By Frank Hurtte
River Heights Consulting
The economy is expanding. Noting comments from economist Alan Beaulieu, of ITR Economics (view more here), the 2017 economy looks like a great year for growth. The forecast calls for a bright, sunshiny sky with 3.7 percent growth. It’s been a mighty long time since we’ve enjoyed this type of up cycles.
Now is the time for distributors to raise their prices. Join with me as I outline why and where to look for price increases.
Downward pressure on margins is the universal distributor complaint. New competitors, supplier sales teams setting prices at unsustainable levels, the internet and customer pushback are all finding their way into the discussion. Further, in spite of some major productivity advancements, operating costs continue to rise. One distributor, who closely monitors operational costs, commented costs have risen nearly 25 percent faster than offsetting gross margin gains over the post-recession era. Clearly, we need to do something.
When times are tough, margins get another squeeze. During “The Recession,” many suppliers instructed their field teams and distributors “not to let price be an issue” while grabbing what little business was available. We responded. Pricing levels extended on projects and ongoing flow business took a gross margin nose dive for manufacturers and distributors alike. The problem lies in the fundamental difference in the distributor and manufacturer business model. The distributor slice of the total “supply chain” gross margin is much smaller than that of their supply partners. For example, Manufacturers make 45-60 percent gross margin and the Distributors receive 20-30 percent. Simply put, we distributors have less wiggle room.
Once The Recession ended, we found ourselves stuck with the lower prices and lower margins. On the customer side, customers discovered new base-line low prices and latched onto the savings. With this fact freshly planted in their minds, many pushed/negotiated to extend the lower level.
Experiencing growth after the economic storm, our industry ramped up. New salespeople were added and many of them used low price to leverage their way into accounts. This resulted in more low prices and free service giveaways to grow their new territories.
While there was a definite period of growth in the years immediately following the big economic storm the last few years have been mostly flat. The economy has moved but it was definitely slow growth. While most distributors have only been able to maintain their sluggish margin position, reports from nearly every sector indicate faster growth on the horizon for the next year and a half.
Good times are the right time to ask for a little more. Fortunately, most of our customers are out of their own financial crisis. They no longer need to squeeze their suppliers just to survive. The new sellers pumped into our territory are mostly settled into position. They have discovered enough accounts to justify the meager commissions needed to survive. More importantly, customers are busy. They, along with their purchasing/procurement departments, are relying on you for expanded services and dependable deliveries, not record setting prices.
If ever a time existed to push margin to a new level it is now. The window, however, is narrow. Business cycles, by their very nature, move from great to poor. According to economists, this growth spurt will extend into mid-2018. Time is short. We cannot and should not procrastinate our plan.
The following is a prioritized list of actions which will enhance margins. By the way, we have prioritized them based on how quickly they can add real and measurable margin dollars to your coffers.
1. Review all long range pricing contracts.
Strangely, many distributors have long term pricing agreements without expiration dates. The customer asked for
longer range pricing stability and the distributor pushed competitors out of the way with a pricing agreement. Some of these are well crafted, while others ask the question: Exactly when will the distributor ever be able to execute a price increase?
Any agreement over one year old is ripe for a price increase, regardless of your current margin. With exception given to a limited number of commodities, it’s just not reasonable to assume the cost of anything has remained the same for over a year. I recommend a proposed price increase of 2-3 points here.
When establishing new agreements, put in openings for new price increases in the future. Ideally, these would be tied to a six or twelve month cycle.
2. Review all quantity driven pricing agreements.
In this type of agreement the customer commits to purchasing large quantities in return for deeper discounting. Our experience indicates customers almost always overestimate. Further, customers with strong purchasing/procurement groups are often trained to overestimate. They don’t see this as lying because if the sun, moon and stars all fell into perfect alignment, they really could buy a million bucks worth of your stuff.
When the customer has vastly exaggerated the purchase quantity, ask them to allow you to increase shipments to reach the number. They will almost never agree to this condition. Once they disagree, ask if you can extend a nominal price increase. Again, 2-3 points is a reasonable request.
3. Review all Manufacturer extended Special Pricing Agreements.
These pricing agreements negotiated trilaterally with the manufacturer, distributor and customer. Typically, distributors raise the price only when the manufacturer raises the price. Sometimes, the manufacturer price increases are not passed along to the customer. This needs to be addressed as soon as possible.
Whatever the manufacturer’s increase, move the gross margin up at least full point. To illustrate, the manufacturer increases the distributor price by 2.75 percent, the distributor increases the customer price by 3.75 percent.
4. Pre-plan for Manufacturer price increases.
Some customers require a 30-day notice prior to price increases, other do not. For those without this requirement, I suggest moving distributor price forward on the first day the price increase is announced. The distributor gets added revenue for a short time and the money improves margins.
5. Get a pricing process in place as soon as possible.
Let’s be realistic. I attended my first distributor Branch Manager training session in 1991. We devoted a day to the concept of matrix pricing. Each of the 30 some attendees vowed to go home and create a matrix to maximize their revenues. Two decades later, only two of the attendees had anything worth talking about.
Developing a pricing process is tricky and difficult. It requires a combination of product skills, analytics and manpower. These skills are in scare supply. It won’t work without assistance. Even if you get “cranked up” and start working full time tomorrow, the uptick will be over by the time you perfect things.
I recommend Cleveland Ohio’s Strategic Pricing Associates for a pricing process. Why? First they have experience in the distribution world. This translates into the right tools to pull data from your computer system and run the analytics. They do the heavy lifting and you only provide feedback on products, customers and supplier types. The typical distributor employing their work gets a 2 point improvement in gross margin over 90 days. You’ll see results before the end of the growth cycle. In addition, the distributors we’ve seen using their system fair better in the down turn, too.
6. Get some negotiation training.
If you haven’t noticed, items 1-4 all require a bit of negotiation. It’s a travesty to note that most distributors completely overlook the whole negotiation thing. They lull themselves into a state of false security with three misconceptions.
If any of your customers have a purchasing person who is a Certified Purchasing Manager, Purchasing Professional or any of the related credentials, they have not only been trained in negotiation, they have taken a refresher course in the subject in the past 18 months. They are constantly negotiating with you. The problem is, you are unaware of it.
Distributor style selling requires an ongoing relationship beyond those in other fields. The normal sales approaches taught in generic classes likely won’t work; however, negotiations are still present. See the comments above. Unless you rely on standard terms and standard pricing on 100 percent of your sales, you are being hit with a constant barrage of small points which add up to big dollars.
Good times can distract us all from what’s important. Many distributors operate under what we in Iowa call the “Make hay
while the sun shines” mentality. We are so busy taking care of business, we fail to carry out the truly strategic actions needed for long term sustainability. There are few things more strategic than fixing our margin situation. Now is the perfect time.
Good times are here. We’re in this for the long haul. The next cycle will arrive sooner than we think. Time isn’t on our side. Prepare now.
This article was originally published here on April 9, 2017. Reprinted by permission. The opinions expressed in this article are that of the author.
About the Author
Straight talk, common sense and powerful interactions all describe Frank Hurtte. Frank speaks and consults on the new reality facing distribution. He blogs on “The Distributor Channel” at http://thedistributorchannel.blogspot.com. Contact Frank at River Heights Consulting via email at email@example.com or via phone at 563-514-1104.