In dealing with pricing strategies for clients at CEO Strategist we always try to seek out opportunities that have the biggest impact in the shortest amount of time creating the most value.

We call it "picking the low hanging fruit."

In almost every case we deal with looking to improve profitability, we find low hanging fruit on many of the different branches within the pricing system.

This article addresses a few concepts to help you find that hidden fruit within your pricing system.

Low Hanging Fruit 

Some of that low hanging fruit is revealed by looking at the following:

• The pocket price band
• Self imposed margin caps
• Pricing strategy

The pocket price band is an exercise designed to create a graphic picture of all your pricing activity during a specified period of time on your "A" items.

Analyzing the pocket price band and taking action based on the results can add as much as two points to your overall margin.

The horizontal axis shown in the graph represents the percentage of business sold at the particular margin listed on the vertical axis.

In other words, in the above example, 6.1% of the business sold during the specified period was sold at 16% margin, 4.8% at 17% margin, 12.4% at 18% margin, and 15.2% at 19% margin and so on.

So What Does This Graphic Tell Us? 

First of all, it tells us that the street price margin on your "A" items during this period happens to be between 18 and 21%. Approximately 71% of your sales fell into this category.

Your peak street price came in at a 20% margin but it is difficult to change the street price. The street price is set by the dumbest competition in the market place. It is your job to make sure that you are not the dumbest competitor. What you can do is analyze those sales that fall on both the upper and lower side of the peak street price margin. In other words, look at those orders that were priced at a margin of 16, 17 and 18%.

Determine how that price was calculated. What were the justifications, if any, for pricing at a lower margin? Chances are that most of these lower prices can be justified and were necessary to secure the business.

However, chances are just as great that a number of these prices aren't justifiable and were not necessary to secure the business. This is where you learn to improve your margin and increase the price on future business.

In fact, in some cases you may decide to walk away from that business. You then apply the same concept to the upper side of the price band and analyze the orders received at 22% margin and higher. What did you do right? Did you charge for value added services that you gave away at the lower end of the price band? If you can shift your price band scale more to the right and get many of your lower band pricing up to street pricing, you could increase your margins by as much as 2%.

Self Imposed Mental Margin Cap 

This Mental Margin Cap analogy is very simplistic. Just chart every price charged by invoice for an individual sales rep based on margin. List every invoce.

It is a given that if you go through this exercise and create a chart as shown above for each inside sales representative and each outside sales representative who has pricing authority that most of your graphs will come out as a typical bell curve.

However, it is just as likely that one or two of your sales reps will come out with a graph that demonstrates they operate with a self imposed mental margin cap (MMC), "I can't charge my customers more than a 30% margin. That would be gouging them." Their particular graph reaches a specifc margin and stops.

Some sales reps just don't understand that profit is not a dirty word and that unbundling your services is the only way to ensure growth and stability. Of course, you cannot gouge your customers, but that does not mean you need to give away services for free or letting a purchasing advantage slip through your fingers by giving it away.

Educating and monitoring the sales reps you find within your organization that suffer from the MMC can add points to your overall margin.

Pricing Strategy

So, what is a pricing strategy? What is involved? A pricing strategy is nothing more than determining how you are going to price your product in the marketplace to maximize profitability.

That sounds pretty simple. The complexity of the issue comes into play when you start looking at all the factors that may play a role in determining your strategy. Those factors start with knowing your competition.

Remember the statement that "market price is set by the dumbest competitor." Knowing your competition and what their objectives are plays a key role in determining your pricing strategy:

• What is their market share?
• What is your market share?
• What is your competitive advantage?
• How would they describe their competitive advantage?

Answering these questions will give you insight into building your pricing strategy and determining the components of your strategy and how they will be used. Typically there could be three or more components to a pricing strategy as indicated by the illustration.

Matrix Pricing 

Matrix pricing is nothing more than a pre-determined spreadsheet that enables you to set different prices for unique combinations of customer types and product categories. The key profit leaks that exist in virtually every pricing matrix is in maintaining the matrix with current, timely increases.

Another leak is the self-imposed authority often assumed by the inside sales reps to shift column pricing in an effort to be more competitive and please the customer. I once had an owner tell me he tried two experiments with his pricing matrix.

First, he increased every price by 2% and did not tell anyone.

Second, he shifted his pricing one column to the left so when inside sales backed off a column, they ended up selling at the initial desired price anyway.

He swore nobody even noticed for six months and his margin went up by 2.3%. Maintain your matrix, review it regularly and monitor the pricing activity and margins will definitely increase.

