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By Scott Benfield Benfield Consulting Author, Capturing Value: A Guide to Strategic Pricing for Wholesalers

N/fOlT distributors have loose IYlpricing systems. Essentially, sales managers let their sales personnel set price in many situations. In fact, they actually pay them to cut price.

Why? Because they assume the salesperson knows all about the firm's cost structure and how these costs move, and therefore how to use a marketing template in strategic pricing.

The fact is sales-driven pricing ends up at the low end of the scale. There are numerous reasons for this, including a lack of financial acumen, poor understanding of how to base pricing on customer-not productsegments, and a compensation system that rewards on top-line sales or gross-margin dollars, not bottom-line dollars. Simply rewarding sellers on activity profits (sales minus cost of goods sold minus the specific costs of servicing a specific account) would correct much of the problem.

In addition, one of the most common methods of pricing for distributors, called velocity pricing, typically doesn't work. Velocity pricing is predicated on product movement: the faster a product moves (that is, the more sales it generates), the smaller the margin it yields. This makes sense, until you realize that all customers don't buy products at the same rate. A slow-moving item with a high margin for one account may be a fastmover with a necessarily low margin for another. In short, instead of looking at product movement, a wholesaler should first segment his entire customer base. Then he can deter- mine velocity movements for these individual customer segments.

Distribution is primarily a variable-cost business: costs move up and down with sales volume. But too many owners and managers tend to manage their businesses as if costs were fixed. The implications for pricing policy are profound. If costs move up or down with volume, the strategic objective is to maximize gross margin (sales volume minus cost of goods sold), while maintaining sales volume. But by thinking costs are fixed, managers cut price just enough to cover costs, plus a little more. In doing so, they essentially diminish pre-tax returns, because operating expenses actually rise with volume, even if their product costs fell because of bigger buys. A simple price increase of lVo to 3Vo-before-tax business has the top-line sales equivalent of $33. This is a 33: I leverage on assets! There is only one other place in distribution-cuts in operating expenses-that offers this kind of payout.

Distributor accountants think of fixed and variable in black and white terms, instead of the relative definitions they really are. The average wholesaler has roughly only 40Vo of the fixed assets, as a percent of total assets, that their manufacturers do. In other words, manufacturers have a high proportion of fixed assets in plant, property and equipment, while distributors' operating expenses are largely tied to sales volume.

Traditional budgeting and cost-cutting are also largely ineffective because expense cuts of any substan- tial nature involve head counts, representing $6 to $7 out of every $10 in expenses. Hacking at these costs, which is what traditional budgetary accounting does, doesn't take into account the quality of the service in the customer's eyes.

For instance, if you had an inefficient credit process, a comparative budget analysis would say you had too many people and it's time to cut heads in the credit department. The real problem, however, is that the process was inefficient with bottlenecks. Cutting heads only makes the problem worse, and customers go elsewhere. The key is to rework the process to make it more efficient and accurate, and then cut heads.

Good cost-cutting in a high variable-cost, service business takes process documentation, process rework, and customer-satisfaction measurements. These disciplines are found in operations and marketing, not accounting.

Marketing's aim is to build bottom-line profitability; sales aims for top-line volume growth. Distribution has been and remains a relentlessly sales-intensive business. Most distributors are content to sell like hell and count the spare change at yearend. It is a tenibly old and inefficient model compared with what an emphasis on marketing can offer-studying the actual needs of discrete customer segments; customizing a full marketing mix to these various segments (product mix, service mix, pricing and sales promotion); establishing a pricing matrix that reflects the costs of the services these various segments need, and only then letting the sellers hit the pavement-if the customer even needs a sales call.

I think good marketing will come into its own in the near future. Wholesalers have tried "sell-like-hell" and growth through acquisitions, but these things just aren't that profitable. Planned growth by creating value is the way to generate superior earnings. A.T. Kearney recently released a survey that traced mergers and acquisitions for over 50 major companies. They found that close to 70Vo have worse earnings and worse shareholder value a long time after the mergers. I don't think you would find the trend is that different in wholesaling. A lot of the recent consolidation talk is, in my view, a bunch of hullabaloo when it comes to generating profitable growth. I think we're headed into a downturn and good, hard-nosed pricing will be especially needed. to the detriment of their already meager bottom lines. special services, just like he pastes a Kohler or Square D logo on his co-op advertising today.

