To introduce Part 4 of the sins of margin management I'd like to borrow a quote from the movie 21 as said by Micky Rosa the MIT teacher who leads his students to play blackjack in Vegas. "We're counting cards, we're not gambling. We're following a specific set of rules and playing a system." In this issue we look at some of the tactics you can implement when putting together your system to balance risk vs profitability in your pricing policy. Remember folks, even though we came down hard on cowardice last week you can't go too far in the opposite direction, you need to find balance, or as Micky said when his student lost control, "You didn't do your job. You weren't counting, you were gambling."
Let's start by acknowledging that the food industry overall is highly price sensitive and competitive, so when we say "low price sensitivity items" we mean compared to other items in the food industry. It is because the industry runs at such high sensitivity levels that it becomes critical for food distributors and processors to "play a system" and balance the risks professionally. Let's look at some of the key techniques you'll want to consider when building your system of pricing policies.
One quick aside before we dive in, just like most people can't explain how you catch or throw a baseball (it involves some high level physics and trig equations about force, distance, speed, gravity, etc.) it is a challenge to break down what you've learned to do "instinctively" into a system. But just like a pitching coach will break down the steps towards the perfect pitch, you need to break down your steps into a system so you can analyze it and improve yourself (and others in your company).
First let's look at the factors that lead to price sensitivity in an item. The chart below was provided by Advanous.
| Factor | Importance |
| Total Sales Dollars (price x quantity) | 30% |
| Purchase Frequency (# of times item is ordered) | 25% |
| Unit Cost (higher cost items receive more scrutiny) | 15% |
| Unit Quantity | 10% |
| Use Frequency | 10% |
| Visibility of Item | 10% |
In order to take this information and turn it into a system for making pricing policies you're going to need a few things. First off you must have solid sales reporting. 80% of the factors that go into how price sensitive an item will be to a customer is information from available from your sales records. Only 20% is your "read" on how the customer uses the items.
So let's look at the "system" first:
- Run a total sales report by item and look at the lower part of the list.
- Identify items on the list that are purchased infrequently.
- Identify "low cost" items in that group.
This gives you a list of items that tend to have low price sensitivity for the customer. Remember, this list will be different for customers with different buying habits. Next you need to identify items on that list whose pricing policy is due for a change.
- Items with a selling price below the value provided to the customer.
- Items that do not meet profitability goals.
Remember from our earlier conversations that low cost low volume products need to have HIGHER profit margins to offset fixed costs. Recognizing this is one of the benefits of formalizing your pricing policy rather than "gambling". Just like these items have a low price sensitivity to your customer they often have a low price sensitivity to you. Force yourself to pay attention to these prices.
Finally it's time to start implementing the pricing policy changes. Keep in mind that the goal of this exercise is to balance risk against profitability, so start with your safe bets and move in a controlled manner towards the higher risk items.
Advanous advises "Analyze accounts, identify under-priced items that are not generating an adequate profit, and begin moving margins up. DO NOT go into a system and raise hundreds of prices all at once.
So what’s the conclusion? Price an account’s sensitive items competitively and its non-sensitive items profitably. Doing this will allow a sales rep to achieve an overall acceptable profit for that customer, and deliver improved margins to the company’s bottom line."
Margin Management is a discipline that should be part of your sales meetings after discussions with your Controller analyzing your current sales analysis reports.Remember there are only 2 ways to make more money, reduce Cost or increase Margin, do both.
| < Prev | Next > |
|---|
