These days, everyone in the analytics space has a pricing product to talk about. Toss enough transaction data points at the problem, you’re going to get a few insights that may help you earn higher margins. This is particular true in industries such as a wholesale distribution and business services.
The problem is most of these products are grabbing at pennies. Dig past the consulting jargon, most of these really just mix two big ideas:
- Process Discipline: if we’re going to increase prices, make sure everyone participates
- Raise Target Price: use math to give the reps confidence to raise their opening bids
Do these tactics improve margin? Certainly. I’ve personally seen companies who rigorously execute these programs achieve margin lifts of 1% – 3%, most of which drops straight to the bottom line. These can be a fantastic way to increase the profitability of an acquisition or company for sale.
But if this is all you’re doing, you’re leaving money on the table and putting relationships at risk. Customers and competitors eventually get wise to the fact that you price on the high side – and start targeting your accounts. You’re selling the same value at a higher price. But there’s a better way…
The stories I’m about to tell you are real, drawn from two decades of studying customer relationships and account profitability. Some of these were spotted in pricing and sales assignments, the best of them were spotted when I changed teams and working in sourcing, unwinding a supplier’s deal. The principles, however, are timeless.
Case Study #1 – Do the Buyer’s Job (and cover for them)
Why settle for charging prices that are only 3 percent above average when you can charge prices double that amount? For the full bundle of services provided to a prestigious, highly competitive multi-million dollar account, no less.
We had just merged with another business unit and were comparing notes on costs. This vendor was very high, charging double the typical price for a particular service offering. We asked them for a million-dollar concession; they declined and we started moving the business to our new provider.
Within a week, we understood why the prices were so high. First, these services supported one of our company’s largest clients, the source of many million dollars per year in operating profit. We had been forced to write a check for quality errors the prior year, so any failures were unacceptable. The problem was – our long time vendor manager proved to be utterly clueless, incapable of managing the process without their prior vendor. The supplier had been covering for them for years, loading up the bill with additional services, taking every price increase, and pocketing any savings. They had correctly figured out that their recipe for survival was making him look good. We finally had to swap out team members to make this work. Our failure to hire the right $75,000 per year employee ended up costing us over $1.5 million dollars per year since we were at their mercy.
In retrospect, the vendor’s biggest mistake was aiming too high. Had they padded their margins by a mere 10% – 15%, it wouldn’t have been worth the time and effort to sort through the mess involved in moving the business.
While this is an extreme example, the underlying principles are valid and can be implemented in an ethical manner. Suppliers who can elevate their standing to “trusted advisers” and “solution experts” can earn higher margins than less sophisticated providers. Even better, does the work require complicated instructions or close alignment with your other services? These serve to increase switching costs and can be a source of cost efficiency.
Case Study #2 – Understand (and remove) middlemen
My partner and I looked at the website. He looked at me: “you know, my wife regularly hires people to build projects like this. Want to know how much they probably spent?”
Her response was swift and listed three prices for the same site:
- $1,500 for ‘friends & family’ development (where you know the programmer)
- $5,000 if you’re going to hire an independent consultant who builds websites
- $15,000 for a digital agency
Same basic product, three levels of service. And likely the same level of talent in terms of the person actually writing the code. All three prices are reasonable, incidentally, for the degree of service provided.
Someone hiring a digital agency doesn’t expect to have to get involved in the technical details of how the website works. They probably don’t even really want to solve for the details of the solution beyond a broad sweeping statement: “Shows our stuff and looks cool”. The cost also covers the expense of selling the work to higher end corporate clients and a certain amount of hand-holding.
The lowest level of this scale is what consulting firms call staff augmentation – you’re getting paid for the labor hours provided, nothing more. The next level up, independent consultant, requires learning a little bit about how to manage your own business and manage projects. You’re replacing the project manager who would otherwise be needed to manage your efforts. But in the process, you can triple your earnings. The next step up, ad agency, involves replacing the sales and client management skills required for high touch corporate accounts. Of course, if you paired up with a friend who liked that kind of stuff, the two of you could split the revenue 50/50 and you end up with a 50% raise over the independent consulting option.
Each of these layers adds additional people, who add cost to the process, often spent communicating with each other rather than you and the buyer. Every one of these layers you can remove increases the amount of money you can put in your pocket. Or offer to the customer as a discount, making you even more competitive against higher cost options such as digital agencies.
Taking out middlemen, giving the customer a small price break, and pocketing the rest is great way to earn high margins – and stay competitive.
Case Study #3 – Push Preferred Products (Mix Improvement)
This strategy takes the data from your customer profitability analysis and uses it in a new way. Look at your most profitable accounts – can you spot trends in their product selections? Your best customers will generally be doing two things:
- Purchase most of your relevant product categories
- Buy items, brands, or private label offerings with higher margins
So this strategy is pretty simple… we’re going to look at each customer and try to sell them the full bundle we sell our best customers. And convert any existing business they have to our most profitable items within each category.
This is a common problem in wholesale distribution. Many small, unprofitable accounts are situations where you are getting cherry-picked on a couple of specific items. This hurts you in several ways:
- Fewer product categories results in smaller order sizes, increasing delivery cost as a percentage of goods sold
- Often missing higher margin product categories or brands in the assortment
- Less productive sales conversations (smaller base of active opportunity)
- Increased scrutiny on item level pricing since buyers are price driven vs. looking at overall relationship value
The first step to correcting this action is to start segmenting your customers and products into logical groups and analyzing them to identify the key characteristics of your best blocks of business. Then, simplify this into a set of simple rules for your selling organization to pursue.
Case Study #4 – Price Based on Customer Value