During my first stint with Supply House Times in the late 1970s and early 1980s, every management guru in the industry preached price integrity.
“The damn price cutters” was the phrase used to describe every other wholesaler in town by anyone doing the talking.
When I rejoined the wholesaler side of the HVAC and plumbing industry in 2001, a profound change had taken place. Wholesalers have all but given up trying to hold the line on pricing. The focal point now is squeezing costs out of operations so you can afford the price chopping that’s regarded as an immutable fact. Today’s marketplace is characterized by a never-ending price war with no winners but plenty of casualties.
My opinions are from the American Supply Association Educational Foundation’s Essentials of Profitable PHCP Distribution training manual, which I wrote. The book is aimed at educating industry newcomers, but veterans and novices alike would do well to remind themselves of the bleak arithmetic of cutting prices.
Margins are calculated in percentages, but percentages are abstractions. In the real world you pay your bills, your people and yourselves with gross profit dollars, and hopefully have a little left over as net profit for capital investment or mad money. The overall health of a business is largely determined by the amount of gross profit it generates.
The big boysHere’s where the big-volume companies can wield their pricing power, because they can generate more gross profit even with smaller margins than a small competitor. It’s suicidal for a small firm to get into a price war with large competitors.
Yet, for large and small companies alike, there are disproportionate penalties to pay for trimming margins. To make up for gross dollars lost by reducing gross margin a mere 5 percent, a wholesaler needs to increase unit sales by 25 percent.
Think of it like a 25-year prison sentence for stealing a loaf of bread. Discounts of 20 percent - not unheard of in the industry - entail the daunting task of trying to sell five times as many goods to make up the gross dollars shortfall.
Unfortunately, this is the arithmetic that prevails throughout the industry, especially in the commercial bid-and-spec sector. Wholesalers and their vendors are willing to trim margins almost to zero to land a big order. The quest for volume trumps profit, even though sales volume has about as much to do with business success as a ballplayer’s weight has to do with his batting average.
I know. You’ve got to do whatever’s necessary to get the order in many cases. I just think it’s a good service to readers to point out on occasion the dire consequences of that mentality.
Jim Olsztynski - pronounced Ol-stin-skee - is editor of Supply House Times, a sister publication of Snips. He can be reached at (630) 694-4006, or e-mail firstname.lastname@example.org.