Pricing has become a hot topic in our industry as automation through ERP systems becomes more advanced and easier to manage. That said, it’s still much too common to send out flat margins per product type, or worse yet, leave pricing completely at the discretion and whim of the sales team. And yet it’s not unusual to see companies with little-to-no process around pricing learn how to incorporate one and enjoy the addition of points straight to the bottom line. Over the next couple months, we’ll cover different strategies and processes to help you start or improve your systems around pricing.
The best place to begin to examine pricing is to look back at how we created an extended look at cost-based accounting. Ask the same question. What is “cost?” Many see cost as the average price paid for the inventory, sometimes including any additional freight needed to get it there. Of course, I believe it is much more than that.
If you still haven’t started an activity-based costing system, start down this road by adding those miscellaneous inventory costs that we all incur. Every company in our industry experiences “inventory shrink.” This is the cost of doing business that is easily passed on to the customer for managing the material in your yard.
Consider that companies often make strategic purchases in trade for a lower cost from the supplier for the product. Most companies pass this savings on to their customers, experiencing no true profit gains, while simultaneously incurring an added inventory carrying cost due to those inefficient inventory turns.
Here are some simple suggestions:
1. Add an additional cost to every stock item that is brought in
— Don’t go less than 2%.
— This can be automated in your ERP system.
— You can also choose where the added cost goes on your income statement.
2. Keep the profit on your “strategic buys”
— Set the internal cost at the price you normally would pay and move the investment buy into additional cost at the time of creating the purchase order.
— You can put this in the same income statement, or create a completely different income statement to use for different purchasing and financing tracking.
Some may say this is merely inflating the cost and moving money from one hand to the other, but I disagree. The key to success with this strategy is to keep it internal on the leadership team. If the sales teams know this is happening, they will adjust their “margin logic.” If your sales reps have any pricing/margin controls, they will default to a margin percentage that they feel comfortable with. If their preference is 20% on studs and OSB, then they will mark up the inflated cost in the same way as the average cost and create a higher sell quote to their customers, all while selling with the same confidence as before. However, if you asked them to sell studs and OSB at 24%, they begin to think the price is too high, and that affects their confidence, customer approach, and negotiations. Building it into the cost means there are fewer arguments, fewer anxieties, unaffected sales, and ultimately greater margins.
Some pushbacks on this cost capturing model stem from believing it’s dishonest to keep this kind of information from the sales reps and the thinking that it keeps them from earning rightful commissions. But do these same companies charge their salespeople each time there is inventory shrink? Do they ask the sales team to help pay for the additional inventory carrying costs that are paid by the company? The answer is, unequivocally, no. These are true expenses that should be reflected in costs and ultimately paid for by our customers.
When evaluating your pricing strategy, start with internally defining, “What is cost?” Margin is the percentage added to cost to get your selling price. Avoid selling yourself short before the first percentage point is even added. This simple correction will forward at least 50% of whatever you add to the inventory values directly to the bottom line. Start with cost, end with profit. That’s what works.
Shane Soule consults with LBM and component companies to increase productivity and profits, and improve the experience for both customers and team members. Reach Shane at shane@shanesoule.com
