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Real Issues. Real Answers. Fair profit vs. price gouging

“As long as you’re just trying to maintain a normal profit margin there should be no question about price gouging. You can justify your prices then because all you’re doing is maintaining margins, then being open with your loyal customers shouldn’t be an issue. Price is important, but a reputation for doing business honestly is just as important.”

“One man’s minimum margin is another man’s gouge. It depends on which side of the transaction you are on.”

“The manufacturer deals with this pricing mechanism and considers the cyclic nature of the market. When prices are down because of low demand, the purchaser doesn’t go ‘soul searching’ on whether the low price is going to break a manufacturer. The only price gouging occurs when a weather event happens and there are insufficient products at the scene of the emergency. Then the parties need to exercise good sense and sell at a little above the prevailing price in other parts of the nation.”

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“Share market information and what is happening in the industry so that customers know what trials you are facing with regard to purchasing materials. Ask that they give you as much advance notice of their needs so that good purchasing decisions can be made.”

“I believe that there is not much concern with getting away with ‘gouging’ in these days of ample competition and savvy internet shoppers. It’s important to get the margins required to be a responsible, stable business owner. If gouging is the prime directive of any business, it’s a short-term existence.”

“The threshold is different based on your interaction and terms. Does this customer pay their account by credit card costing you 2% fees? Does this customer always require special rush deliveries? Does this customer consistently change orders at the last minute? Is your customer really loyal to you or do they buy only on price? Does the customer work with you in forecasting their needs? This last question is one that definitely speaks to whether you take a little extra when you can or pass it along.”

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“Your job is to generate enough profit to ensure that the company can pay its bills and save for the inevitable downturn. Fair profit is the maximum margin you can achieve in your market to pay for the services you provide your customers based on their volume of purchases and service needs. Price gouging would be charging your best customer the same or more than your most difficult, highmaintenance customer.”

“It’s all about competition. Our perception of our competitors, largely gleaned from our relationships with our customers, determines pricing. Due to the high degree of competition, price gouging seems impossible.”

“Every true business entity must know the difference between fair profit and price gouging for long term business success.”

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“Price gouging is when someone doubles the price of a high-demand product like plywood or gasoline just ahead of a hurricane. Outside of extreme examples like that, the everyday mix of products sold is always a ‘blend’ of a wide variety of margins. In today’s competitive landscape, if that blend doesn’t include a good number of products with very high margins, your profitability will slowly be eroded by the growing number of items with thin margins. Cost should never dictate retail pricing. The marketplace determines retail. What’s a ‘fair’ return on your overall operational investment…5%, 10%, more? Achieving that objective demands continued pricing diligence to both keep those highly visible items competitively priced and find those blind items where the margins can be much, much higher.”

“Any attempt to get more for your product than what the market allows borders on price gouging. The market will dictate what you can make. We have established four-tier pricing based on volume and potential. As long as we stay within those parameters, we should make an acceptable profit. The key is to set your pricing as high as you can within what the market allows.”

“Price for your business model. Ours is excellence throughout the experience with premium products. Our profit margins are higher to fund the efforts to deliver excellence.”

“I think it is hard to price gouge in the market today. Unless you have an exclusive on a product, which is very hard to attain. Even so, a competitor’s product keeps that in check as well. No one is forcing anyone to buy anything.”

“The fair price is what the customer is willing to pay. If the dealer adds value sufficient for the customer to justify buying, then that is a fair price. This industry is very competitive. There are multiple dealers chasing the same customers. Customers know their options and they know the value that each dealer brings. Items that are easy for builders to shop on an apples-toapples basis have the slimmest margins. Items that have value-added features like design, manufacture, installation or frequent small deliveries can offer the dealer higher levels of margin. We typically hear price objections and may lose some orders, but customers often come back because the ‘cheaper’ dealer fell down on some aspect of service.”

“Gouging? Has anyone considered the absurdly low margins we have historically worked on?”

