Coping With Today’s Pricing Pressures
By Joan S. Adams <adams@pierian.net> +1-212-366-5380
Different customers and different situations demand different prices.
Downward pressure on prices is something PVF supply houses deal with every day. Thanks to the Web, PVF prices are more transparent than ever before. Customers shop around. They have a pretty good idea of vendor prices, competitor prices and everyone’s margins. Yet pricing at many PVF houses remains quite old-fashioned and arbitrary.
Here are some implications about the modern pricing world.
1.One size does not fit all margins.
Different types of inventory should have different margins. Slow-moving items merit a higher margin than the fast ones. For instance:
- Valve A is purchased for $250.
- Valve A is direct shipped to the customer.
- The customer is invoiced that same day.
In the case of Valve A, the supply house was out of pocket $250 for a very short period of time and didn’t incur any handling costs.
- Valve B is also purchased for $250.
- It sat in the warehouse for six months before being sold.
- The customer is invoiced only when the valve is shipped.
In the case of Valve B, the supply house paid $250 up front and didn’t recover that money for six months. Basically, the supply house gave the customer an interest-free loan of $250 and use of shelf space in the warehouse rent-free for six months. Valve B also needed a lot of handling as well—unpacking, stocking, picking, packing and shipping.
While Valve A and Valve B were both purchased for $250, they should not have the same markup. Valve A is a fast-moving item and Valve B is not. Valve B must have a much higher margin in order to recoup the actual costs and the risk.
“Where’s the risk?” you ask. The supply house buys five of Valve A and five of Valve B. The fast-moving valves are sold within a week, direct shipped from the vendor and invoiced immediately. The slow—moving valves sit in the warehouse. One sells in two months, another in six and the remaining three are still there a year later. In addition to the cost of the interest-free loan and the warehouse space occupied, the price of Valve B must reflect risk that some of these slow movers may never sell.
Categorize your inventory into three groups:
- A = fast moving (turns every week).
- B = moderately fast moving (turns in a few months).
- C = slow moving (turns a few times a year).
Each category has a risk associated with it. “A” items have a very low risk of being scrapped, “B” items have a little bit higher risk and “C” items have a much higher level of uncertainty. The margin percentage you need to add above your actual costs must reflect these different levels.
2. All customers are not created equal.
Some customers are more expensive to service than others. Every supply house has customers who don’t pay on time (more interest-free loans). Some customers aren’t terribly organized—they always seem to need their order “right now,” and rush orders are more expensive than scheduled orders due to more handling and special procedures. Other customers never quite get it right—they place an order, then they change it, and change it again. Their orders are never quite right—requiring your truck to go out a second time to pick up the ‘wrong’ material and deliver the right material.
It is perfectly reasonable for the supply house to price differentiate between customers. Categorize your customers in much the same way you sorted out the different valves.
Platinum customers: These folks order regularly, they order a lot, their orders are correct and they pay on time.
Gold customers: They order lower quantities or less frequently, most orders are correct and they pay on time.
Silver customers: They require more effort from your inside sales (changing orders, etc.), from your delivery guys (exchanges, rush orders) and from your accounts receivable people (partial payments, late payments).
Platinum customers merit discounts for quantity, early payment, long term contracts, etc.
The Gold customers are pretty good and deserve standard pricing.
It’s the Silver customers you need to go after—they should pay for all the extra headaches they cause. Figure out trip frequency, number of order changes, days of late payment for the Silvers. Bump their margins up some percentage until they clean up their act.
3. Costs have changed over the years—your margins should too.
The PVF business has grown more complex. Supply houses offer more products and services. Costs have gone up. Every supply house should take a hard look at its margin calculations to ensure it is covering the cost of doing business.
Break out the calculator, add up rent, payroll, computers, trucks, insurance, etc. and figure out the break-even margin.
4. A little price flexibility is good—cutting margins on a whim is not.
Cutting prices just “to get the sale” is a bad idea. You did the above calculation and now you have a rock solid margin number. You need to educate the inside sales people. If they don’t get it, they will continue to cut prices when pushed. The inside sales guys think this is a one-time concession. The customer thinks, “That was easy,” and will want more price concessions in the future. Cutting prices also makes the customer think they were way too high to begin with.
5. Cost plus is coming—be prepared.
There is a pricing arrangement called Cost Plus and it is coming to the PVF world. Customers demand to see vendor invoices, so they know your “cost.” Then they negotiate your margin. So get ready—you will need to break down your price for this kind of customer: vendor price + % mark-up for break-even + % profit. You will need hard numbers to negotiate effectively.