What about seasoned sales reps who know their local market? When a seller says he knows his market, a wholealer's pricing and margins are probably in big trouble. What he knows is how to match a competitor's price on a handful of fast-moving commodities. But most distributor pricing strategies must encompass 30,000 SKUs, backed by a good customer-segment logic and valid statistical comparisons of customers within a given segment to maximize margins.

Distributors should be charging for consultation and giving away product for cost plus whatever physical processing and shipping fees are incurred.

There will always be a need for technical and new product sellers, as well as for relationship-management sellers. Most distribution sellers are allocated by geography, which has nothing to do with a specific customer's specific needs. Nor does it do much to match a seller's strengths to a customer's service requirements. Organizing work loads by territory is done to keep travel costs down or to make the math for figuring compensation easier.

In the end. distribution will move from a sales-driven, just-in-case structure to a lean, buy-it-how-you-want-it culture. As far as the sellers go, inside sales will be lean, but still powerful and very much in need. There is just too much to do for the customer that can't be captured or delivered on a computer screen. Outside sales is a problem, though.

For how many of those 30,000 SKUs can your average seller really "know the market"?

I look at distribution today and ask, "Why all the sellers?" The products are mostly commodities. The ones that aren't are pseudo-commodities on old product platforms. Why throw a seller, no matter how experienced and talented-and especially if he is experienced and talented, because he likely carries a heavier cost load-at a product that every customer in every territory already knows about?

Distributors are so confined by their in-bred sales cultures, they keep sellers around'Just in case." They look like those gasoline stations of a bygone era, where the attendant ran out, pumped the gas, washed the front window, checked the oil, and made change. That model gave way over time to self-service paid for with credit cards at the pump, because the typical customer was no longer willing to pay for the attendant's services. The same thing is coming to wholesaling, regardless of the commodity line.

Beyond looking at the fast-movers, pricing inevitably gets less time than any other function-sales operations, accounting, you name it. Managers spend their time creating value, or at least what they perceive to be "value," for individual customers. But they devote comparatively little time to capturing value through a strategic, systematic approach to pricing. Too many dollars are being left on the table by too many wholesalers,

Two things will happen, and both will transpire because of e-commerce. First of all, distributors will use technology to give their customers meaningful choices on how they buy. For instance, a distributor could say, "You can go to my Web site and buy online. Or you can buy online and use an inside seller for product questions. Or you can buy the way you always have, with my sellers around Just in case."'

The rubber will meet the road when distributors create meaningful price levels for each of these three transactions. The cost of an inside and outside sales force is somewhere between 8Vo to llVo of sales, or roughly 45Vo of all operating costs. The winning distributor will likely do three things: First, he'll pass on 57o to 77o to customers who order online. Second, he'll charge a time-based fee for the inside sales consultation or roll the cost of the inside seller into the price. Third, he'll let the outside seller be paid a consulting charge, or the customer can pay for the just-in-case transaction like before.

The other major impact of e-commerce on distribution will be an outgrowth of this move to charge customers according to how they buy. The winning distributor will differentiate his organization by offering services for fees, while branding the high value-added services by promoting them the way he does his major product lines today. Instead ofpositioning himself as simply a Kohler, Trane or Square D distributor, he'll advertise his same day delivery or inventory management services. He'll create separate identities, logos, advertising and promotional strategies for these

The decade ahead is going to be very interesting, and the overall distribution business will look very different at the end of it. I believe that distributors will begin to change their sell-like-hell cultures, using technology to do it. The additional profits they generate through a more strategic approach to pricing will go a long way toward paying for the new technology. They can start by trying out different pricing and buy-how-youwant-to combinations, to determine the model that fits their customer bases the best. Whoever does this first and does it well will win bis.

Why Managed Pricing?

l. You can add value through better delivery, more product knowledge, products with increased features and benefits, quicker turnaround on warranties and returns, more knowledgeable sellers and automated, more accurate warehouse management. You can only capture value in one place-pricing.

2. If you think the average seller prices well, answer these questions:

(a) Do our sellers voluntarily and systematically increase prices?

(b) Do our sellers group customers in common segments and analyze pricing discounts?

(c) Do our sellers understand the math behind pricing and how it influences the company's profit?

(d) Do our sellers price using relevant costs (costs of operations that vary with the next order)?

3. n W price increase ina2%o pre-tax business is worth $50 in top-line sales,

4. vetoclty pricing C'A" item pricing or blind item pricing) doesn't work without customer segmentation.

5. Cost plus pricing is only good for velocity products or bid/buy situations and is a poor pricing mechanism for other types of transactions.