“This is a question that recently got brought up internally regarding special orders for retail customers (non-pro). On the sales counter, we have one employee who flirts with the line of ‘fair profit’ and ‘price gouging’ very often. He is very knowledgeable on the products he is selling, very personable with customers when they come in, and is always very quick to respond with pricing or answers to questions a customer may have. I’m under the opinion that a level of service that goes above and beyond what others in the area are able to offer can warrant a higher price for the product. The better the experience we can offer a customer, the easier it is to ask for a higher dollar amount. With our pro contractors my thoughts are that I would rather find a ‘fair price point’ than attempt to gouge. I would much rather have a happy customer, paying a price where we both are able to make money, who is loyal and isn’t always price shopping.”

“I believe in just being fair to all of my customers. Honesty is the best way and it’s sad we even have to be asked this question. This is why I started my lumberyard, because you had to watch what the suppliers were pricing all of the time.”

Pricing and profitability benchmarks

We reached out to LBM industry operations expert Bill Lee for his thoughts on this question. Here’s Bill’s response, which we’re reprinting with his permission.

I maintain that the “average” pre-tax profit margin in our industry is in the neighborhood of 2.5% to 3% of sales. So a building supply business that is generating $10 million in sales is—on average—earning $250,000 to $300,000 before income taxes.

Businesses that are generating this approximate level of pretax profitability, are most likely averaging an overall gross margin of 20% to 22% of sales.

To earn 20% to 22% of sales, the typical business in our industry would have to mark up their cost between approximately 25% and 28%.

$100 cost
x 125% (25% markup on cost)
$125 sell price
$25 gross profit divided by $125 sell price = 20% gross margin

$100 cost
x 128% (28% markup on cost)
$128 sell price
$28 gross profit divided by $128 sell price = 21.88% gross margin

Again, on average, this business would have operating expenses as a percentage of sales that would run between 17.5% and 18.88%.

Gross margin – 20.00% of sales
Less Operating Expenses 17.5% of sales
Pre-tax Profit 2.5% of sales

The next level of profitability would run between 4% and 6% of sales before income taxes. Dealers that are earning “top dollar” would be generating 6% to 8% of sales before taxes. This level of profitability is pretty rare for me to see. Because the majority of building supply businesses are S Corporations and the owners pay income taxes as individuals, I typically use pre-tax profitability rather than after-tax profitability when I set benchmarks.

As you can see from these numbers, 80% of building supply businesses are a far cry from “gouging” their customers. I have frankly never seen a building supply business that is earning so much gross margin that their pricing would fall into the category of “gouging.”

“I don’t take advantage of our customers. If I can get a product at a reduced rate I pass that on or if I have to purchase at a higher rate I increase our price.”

“A dealer has to ensure himself that he is earning a large enough profit to support his capital requirements, or he won’t be supplying that loyal customer in the future.”

“This is an interesting question because we have competition in our market that keeps most prices more than fair for consumers. The question for me is how do we maintain margins and stay competitive in the market place.”

“If you have any competition you never have to ask this question.”

“There isn’t a threshold, everything today needs to be priced properly to be competitive today. Blind items need to make up what the competitive items don’t. The box stores are the ones that use this, to not look bad we need to follow the same strategy.”

“Being in a competitive market, gouging is nearly impossible for our company. Not to mention, younger, more connected people, can find an equivalent price online in a matter of minutes to check your pricing integrity. I think if you can make margins, fair margins that is, you should. You never know when that well will dry up or when a competitor can come in and change your ability to be profitable. New competition will always lead with price because customer service doesn’t come into play until you’ve actually sold something. I feel like the goal for any lumber dealer would be to net profit anywhere between 5% and 8%. I think that is fair and reasonable.”

“There is no such thing as gouging in retail with the exception of taking brief over-advantage of a tragedy like a hurricane. Supply and demand, competition, operational excellence, and sales and marketing talent tend to set the tone for a business’s profit ability. Be the best and smartest you can be, grow the business and never feel guilty about profits, whatever their level.”

