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Pricing For Profit
By Jeff Butcher on August 31, 2012

Free market America is a competitive place. Closing sales is paramount to building a loyal customer base. Generating volume leads to growth. Growth pays the bills—or does it? My definition of selling includes closing the sale while making a fair profit. The free market system only allows for a modest profit—especially in racing, where our customers fight for every penny to keep cars running all season long. For all you racers reading, you can be assured that your manufacturers and dealers run on minimal profit. While it is great to have low prices, it is also nice to have needed items in stock on Fridays. Knowing your dealer will be around next week is good too!

We manufacturers and dealers chase after the discretionary dollars of our customers. Our biggest competition is less likely to be our direct competitor and more likely to be found at all of the places that take cash from the wallet of our customers. While we need to make quality product that gives customers a reason to purchase “our” brand, we also must remember that we need to make a compelling case for customers to buy from us in the first place. We need to make our products exciting to buy—and we need to make a little profit, allowing us to serve our loyal customers year after year. Profit funds growth and ingenuity. To keep our customers excited, it is vital that we companies evolve and invent.

Our true competition surrounds us at every turn. The purchase experience needs to make customers feel good about buying from us. Competition is good and helps us to focus on how to create an environment where price is just one of the factors instead of it becoming the only factor. Would a driver work as hard if the grandstands were empty and no other racecars or teams were at the track? Competition provides the relativity and drives performance. We should strive to lead and initiate, as falling down to the level of lesser competitors is bad business. While comparing your company to another can provide insight, the real goal is to reach for new heights that lift us above comparisons.

Companies that drive prices down as their only tool to create volume usually fail. It is OK to make a profit—even the people that buy from us understand that we have expenses. Our customers know that our companies must make money. Even though those same customers are trying to save on every purchase, they reluctantly understand that businesses need to be paid for hard work.

Often, dealers lower prices too quickly for fear of losing a sale to competitors. Market share is important, and paying close attention to market pricing is a worthwhile effort. As a dealer, it is difficult to hold onto a higher price and lose a sale. To be successful, sometimes it is wise to lose a sale if the price required to close a deal is a break even proposition. Technology has created new pricing pressures as consumers can shop from many places in a short amount of time—even on the road right from their phones. Prices today are now pressured by access to instant information and gratification.

When dealers enter into technology-based sales platforms to sell their products, a new set of rules becomes part of the game. E-commerce, online advertising, and product sales through online product fulfillment resources cultivates new business. A new set of customers is introduced to the company product line in a dynamic fashion that evolves daily. Print media is etched in paper and information can become stale the second it is printed. Dealers benefit by accepting both sides of the T Chart by realizing that the new digital marketplace has wonderful advantages. In return for advantages, new and challenging disadvantages must be accepted and managed. Taking the good with the bad is an old adage that is built into utilizing new online technologies.

Accepting the limitations will help dealers to fulfill their goals with less frustration. The “system” will give you advantages, but the same system comes with the strings of instant visibility. Online pricing is broadcast instantly for all to see. Competitor reactions that took days or weeks in the past, now take seconds. Companies that realize the digital marketplace is constantly changing will prevail. Relying on a low price business model as a selling tool is erased by competitor reactions. The new digital norm places a focus on providing service, as low pricing published online will be matched by your competition before sunset.

In fact, dealers that enter the technology-based world with a methodology of undercutting the established norm start a battle, and the casualty is likely to be lost profit. Reactions are swift—retaliations are harsh. All dealers work on thin margins. I ask dealers often to focus on knowledge and service while they have a little margin at their disposal. The company that relies solely on pushing a lower price tips the dominos to fall in the wrong direction. Within minutes, competing companies simply match price, and instantly the segment is running on unsustainable margins.

The economy we now live in has already squeezed most companies to the brink—the cutbacks have already been made. To survive, efficiency is required and some of the savings should be pocketed. The market needs more service as cutbacks have eroded the knowledge sharing that was once plentiful. Employees wear many hats as smaller staffs are asked to do more. Just watch the poor person at your favorite fast food drive thru that is taking your order through a head set, packing your meal and forgetting your fries!

So yes, competing dealers can see low online prices just as quickly as customers. In fact, they are likely to see price drops even quicker than customers. Software programs and simply paying attention bring new low prices to light at about the speed of light. Loyal customers call to buy product and reference a lower price from the company across town or even more likely out of state—dealers nearly always match price to keep the sale. Yet, sometimes it pays to simply let the sale go as profit is the energy drink that keeps companies energized. Most industries are limited by the free market system, and it takes hard work to have a few dollars left at the end of the year. Growing companies nearly always reinvest profits to fund growth—at least the smart ones do. Growing builds equity and your accountant will tell you that the tax man is rich enough. Re-investing verses paying more taxes.… Not a hard call there?

A long time ago, one of my dealers felt it was best to move product off the shelf instead of carrying non-seasonal inventory through winter. His belief was that he needed to lower prices to move product and move it now. Agreed, inventory turns are important, as turning inventory quickly creates healthy cash flow. That said, losing money based on fear of lower than desirable inventory turn levels creates a quick path to purchasing an Out of Business sign.

