Margin Erosion

Every place I go to surrounding electrical and plumbing distribution I see the same thing. Margin erosion! Quite frankly, I take comfort in the fact that I’m now merely a consultant whose job is to consult where contracted. I’m contracted as a software trainer, not a margin consultant but one thing is always obvious.

Distributors who don’t study price from the top, are doomed. By the top, I mean a CEO who builds an executive plan which implements consistent, fair, and profitable pricing strategies. I’m sorry but the 30-year veteran who has the culture of a family owned distributor just isn’t the correct person to make everyday pricing decisions. I like to take informal surveys when I tour a company and consistently find these are the guys knocking down the 40% margin to 25% for “a dozen donuts”.

What do I mean by donuts? We all know closely what we pay for a gallon of milk, but do we know the price of a dozen donuts? No, when we need donuts, we just buy them.

A great company known as Profit 2 explains it like this. “Most wholesale distributors underprice incidental items because of lack of buying history and market feedback. These items tend to be priced for convenience not optimization.”

Profit 2 goes on to say on their website, “Most distributors have 20% to 30% of their sales that aren’t price sensitive. You can identify them easily. Look for items purchased infrequently by a customer and when their annual spending on that item is less than $1,000. Most of these sales are relatively price-inelastic. These sales are the low-hanging fruit for margin optimization.

You should compare your margin on these incidental sales vs. your average margin. Most distributors make 6 to 8 margin points more than their average on incidentals. However, 25% of distributors in each industry (i.e. electrical or HVAC) make more. These higher earning companies make an additional 5 points of margin on incidentals. As a result, their EBITDA is 2 to 3 times higher than comparable companies.

• Customers spend an average of $250 a year per incidental item

• You can increase margin 4 to 5 points without reducing units sold

• Your customers will only spend $5 more a year per incidental item

I worked with Paul Parsons from P2 many years ago after spending a full year studying the pricing problem with a committee of seasoned electrical distribution personnel. In the end, the information was too much and the cost of assigning a key 30-year employee was simply too expensive. Our key employees simply generate too much revenue and taking them away from sales and specification is too expensive. A distributor makes overs 100,000 pricing decisions each year. Allowing a proven method of AI to help break this down into milk and donuts will pay huge dividends!