“My dad taught me, ‘If you can’t make a profit selling to your friends, you’ll never make a profit selling to your enemies.’ I believe most dealers’ prices are within 5% of each other. We all try to be competitive in the market and must do enough research to determine what competitive is. The problem comes when we are so insecure that we try to ‘buy’ our way into a new customer versus sell our way into a new customer. Fair profits are a challenge sometimes, but the competition in our market is so strong, that there’s certainly no room for price gouging.”

“Knowing the cost and the selling price of an item, would you feel gouged as a customer of your product? If you think you’d feel gouged, likely your customer will.”

“If you are price gouging, you will know soon enough because these contractors will just stop doing business with you. My contractors are my business partners. if they are doing well and selling a lot of projects then I am doing well too.”

“We have a good feel for current market pricing. We try very hard to make sure we offer competitive or better-thancompetitive pricing for our loyal customers, many who do not seek competitive bids. We feel strongly that loyalty should be rewarded not abused. If we were found to be taking advantage of a loyal customer, we know that this would result in loss of a good customer.”

“The free enterprise market will prevent gouging fairly quickly in a competitive market. My experience is with competitors who do a pretty good job of keeping pricing below what I consider ‘fair profit.’ When working on raising profit margins, I believe we must create win/win scenarios for all. The best way to do that is find ways to take inefficiencies and costs out of the system, then keep some of the margin for our share of the ‘fair profit.’ For example, we raised our margins significantly when we improved our service levels by committing to deliver within 24 hours of an order placed. Our customers gladly pay us the higher margin because their overall costs go down when they have the materials when needed. Just ask a framer what it costs when his crew shows up and there is no material on the ground.”

“Fair profits and price gouging do not belong in the same sentence. Profits are always fair, because customers will always walk away from price gouging. Figure out how much do you need to charge to break-even. Then set your profit goal. Retirement within the year probably equals gouging.”

“Price gouging only occurs when the customer has no choice in the market place other than you.”

“As an 82-year old company, we do not nor have we ever taken advantage of or gouged any customer, loyal or not loyal. Had we ever done so, we would not soon be beginning our 83rd year in business.”

“I am looking to make 5-7% on my equity every year. A fair profit is what allows me to cover my cost of goods, selling expenses, general and administrative expenses, taxes, and give me the net margin I am looking for.”

“I believe that there is not much concern with getting away with ‘gouging’ in these days of ample competition and savvy internet shoppers. It’s important to get the margins required to be a responsible, stable business owner. If gouging is the prime directive of any business, it’s a short-term existence.”

“In today’s competitive world, you have to balance pricing with tight margins just to stay in business. If you price your products according to market, and find you still have better-thanexpected margins, you are very lucky. That’s when you can work with loyal and volume customers to give some pricing breaks. While you’re at it, take better care of your employees. If you don’t, you might lose them to competitors.”

“There is always a fine line between the two, however market pricing helps keep everyone honest.”

“It is very important to maintain a good relationship with longer term loyal customers. Determine a fair margin, considering all costs of dealing with individual customers. Payment histories, back-charge abuse, special demands that increase cost, etc. When a customer demands that pricing be held for extended periods of time, adding risk premium for cost volatility may offset short term losses. As much transparency as prudent will help customers understand that there is a formula for pricing that benefits their loyalty. In the absence of credible information people will fill in the blanks with thoughts of arbitrary gouging. Supply crunch premiums can be extracted from new customers, especially one-time customers coming because of limited options. If they transition to more loyal customers, pricing can reflect their importance to the business. Pricing to new customers can be a safety valve to make certain new business resource demand doesn’t impede your ability to adequately serve your core customers. Also the business you get will enable investments valuable to enhance the experience for all customers.”

The reader who suggested the “Real Issues” topic will receive an LBM Journal prize pack. Includes: a polo shirt, cap, mug, and pen.

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