April 11, 2023
According to McKinsey, traditional methods of expanding profit margins are falling by the wayside in supply chain and distribution industries. Instead, pricing has become a “distributor’s most powerful value-creation lever.”
McKinsey predicts that companies rising to the top will be those that prioritize more profitable deals through pricing optimization. This allows them to be in touch with what consumers want and are willing to pay, which means sales teams can make more and bigger deals.
With this knowledge, distributors need to focus their pricing strategy and models to ensure they’re creating the most profitable deals for their business. As you optimize your distribution pricing and make pricing decisions, consider these few tips.
Choose Product-Level Strategies
Companies will often become known for either low prices or high quality and price accordingly. However, I’ve found that the best distribution businesses and wholesalers apply their pricing and marketing strategies at the company and product level.
When considering how to price your products relative to competitors, there are three potential strategies: penetrate, shadow, and skim.
- Penetrate: The product is priced to gain market share and beat your competitor’s price. This strategy works best with core products you want to compete with (and win).
- Shadow: The product is priced comparable to your competitors. You don’t have to match your competitors exactly, but you need to be close enough so customers perceive that your products are priced the same.
- Skim: The product isn’t a part of your core product set, but if people are willing to buy it you should sell it to them at a higher price.
A good example to illustrate these strategies in action would be shopping at a grocery store. Every time you shop for groceries there are a set of “core” items you purchase, such as bread and eggs. Because you buy these every trip, you have a good idea of what the price should be and you shop where you get the best value.
However, suppose on one trip you also need to buy paprika. You can’t even remember the last time you purchased paprika and have no clue how much it should cost. You also aren’t going to spend the time and effort to compare costs and drive around to other grocery stores, so you purchase it along with your bread and eggs because you need it and your regular store has it.
Paprika is the store’s “skim” item, while the bread and eggs would be their penetrate or shadow items.
Companies have the potential to make a lot of money by setting product-level strategies and pricing accordingly. So when it comes to strategic pricing for distribution, you can certainly set a strategy at a company level, but to really make an impact you need a product-level strategy as well. By analyzing total product sales, their volume, quantity, and invoice lines (or the number of transactions) you can better understand what strategy each product needs.
Perform a Price/Volume Analysis
A common distribution pricing strategy is to offer discounts for bulk sales as a reward for customers who purchase the most. For example, if your company sells building supplies, you want to reward contractors and customers that buy from you regularly. Those customers aren’t going to be enticed on a transaction-by-transaction basis like your average customer doing a one-time home improvement project. They want the best price every time they shop.
As a distributor, you need to look at the overall relationship you have with your customers and set discounts based on how much you expect them to buy over a certain period of time. The goal is to offer lower prices to reliable customers without hurting your profit margin.
At EnterBridge, we do a pricing process called matrix pricing. Sticking with the building supplies example, if you have a successful contractor as a customer, your assigned sales rep will work with them to create individualized pricing terms to secure an amazing discount because you want to keep their business. The bigger they are (or more money they regularly spend), the better their pricing terms will be.
However, many customers will fall in the space between the DIY homeowner and high-volume contractors. You want to make sure you give these people a better price than the general public, but you don’t want to create individual pricing terms for each one. Matrix pricing allows you to group these customers into “buying groups.” These buying groups consist of customers with similar characteristics who are purchasing similar products.
You might have one buying group of small residential plumbers and another of mid-sized electricians. Within each group, the customers will be offered the same discounts and incentives. With the flexibility of matrix pricing, you’re able to significantly increase margin through small changes in pricing for similar groups of customers.
Price/volume analysis performed at an account or customer level— not a transactional level — helps you keep a pulse on the customer experience and ensures you’re seeing the necessary relationship between your sales revenue and profit margins.
Plan for Hidden Costs
There are different ways to look at how much an item “costs”:
- Invoice Cost: the direct cost of the product as it was purchased from the vendor.
- Replacement Cost: the cost you have to pay to replace that item in your inventory when you sell it.
- Commission Cost: the loaded cost where indirect, or fixed, costs are included in a price markup. Those indirect costs are then distributed across your products.
Just like in any other business, there are always hidden costs in your distribution company. Be sure to plan things like operating costs, transaction fees, and fixed costs along the distribution chain into your pricing policies.
Finding these hidden costs can take some time, but if you keep data on all aspects of your business and distribution channels, it’s a simple matter of aggregating and analyzing. This also goes for any added perks you include for customers, such as free shipping or a free product with a certain level of purchase. The more accurate you can be about your costs, the more accurate your pricing, which helps you achieve business goals faster.
Build in Flexibility
The economy is seemingly always in flux, but especially lately. That’s why it’s crucial to build flexibility into your pricing model. Your business needs to be able to adjust to a changing market and economic scenarios that affect the prices of goods and services in your industry.
Products are typically priced using one of three methodologies:
- Fixed Price: This is the easiest one but perhaps the most inflexible. This is when you give your customers a specific fixed price, usually based on your cost and desired profit margin. For example, your cost may be $5, so your selling price is $25. However, when your cost changes, your selling price doesn’t move accordingly. You have to decide whether to implement price increases on your products or keep prices the same and have it cut into your bottom line.
- Discount Price: Discount prices are expressed as “List Price minus 20%.” You set a list price for each product, and as the cost of that product increases, you raise the list price accordingly, so the discount remains stable. This is the pricing method predominantly used by distributors because it gives you the most flexibility.
- Margin Price: Margin prices are expressed as “Cost plus 20%.” This is when you decide what percentage margin you want on a product after factoring in your true commission costs. You might set the margin at 20%, and as the item starts to cost you more, the list price goes up to maintain the 20% margin.
Your business must be able to adjust to a changing market and economic scenarios if you want to remain profitable. The COVID-19 pandemic, for example, drastically disrupted the supply chain, which affected distribution and caused prices to rise across the board.
Any small change in the overall market can mean big losses for your business if you’re not prepared to adjust your prices accordingly.
Plan Your Pricing
For distributors, understanding the importance of pricing is essential for a successful strategy. Optimizing your distribution pricing should be about more than just crunching some numbers. You need to take a close look at certain aspects of your business and consider these four factors to ensure you’re competitively pricing your products and setting yourself up for long-term success.
We help companies analyze and optimize their pricing strategy to help them earn the profits they need to reach their business goals. Book a call with us to see how we can help you optimize your pricing strategy.