Pricing is one of the most complex day-to-day decisions in any business environment, and the distribution industry is no exception. In fact, pricing is the most critical profitability lever for wholesaler-distributors due to their position in the supply chain, ever-increasing competition, and other business forces like commoditization and globalization.
The range of variables involved in pricing makes its role and importance even more evident. There are so many variables in this process that it’s daunting to imagine listing them all. Instead, distributors tend to just scan them in their heads before making decisions based on their experience and available tools.
Today, many sales teams have transitioned to virtual selling and are more reliant on access to their systems for guidance. As such, it’s more critical than ever for distributors to focus on value rather than have customer conversations around price all the time.
Scenario 1: No Value-Based Pricing Strategy in Place
Let’s go through a typical pricing process to understand the enormity of this decision. For this example, assume the salesperson can make the pricing decision or adjust system-recommended prices dynamically while on the phone with the customer. The customer calls and asks for an item. The salesperson checks the system and confirms availability. The customer requests a price, and the salesperson looks in the system for the cost. Now, the salesperson may have these questions:
- Is the item fast-moving?
- Is the customer high potential or high service?
- What is the price tolerance for the customer?
- What is the competitors’ price?
- What is the volume discount structure?
- What is the impact on sales incentives?
- How much does he or she like the customer?
The salesperson may remember some of these variables readily but needs the system guidance for the rest. If the system can’t present these variables concisely, the salesperson relies on recent memory. So past interactions become the reference for making the decision, which often leaves money on the table.
Based on our research, on average, most distributors leave up to 450 basis points in gross margins.
Scenario 2: A Value-Based Pricing Cube in Play
Our pricing research study identified more than 200 variables considered by sales forces and decision-makers in the pricing process. This large number of variables demonstrates the complexity of pricing. The sales force can’t analyze each variable in detail and perform due diligence before making a pricing decision.
You must equip your sales force with a holistic pricing optimization framework that focuses on the most critical variables. This framework must be easy for the user to understand and use in daily negotiations with customers.
Keeping it simple, incorporating only the most fundamental pricing drivers, is imperative. Though distributors often have the computational power to crunch the numbers using hundreds of variables today, most businesspeople will not practice what they do not understand. To ensure your pricing framework is actionable for daily use, you should make your variables readily available in the system and, most importantly, make them quantifiable.
We’ve identified six primary pricing variables based on multiple interactions with hundreds of distributors in the last 10 years. We refer to them as the Six Faces of a Pricing Cube. Let’s take a quick look at the variables that should drive your value-based price cube and are foundational to a robust pricing process.
1. CUSTOMER VALUE: Who buys from us?
Classify customers based on sales volume, profitability, cost-to-serve and alignment into predefined groups — core, opportunistic, service drain and marginal.
2. SUPPLIER VALUE: Who do we represent?
Classify suppliers based on spend, performance, alignment and profitability into predefined groups — core, service driver, volume driver and marginal.
3. PRODUCT VALUE: What do we sell?
Volume, velocity and profitability metrics assign products into predefined groups — critical (A, B), support (C) and non-critical (D).
4. ITEM VISIBILITY: How often do we sell?
This variable addresses the price sensitivity of the item to each customer. Products have different levels of importance to customers based on their usage and frequency. Predefined groups are very high (more risky), high, medium and low (less risky).
5. PURCHASE VALUE: What is the cost to buy from suppliers?
In pricing decisions, the unit cost makes a big difference in opportunity and customer sensitivity. Companies have anywhere between four levels to 10 cost levels. A set of predefined cost levels are level 1 (high unit cost), level 2, level 3 and level 4 (low unit cost).
6. REALIZED MARGIN: How much do we make?
Often used together with purchase value, this variable applies past margins to set pricing guidelines and expectations. In order of importance these are a set of predefined groups: high (currently provide high gross margins), moderate, low and negative (items that are sold below cost).
A robust process must have a well-defined pricing cube based on these six drivers to be effective and actionable. Learn more about pricing optimization for your distribution business with our NAW book, Pricing Optimization: Striking the Right Balance for Margin Advantage.