The New Normal of Vendor Cost Increases: Gold Rush or Wildfire?
The current economic environment provides a once-in-a-generation window of opportunity for manufacturers and distributors to take pricing actions that boost profitability – significantly – now and compounding into the future. Due to the overwhelming demand, supply-side constraints and monetary inflation, both manufacturers and distributors are experiencing an unprecedented frequency and magnitude of cost increases.
Many vendors are preparing their third and fourth price increases of the year, with each increase boosting prices/costs by 5 to 10 percent or more. And still, customers experience backlogs and allocation limitations. In other words, certain manufacturers and distributors are failing to implement pricing actions to encourage supply and manage demand. Is the new normal of vendor cost increases a Gold Rush or a wildfire? This article explores both realities and outcomes for you.
The Haves and the Have Nots of Pricing Systems
For companies with high-performing pricing systems, vendor cost increases are a profit-accelerating event, boosting the value of their book of orders while increasing satisfaction for those customers fortunate to get product. For those who have undeveloped pricing systems, vendor cost increases have become a never-ending fire drill of ERP queries, contract reviews, and half-efforts to pass along cost increases and not absorb them with shareholder dollars — while frustrating their customers who can’t get the product they desperately want.
The reality today is companies are reaping from pricing what they have sown. Those who have Wild-West-style pricing (where sales reps make up prices as they go along) are discovering that out-of-control overrides, special net pricing, last-price-paid practices, and endless other ingenious system workarounds break down in periods of extreme velocity and magnitude of cost increases.
How Vendor Cost Increases Become Either a Wildfire or Gold Rush
Historically, when cost increases were normal and the required response times were generous, the pain was tolerable and may not have reached the threshold level to trigger a systematic response. When the velocity is 3x or 4x and the magnitude is 2x or 3x or 4x – well, you get the point. As a result, there will be manufacturers and distributors with profit and cash crunches, who also end up with frustrated customers, as they fail to balance supply and demand. For these companies, this economic cycle promises to be a hellish, never-ending cycle of wildfires and fire drills. Many of these will be acquired under financial duress by those who have mastered their pricing.
By contrast, for executives who have the presence of mind to focus on the New Normal of scarcity and inflation, this economic cycle will be a gold rush. For the elite, every cost increase creates an opportunity to fix longstanding pricing mistakes and opportunistically capture price premiums on scarce, low-sensitivity or high-cost-to-serve products sold to certain customers, projects, etc. Phased-in price increases that ordinarily would have taken years to execute, can now be accelerated into three or four quarters. The vendor goes up 5 percent and you’re on allocation for product? You will need to go up more, say 7 to 9 percent. If you don’t? Expect unhappy customers and margin compression.
The Need for Structure and a Coherent Pricing System Hierarchy
With thousands of customers and thousands of products, producing millions of potential customer/product combinations, a company’s ability to master this dance comes down to pricing architecture — which in turn is predicated on deep pricing and sales analytics, robust processes, and disciplined sales force execution. Companies with clearly organized customer segmentation and deep insight into customer wallet share and profitability can systematically manage and drive execution in a coherent system of pricing hierarchy:
- Contracts and Customer-Specific Pricing (CSP) Libraries: A collection of CSPs for managed customers’ most sensitive products, with the long tail-spend of low-sensitivity items hit assigned pricing matrices (expressed as factors off current list or current cost, automatically adjusting as the list or cost master file is adjusted). No more exhaustive laundry lists of products, no needless special net prices, no last price paid – none of that nonsense… Focused subsegments of customer market baskets, actively managed for product set, price, vendor cost supports and customer share of wallet, typically covering 35 to 40 percent of non-project revenue.
- Optimized Customer Pricing Matrices: Customer and Product Segmentation allows large clusters of smaller customers and low-sensitivity product combinations to have differentiated pricing in a simplified pricing architecture. Thousands of products being sold to thousands of customers (resulting in millions of potential special price records) can be quickly and efficiently structured to strategically differentiate price while (structured as list or cost multipliers) making vendor cost adjustments as simple as updating the product master. Well-designed matrices typically cover 60 to 65 percent of non-project revenue.
How Will You Respond to Cost Increases?
Properly structured, the cost recovery aspect of price increases can now be separated from the opportunistic, demand-balancing aspect. Cost recovery occurs in the product master and opportunism/balancing occurs in matrices’ list/cost factor tables. The goal is to build and sustain a structured system that is market-sensitive, differentiated, simplified, and yet robust enough to handle the New Normal of vendor cost increases.
Which side of this divide are you on? If you’d like to put an end to firefighting, we’re happy to help your company accelerate profits. Your customers and shareholders will be glad you did!