I eloquently explained to the fearful dealer the math and visually showed him how he lost money by reducing pricing to below sustainable profit levels. When you factor in freight, cost of funds, salaries, overheads and all the elements needed to keep the doors open—the sales price he chose cost him both cash and profit. Ironically, he was happy that he “moved” the product off his shelves and put less cash back in his pocket than before he bought inventory. My time in the banking industry taught me that cash is King. If cash is King then profit is Queen. We need both, and we need the King and Queen to be powerful equals. The Cash King reign only lives as long as the Queen produces profit to repeat the cycle. Then we have the prince and princess that will take over someday. Build some profit as the heirs to the throne spend first and add later.

My dealer friend literally sold product at the cost he paid me (the manufacturer) for product so as to not carry inventory through winter. He did it with me standing right there —so much for my MAP policy. The dealer I refer to was adamant about his pricing habits, and I had to work hard to show him the math. He listened, but he didn’t act on my advice. Instead, he chose to initiate a price battle with a competitor that was located an hour away—even farther during rush hour. I wish the strategy of my dealer was successful. He was a good person and a friend. He built a nice customer base and literally built a new market from scratch. Pricing missteps proved to be the domino that knocked his business out. The benefactor was the Out of Business sign company where my dealer friend purchased his last item. The Out of Business company closed their sign sale deal—literally.

Analyzing product pricing and positioning is difficult and takes experience. It also takes confidence during those times when you charge more than your competition. To help illustrate the importance of focusing on profit, I built myself a spreadsheet that shows me what will happen if I lower price in a visual format. I can just give you a formula (Simple Formula: Existing Gross Profit dollars: Divided by Proposed Gross Profit Dollars: Multiplied by Existing Unit Sales = New Unit Sales to Maintain Current Profit Dollars), but I like the visual look that my spreadsheet provides. Just email me at jeff@joesracing.com and I will email you my spreadsheet. To use the spreadsheet you simply plug in a few numbers and everything instantly tabulates automatically—if you don’t like how the sheet produces prices or profits, you can just keep plugging in numbers until you find a price/profit balance that passes your common sense test. I wonder how many companies lower prices and simply have zero idea how many more units they will have to sell to make the same amount of cash. Cash pays the bills—percents are just funny symbols on your keyboard.
 
Often, what seems to be a modest price decrease presents a scenario that forces you to double sales to make the same amount of money (real cash). If you knew how many more pieces you needed to sell in advance of a price drop, I bet companies would be more selective about lowering prices. Maybe the price drop would have been less? Maybe a pricing issue would be viewed as it pertains to one retail situation. Blindly making an across-the-board price change available to all is likely more detrimental than companies realize. The spreadsheet is easy to use and fills in within seconds—it is meant to be a guideline and not the end-all decision maker for business. You only need a few basic pricing numbers to get a visual look at cause and effect. Even if you estimate the numbers you plug in—the relative message will be the same and your business decisions will come from a scientific baseline verses just guessing.

If you choose to use my visual spreadsheet, you will vividly see how many more unit sales you will need to make the same amount of cash as compared to your established pricing. In nearly every case, you will see that the new unit volume required, based on lowering prices, will appear unreasonable. A lower price may bring in “new” sales. With thought, it may be time to label a specific item as discontinued?

You must make a profit, as more volume multiplied by a product that is losing money equals a lot of lost money! If you lower prices—your goal should be to bring more cash into your company. Why would you lower prices only to manage more unit sales (more unit sales creates more work and internal costs) just to match the current cash level you are bringing in on an item? Your goal is to make more money, not just work harder to make the same money.

The reality is that your competition is going to price match quickly. Dealers that think there will not be a reaction to their low price entry into the market are potentially making a business ending choice. Competition matches price within hours, and now both parties provide their knowledge and service without the benefit of getting paid? Why not simply provide quality, service, and sound knowledge while you can still put some money in the bank?

Pricing products is an art form. Spreadsheets and science should be coupled with keeping a pulse on overall market conditions. Charging a fair price that keeps you competitive is the way to go. Coming into the party thinking lowering established prices rarely works. If you have found a way to lower historical costs and are passing your savings on to your customers, then perhaps you can gain a sustainable market advantage. Efficiency that creates savings, that can’t be easily reproduced by your competition, may allow for sustainable lower prices. Simply placing an X through established pricing and hoping a new low price will give you the market lead is a choice that comes with an unpleasant ending. Service, knowledge and filling your shelves with the correct blend of products builds your company. Cutting price based on believing you will have a monopoly on low pricing shrinks your company and evaporates the contents of your wallet.

It may appear that my process promotes raising prices so that profits zoom upward. Reality dictates what the market considers a fair price. The competitive landscape creates a price range for all products. Charge too much and you will miss every sale. Undercut the market and you will miss making payroll. The idea is to keep a balance and realize that the focus should be on the small portion of every dollar that you get to keep. Too easily, companies look at sales dollar totals when they should be focused on a fraction of that amount found in the profit column. Many good companies thrive on profit percentages in the low single digit range. Double digit profit is a home run. Huge profits are rarely found in small business. 25 percent profit is reserved for oil companies, tobacco companies, and politicians.

Service and ingenuity always prevail—my goal is to prevail before we have zero profit to fund our future. Be fair in your methods and you will profit in more than just dollars. The reward comes in the form of pride, as serving happy customers turns work into play. Spreadsheets are unable to measure enjoyment, so have fun and cultivate profitable customers with an energetic supply of knowledge and service.

Go Forward – Move Ahead

Jeff Butcher

 

About the Author
Jeff Butcher's picture
Jeff Butcher is a veteran of the racing industry based in the Pacific Northwest.
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