Dave Roller’s article “Overcome Fear – A Behavioral Approach to Higher Margin” was featured in this month’s Eclipse Users Group Newsletter. Read the article below, or view the entire newsletter here.
Overcome Fear – A Behavioral Approach to Higher Margin
Your sales people live in fear. Here’s their nightmare scenario… they raise a price…the customer notices….they ask for an explanation…and stuff happens. Sales people know that they’ll be scolded if margins are low, but if sales are lost look out.
If you’ve worked to improve margin, you’ve may have been frustrated by sales force resistance. The fear sales people have at the prospect of raising prices is real. Many Eclipse users have invested in intense pricing work only to be disappointed when the new pricing isn’t used at the point of sales. Industry wide, less than 50% of prices suggested at order entry are used by the order writer.
The key to overcoming this challenge is to view pricing as a behavioral challenge. Start by recognizing that your sales people’s fears are rational. They operate in a stressful environment. Competition is tough, customers know more and more. Faced with this situation, many sales people overact and assume they must maintain low margins on all sales. But in reality, most distributors have 30%+ of their sales that are not very price sensitive.
Distribution executives often rely on their sales compensation plans to prod their sales people to make more profit where they can. The reality is compensation plans move your sales people to focus on sales volume vs. margin, here’s an example of why…
Consider the example of a real estate agent given by Levitt & Dubner in Freakonomics. A real estate agent is paid a percentage of a home’s sales price. Both the agent and the homeowner have a common interest in the sales price. However, their interests are not identical. If a home price is reduced $10,000 it can reduce the homeowners equity substantially. On the other hand a $10,000 price drop may only reduce the agent’s fee by $300 to $400. So guess who wants to sell the house fast vs. at the highest price? Here’s a fact. When agents sell their own homes, the time their home is on the market is much higher than the average and the average sell price is 2% higher.
Similarly, a 1 point margin gain can increase many companies’ earnings by 25 to 50%. How much is a 1 point gain worth to your sales person? Put yourself in their shoes. I’d suggest most sales people live in enough fear they will choose safety over a chance to earn a little more.
Financial incentives aren’t enough to overcome fear. In our practice, our clients have increased margin by 1 to 2 points by following 5 basic strategies to overcome fear and gain the support of their sales team.
1. Play Defense First– The first step you should take is to reassure your sales team. They will breathe a sigh of relief if they know they don’t have to worry about margin increases on competitive sales. We do this by identifying those sales that may be price sensitive to your customers. We look for price sensitivity indicators- i.e. Customer purchase frequency, amount purchased and the type of item. Once identified, we make sure these items are protected so the margin does not change.
2. Make the Process Transparent– When we conduct training meetings with client sales teams we hear one remark over and over. The remark is “just don’t surprise me”. Based on our experience we believe what sales people fear most is being surprised by a customer question on a price increase.
We suggest you involve your sales leadership at the outset of a margin improvement program. Make sure they and their people understand why it’s important to increase margin. Help them understand how you will decide to increase margin, their vital role and what will be done step by step. Don’t try to minimize the importance of the initiative. Rather, help them understand pricing management is another area where it’s important for your company.
3. Start Slow– When taking on a new challenge, most of us are naturally more comfortable with a conservative approach. One of the best ways to reduce fear is to start slowly. You can substantially increase profits by focusing on your least price sensitive sales. Here’s a fact from our practice…most distributors can increase margin 1 point in 3 months with modest price increases on incidental sales.
Most distributors have approximately 30% of their sales that can be considered “incidental”. These are items where the customer spends an average of about $250 per item per year. They are non-competitive sales, typically purchased less than once per quarter. Aim for a 3 to 4 point increase initially. Your customers will pay less than $10 extra per item, per year. Focusing on incidentals is a low risk strategy your sales people can embrace.
4. Give Sales the Final Say– Once you move past the most incidental sales, give your sales people the opportunity to review margin increases.
Our clients’ sales people review our margin increase recommendations. Sales people have the option to accept the recommendation, decline or suggest an alternate margin. Our client executives support this effort by assigning each reviewer with a specific gross profit increase objective for the review.
When assigned an objective, the reviewer looks at the business differently. As they start the review, they protect larger customers first. Then as they start to seek more profit, they become partners in looking for where they can safely get more gross profit dollars. Often, they will enter alternate margins higher than our recommendation.
We think the best validation of this strategy is the utilization of pricing accepted during the review. Our clients’ sales people use 85+% of the prices they accepted on reviews.
5. Measure and Reward– The more effort placed on measurement and reward, the more margin you will gain. We urge our clients to set specific quarterly price utilization objectives. Then our job is to make sure each Order Writer and their managers get reporting analyzing their utilization and a detail of where they have overridden the system price.
Profit2 client executives who recognize building utilization is a marathon vs. a sprint are successful. Consistent follow-up and coaching have enabled P2 clients to move from less than 50% of system prices utilized to over 90%. Key to this effort is to recognize and reward performance. Our clients use different incentives, but the key is to directly reward the Order Writer for utilizing the system suggested price.
Overcoming fear to build margin is a challenge. Our clients have succeeded because they recognize pricing in the distribution business is foremost behavioral. They employ the same bedrock management techniques they use in other facets of their business. This combined with analytics and technology provide the path forward.
Information on the Author
Dave Roller is the founder of Profit2, a 19 partner firm dedicated to helping distributors safely increase margin by helping them improve how they price. Profit2 has helped many large Distributors and Manufacturers build margin and earnings for over 10 years. You can reach Dave at [email protected].