- They use an incorrect methodology (Velocity-GMROI-T&E) to identify SKU margin opportunity
- Slow-moving products have a higher cost-to-serve, not fully reflected in ERP systems
- True product sensitivity isn’t considered in a distributor’s current price matrix
The traditional methodologies using Turn and Earn (T&E), Gross Margin Return on Investment (GMROI), or velocity as measured in most ERP systems are ineffective at measuring true product sensitivity and visibility in the marketplace.
We’ve actually studied the relationship between these traditional approaches and true sensitivity and found that there is less than a 10 percent correlation. In practice, using methods like T&E and GMROI has minimal impact on your bottom line and is visible to sales reps and customers, which creates mistrust.
Segmenting Products to Identify the Long Tail
It’s important to understand each product SKU’s core group or price sensitivity and visibility. Calculating real product sensitivity and visibility in the marketplace requires a data-driven approach. Let the trends in your transactional data do the hard work.
The goal is to find areas for small increases in margin without triggering customer price pressure or sales pushback. In our pricing solutions, we use 12 unique factors carefully weighted to provide an accurate, sophisticated sensitivity rating that we call our “coreness rating.”
When we talk about a SKU’s “coreness,” we are referring to segmenting products into four tiers of sensitivity from Core A and Core B, to Non-Core C and Non-Core D. They’re very fine layers of sensitivity for each of the tens of thousands of products that you sell that help you to see the relative sensitivity of that product. These ratings help determine the optimal price premium to place on that product based on true sensitivity in the marketplace.
A well-designed product pricing methodology should answer the questions:
- Where are the sensitivities in the marketplace?
- Where do we have to play aggressively on price to capture the business?
- Where can we extract premiums to balance out the profitability of the account? (these are commonly the long-tail items)
Once you identify the low-sensitivity products where small premiums can be added with little friction, the next step is selecting the right amount of premium.
Applying Appropriate Premiums in Your Pricing Strategy
Strategic pricing isn’t as simple as just increasing prices to increase margin; there are always products that need to be priced carefully. Core A and Core B products are the most visible products to the customer. These are the products where the competitive dynamics require a competitive pricing strategy.
On the other end of the spectrum, Non-Core C and Non-Core D items are where the economics of cost to serve and the lack of sensitivity in the marketplace create a margin opportunity. To get the most out of your long-tail, low sensitivity products, small premiums to your cost or list price, based on the SKU’s sensitivity, helps transition these products from being “profit takers” to “profit makers.”
We recommend small slivers of margin added to most of the products in this category to recover profitability from the costly long-tail items while not causing sensitivity from sales or customers.
Correct the Long Tail Product Pricing for an Easy Margin Win
Instead of relying on oversimplified pricing methodologies like T&E or GMROI, leverage your data to uncover areas where you can increase prices without pushback from the sales team or the customer.
The major benefit of analyzing your SKU “coreness” and applying prices accordingly is usually a 300bps improvement in the margin on approximately 40 – 60 percent of your stock sales. It’s a quick, easy margin enhancement that corrects the problem that creates many profit-losing invoices.
SPARXiQ provides holistic approaches to distribution pricing, sales, and profitability analytics with a proven process for measuring improvement. We’re here to help. Explore the pricing and profitability resources available to help with pricing improvements for your company.
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PriceGPS™ provides data-driven recommendations to help distributors and manufacturers maximize their margins and allow your sales force to focus on serving customers and delivering value.