In an ideal world, sales strategy and margin strategy are aligned and live in perfect harmony. Unfortunately, I commonly see a lack of strategy for both sales and margin within many distribution companies. And, when companies do have strategies for each, rarely are they aligned. Because of this, the sales team, pricing managers, and product managers each do their own thing, resulting in misaligned pricing.
Too often, a distributor has as many pricing “strategies” as they have individual salespeople. One such strategy that’s prevalent among salespeople is creating pricing or discounting rates that end in zeros and fives, or pricing in increments of five. I’m speaking of round number margins such as 20 percent, 25 percent and 30 percent, or discounts from the list price of 5 percent, 10 percent or 15 percent.
Distributors can do better than this, and be a lot more profitable as a result. Let’s explore why this problem persists and what companies can do about it.
Who Taught Your Team Its Current Pricing Strategy?
Most salespeople learned pricing strategy from “Frank” (the person they worked next to) when learning the business. Frank would tell them this customer gets a 20 percent mark-up from cost, or that we can only make 15 percent on that product line no matter what. This behavior is what we call “peanut butter pricing,” where standard margins are applied broadly across product lines or customers.
It reminds me of a story. In working with a seasoned commercial sales executive, I was informed that, no matter who the customer or product was, with manufacturer “A,” the market would only allow a 20 percent mark-up from cost. One day after feeling incredibly frustrated, I sat with the salesperson and walked through several scenarios, all of which he fervently defended his position.
In desperation, I suggested we negotiate a better purchase price to source the product, saving 20 percent. In doing so, what would be the selling price now? He pulled out his calculator and divided the new cost by .20 to calculate his twenty-percent gross margin. He was prepared to pass the hard-earned savings on to a customer, who wasn’t even asking for a lower price. Ouch. Unfortunately, this story is not an outlier; it demonstrates the flaws in common pricing beliefs that many salespeople have.
Pricing By Zeroes and Fives
After analyzing thousands of companies’ data, we see that “peanut butter pricing” in the vast majority of the salesperson’s pricing results in margins that end in zero or five. The histogram below represents typical distributor gross margins where the sales team has a good amount of pricing autonomy.
When we analyze distributor pricing data, we see this trend over and over again. You can clearly see how sellers gravitate to margins ending in zeros and fives, suggesting that they do not understand market-level pricing, at least not for most customers or products they sell.
Another quick story: In a room of more than fifty sales leaders, I’d often pick out the top ten products sold across the company and offer to pay one hundred dollars to anyone who could guess the average sell price (+/- 10 percent) of the ten products. Out of more than thirty scenarios like this, I may have given out two hundred dollars. And these were the top 10 products.
Many distributors sell tens of thousands of items to tens of thousands of customers. If sellers can’t be expected to know the market price for a top product, how can they possibly know it for the rest of the catalog? It is next to impossible to have a pricing strategy built on the backs of your salespeople alone.
If most salespeople used an optimized pricing model where appropriate margins were applied to individual products, there would be just as many abnormal gross margin percentages, such as 24.86 or 33.4 percent, as there would be 25 or 30 percent. The graph above would have significantly more margin dispersion with few spikes at five percent-increments. It looks something like this:
Modify Common Pricing Behaviors by Salespeople
In environments where sales teams control the vast majority of pricing decisions, we see the following behaviors, which lead to underperforming profits.
Last Price Paid
It may appear inconsequential; however, we understand after working with hundreds of companies, the last price-paid profit leak is worth tens of thousands of dollars. Why?
- Multiple COGS increase over time
- Gross Margin reductions over time
- Peanut butter pricing
- Pricing outside of the Matrix
- Incorrect pricing (errors)
No Margin Stratification
Many people believe that gross margin is created equally, but it is not. Thirty-two percent gross margin for customer A has a different NET profit than customer B, due to cost-to-serve factors not accounted for when pricing orders on the fly. The same is true of products with a 43 percent gross margin on a core “A” high visibility item versus a non-core “D” item.
Every Customer is Treated Equally
An unspoken (at least not with management) belief amongst many salespeople is that every customer can and should be priced the same. Supporting that belief is the concern that they all talk amongst themselves. This can be true in some cases, which would benefit from a multi-prong approach to a strategic pricing program.
In these cases, essential products should be priced closely when customers may be affiliated, part of a membership group or perhaps just drinking buddies. However, in most cases, each customer should be priced based on what the data tells us (customer sensitivity and cost-to-serve).
Every Product is Treated Equally
The beliefs that apply to customers also apply to products, with one additional nuance: many sales reps believe that slow-moving products should be sold at a discount. Ouch! The feeling here is that, since the product has “sat” on the shelf for a couple of months, we should sell it at a discount to get rid of it. While the effort is noble in the real world, the product just gets reordered by purchasing, and all that was accomplished was a significant loss of net-profit.
Pricing Special Order or One-Time Products
When salespeople price special order items, they frequently use cost-plus formulas (with margins commonly ending in… you guessed it… zeroes and fives). This behavior predictably produces unprofitable orders. The average distributor’s special order product sales can represent 20 percent or more of their revenues. The negative loss can easily be 2 to 4 margin points. To succeed at stemming these losses, it is critical to have default-pricing matrices in your ERP system that assign appropriate pricing standards and guidance for special order product sales.
Give Your Sales Team the Pricing Guidance They Need
When you take a more strategic approach to pricing by incorporating data-driven guidance, your sellers gain the tools they need to price correctly. Pricing needs to be a collaborative effort where the input, guidance, and recommendations of salespeople are considered (and valued) in conjunction with a pricing-margin strategy that sets targets based on data. When done well, this process produces a pricing strategy that maintains customer loyalty, enables growth and meets company profitability objectives.
Your management team’s challenge focuses on understanding the analytical, behavioral, and systemic causes of pricing issues and providing your sales team the tools they need to execute your pricing strategy. The trade-off is less autonomy from sales in day-to-day pricing, but more value to the customer and a better bottom line for your company.
Are you working to address some pricing challenges of your own? We’re here to help. Explore our pricing and profitability resources as you consider and plan your company’s vision for pricing improvement.
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