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Build a Pricing Strategy

A couple of weeks ago I attended a distributor strategy conference in Las Vegas.  A select group of progressive distributors and consultants gathered to talk strategies in the post-recessionary period.  I spoke on essential skills to maximize sales growth in this new economy.  Later in the day, Jonathan Skelly of Vetus Partners provided an overview of recent distributor sales (and there has been quite a few).  To summarize a portion of Jonathan’s presentation, the value of a distributor is generally calculated as a multiple of earnings. 

A thought jumped out at me; if a distributor builds a pricing strategy, it enhances the bottom line and affects the value of the whole business.

It seems that I wasn’t the only one in the room thinking this.  Later during a mergers and acquisition roundtable, one distributor with a long history of growth through acquisition made this statement (which I will try to capture as accurately as possible).

“When we look at target companies, we pay particular attention to whether they have implemented a sound pricing process.  If they have not, we know this means the company is undervalued.  One of our first actions is to put one in place.  We see our equity grow the first day the pricing plan kicks into action.”

Interesting point?  I thought so…  At the first break, I started jotting down some numbers.  I thought I would share my startling results.

A few assumptions
Let’s start of with a nice sized independent distributor - a company with three or four locations and sales of $100 Million.  Keeping with our generic example, let’s assume the company produces a nice (but not stellar) contribution to the bottom line of 4%. 

Ok, here’s where some of Mr. Skelly’s new valuation data comes into play.  In today’s market good wholesale distribution companies are valued at between seven and eight times their earnings (mediocre ones are valued at much lower multiple).

The first value calculation
Based on this information, my rough-out of the value of a distributor looked something like this:

My first Value Calculation
$100,000,000 Dollars in Sales
X            4%  Profit Margin expressed as a percentage of sales
$4,000,000  (The bottom line before taxes, interest, etc)
X             8   (The current valuation multiple of a distributor)
$32,000,000 

Valuation of the business

 

Now I wanted to see the impact of inserting a pricing process into the equation.  David Bauders, President, Strategic Pricing Associates has stated for the record, “The SPA pricing process typically impacts the bottom line of distributors by boosting profit by 2-4 points.” 

The new value calculation
If we build the same calculation except with a higher profit margin – we will assume a 2 point jump in profit margin – it looks like this:

  
The New Value Calculation
$100,000,000 Dollars in Sales
X            6%  Profit Margin expressed as a percentage of sales
$6,000,000  (The bottom line before taxes, interest, etc)
X             8   (The current valuation multiple of a distributor)
$48,000,000 

Valuation of the business

Just implementing a pricing process equates to putting $16 million in the bank.  My question for you is:  Why, why, why wouldn’t every distributor in America have one?  This isn’t a new concept.  My first NAED sponsored training back in 1991 featured a half day on matrix pricing, yet most distributors still don’t have something in place.  And, I want to know – why? 

Why, why, why don’t we take advantage of this huge value?
After much soul searching and a whole bunch of “off the record” conversations, I believe lack of a pricing process boils down to four reasons.

  1. The wrong person is in charge of pricing. 
    Somebody has to take on responsibility for the accuracy of the prices shown on the computer.  Often this is seen as a mundane task that can be delegated to a lower skilled worker – someone akin to a pricing clerk.  This person cannot fully understand the nuances vendor partners, multipliers, pricing variances and the intricacies of the business system itself.
  2. They believe the people required to do adequate pricing are expensive.
    Some companies have started honest to goodness pricing processes only to collapse the department during an economic downturn.  Because there was no sure-fire way to measure the economic impact of the process, some of them assumed it to be much smaller than it actually is.  Other times, managers made the assumption that once put into place the pricing process would run on autopilot.
  3. They have delegated Pricing to the sales team. 
    In our industry, most sales people are paid based on gross margin, so this seems kind of intuitive.  Put pricing into the salesman’s hands and he will maximize the gross margin.  Right?  Well as good as it sounds sales people are often not really in a place to subjectively understand pricing.  First, sales people are emotionally tied to the sale.  If a customer says, “your price is too high”, they take it as gospel.  And, often customers let salespeople off the hook by fainting price when the real issue is something else.  Because of the emotional involvement, high price makes more sense than bad service, a botched quote, a competitor who was better positioned with engineering or a thousand other issues.
  4. They mistakenly believe they already have a price process.
    Sad but true many of us are at the point of delusional – we see Sally down in purchasing occasionally adjusting prices and we see a process.  Or we have margins slightly higher than those published by our peers in trade association Profit Reports – and we get to believing we’ve got a process.   A process has provisions for measurement, for real-world feedback, and for training.  Can you flowchart our process?

I believe our industry’s lack of a real live pricing process can be boiled down to a combination of these issues.  Let’s think about a real pricing process. 

First, it’s complicated.  The average distributor has ten’s of thousands of SKU’s and a dozen customer configurations.  This equates to literally millions of price combinations.  Tracking these is outside the realm of even the smartest guy on your staff.  You really need a tool for analyzing and tracking the permutations (and a really good Excel spreadsheet probably won’t hack it).

Secondly, there is continual pushback.  Salespeople are concerned about their customers not being on the best price list – whether they deserve best price or not.  Customers will push for a better deal.  We need to be able to discern normal negotiations and real price issues.  Without a plan for constant review and readjustment, even the best pricing plan bounces back to its normal state – with prices adjusted to a point where nobody argues about them.

Finally, the process isn’t robust enough to handle all of the normal noise created by day-to-day business issues.  Running a pricing process requires metrics.  It requires disciplined care and attention.  Unless the process is define, measured and re-measured there is to great a temptation to leave it to another day.  To quote The Seven Habits of Highly Effective People, it falls into the “Important but Not Urgent” category.  It’s just too easy to let it slip-slide until you are finished with that problem with the office AC unit or a hot customer emergency.

A parting word
There have been some technology breakthroughs that push pricing strategy from a black art to a real science.  And, what more there are organizations who take the risk out of the equation.  If you don’t make more money – there is no cost to you. 

With a value like that, why would anybody not add this significant value to their company?

Give us a call, we have helped a number of companies find the right pricing consultant for their company.  My number private number is 563-514-1104.

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