Unprofitable Customers 

It is a good idea to analyze your customer base each year to determine where you are making money and where your expenses exceed the profit you generate independently on each account.

As a distributor, you have limited resources available to service your customer base. Inventory management is critical, cash flow management is critical, cost containment is critical and a definitive pricing strategy can be your "edge" in creating competitive advantage.

If your organization is not skilled in activity based cost analysis you might try to determine your most profitable customers using a simpler approach. This approach uses basic calculations to give you some sense of where your money comes from and where it goes.

Most of your cash is tied up in inventory and accounts receivable. Consequently, you need to be disciplined enough to ration your cash investments to only those customers who provide a return. 

 The following steps describe the simple calculation:

Determine the average cost of processing an order in your business. What is your cost to process an order, pack it, ship it, and collect payment? Each of these stages has internal costs that you assume are covered in your pricing matrix schemes. For most distributors, the cost to process one order completely is between $50-75 per order.

Determine key figures for each customer.

1)      Total sales
2)      Total cost of goods sold (COGS)
3)      Gross margin dollars (item 1 minus item 2)
4)      Number of orders processed per period

Multiply the number of orders by your estimated cost to process an order. You can use the specific number you calculated in the first step above, or an average provided by your industry association. This cost can change drastically based on the type of product sold and the services provided with each order. However, the $50-75 range would be a good place to start.

Determine the net profit for each customer.  Now that you have multiplied the number of orders by the per-order cost, subtract that cost from the gross-margin dollar figure. Do this for each customer. The result will be either a positive or negative number.

List the results.  List your customers in descending order, from the largest contributor to net profit to the lowest contributor (you will hit the negative numbers quicker than you might imagine).

Not surprisingly the Paretto Rule often applies here also. You may get to zero and negative contribution after about 20% of your customers have been analyzed. It is this remaining 80%that have some negative impact on your bottom-line profits. Eliminating 80% of your customers based on this exercise is not realistic.

However, you certainly might want to analyze how you are doing business with them. Look at all the customers with a negative net profit and determine what their rules of engagement are and what changes can be made to improve profitability. Can you increase prices? Try some of the following techniques.

Pricing Enhancements:

Segment your customers according to Service Output Demands

Set Minimum Prices based on:

• Order size
• Cheapest SKU
• Invoice handling charge
• Delivery fee

Restocking Fees

• Separate stock from non-stock
• Go with percentage or fixed dollars (i.e. $25)
• Exempt counter current A/R (provide instant credit)

Special Order Pricing



Miscellaneous

• Off hours opening fee
• Quote preparation fee
• Don't be a terms "wuss"
• Move matrices up one column secretly
• Round up instead of down

How to make enhancements stick:

• How large in quarterly volume is your smallest customer in the group that give you 80% of your sales volume (assume $1000 / qtr.) develop your enhancements
• Send a letter to all your customers
• Proud of new enhancements
• Big guys have been carrying small guys
• Not anymore, so pricing will be better
• You're a big guy ($1000 / qtr.) you are exempt

Create a rising star category for sales reps (5/each) to exempt customers below the minimum threshold that have potential

To request a sample price increase letter that your profitable customers may "welcome" and be glad you are taking action against those predominantly smaller customers who are sucking up your resources without paying for them, email rick@ceostrategist.com

Firing a Few Customers is Often a Good Move

Before you decide to fire any customers, add to the equation their accounts receivable balances and payment histories. What you may find is that not only are you not making any money on their orders, but you are also financing them with your accounts receivable. Look at what products they are buying and make sure you are not stocking products exclusively for their account. Unprofitable customers should not get special services.

Once you have determined which accounts are not profitable you have several options:

• Raise prices.
• Reduce services.
• Charge for deliveries and add handling fees.
• Initiate minimum order quantities.
• Initiate minimum line item requirements.

Profit Without Pain 

Profit without pain is what it's all about. There may be a lot of hidden profits waiting for you to find them lurking within your pricing system itself. The good news is that chances are it can produce tremendous gain with little pain. Go look at what you are doing and how you are doing it.

Find out if a customer can call your place of business and get different prices based on who answers the phone. Establish some goals, create a strategy and then execute that strategy. You may be very pleasantly surprised at how much additional margin is there just waiting for you to sift it out.

Rick Johnson, expert speaker, wholesale distribution's "Leadership Strategist", founder of CEO Strategist, LLC a firm that helps clients create and maintain competitive advantage. Need a speaker for your next event, E-mail rick@ceostrategist.com.  Don't forget to check out the Lead Wolf Series that can help you put more profit into your business.

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