In Search of the Magic Number

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Read an article that highlights how important it is for distributors to implement a scientific pricing process that gives sales people confidence in the prices they quote and the tools to justify premium prices to the right customers. Excerpts of the article authored by Frank E. Hurtte Jr. who has 28 years of distribution industry experience and a lifetime in sales follow.

“I typically begin my work by searching for the magic number.”

In amongst the normal stuff occupying my inbox was a fresh set of data from a new client. In an effort to better know my clients, I often ask for several months’ billing laid out by product, salesperson sale price and gross margin. This data allows me to surgically peer into the distributor. Based on the turnaround time, I can gage distributor’s capacity for generating analytic data; I love when data can be set into spreadsheets quickly and easily. Most importantly, it exposes an unadorned view the distributor’s sales effort.

Opening the spreadsheet and giving the whole thing a once over for data errors, poor descriptions and rows filled with unreadable characters, I typically begin my work by searching for the magic number. What I have discovered is simple; most distributor sales teams somehow settle on a comfortable margin for orders where they lack solid pricing information.

Using the power of Excel, I quickly build a formula to determine gross margin percentage, copy it throughout the sheet then sort the data. Scanning through the spreadsheet, I quickly notice a couple of noteworthy trends. The first third or so gross margin percentages are relatively random; a few transactions in the single digits, many more in the teens. Then the magic number hits; row after row, page upon page of margins set at precisely 20 percent literally jump off the screen. Pushing on, I notice a number of random orders set at higher margins with the whole thing ending in a flurry of 35 percent margins. Could this be another magic number?

“I don’t believe the magic number necessarily reflects the market price for all of these products.”

Let’s make an assumption. I don’t believe the magic number necessarily reflects the market price for all of these products. First, my review indicates products from a wide variety of suppliers all carry the same magic cost up margin. Secondly, the products represent a diverse groups of technologies. Juxtaposed, the suppliers originate from a wide range of industries; one might wonder how they arrived upon the same pricing structure. And finally, the customer list points to customers scattered across a wide region representing a couple of states, rural and urban locals and various sizes of companies.

How is it possible that such a wide variety of customers, suppliers and market conditions could have so easily settled on cost plus 20? Simply thinking about the supplier side of this, what are the chances every distributor received the same pricing from a wide variety of suppliers? Today’s channel landscape is a patchwork quilt of programs. Sometimes driven by competitive situations, other times through tiered distribution systems and special into stock deals, rarely does every distributor have exactly the same price.

Looking at the magic number, one quickly concludes there is no magic.

“The wide-scale employment of computers gave birth to Magic Numbers.”

Throughout the 1990s and into the turn of the Twenty-first Century, most distributors struggled to maintain the quality of prices shown on their order entry screens. To give you an indication, the term “price not maintained” became a common message within customer service groups. Simply put, this meant the suggested prices displayed on the ERP system were not to be trusted. Sellers were forced to determine their own pricing strategy. These broke down to one or more of the following:

  • Manually look up the price using the old paper method – which was time consuming.
  • Establish pricing based on the history or last sale of the item – but sometimes there was no real pricing history.
  • Use a margin they felt reflected the market price – often soliciting guidance from a more experienced seller.

Over time, safe margins developed. As in, if you don’t know where to price an item use cost plus 20 percent. With time and without research or much real thought, these numbers were held to be the actual market price. Add new sellers who mostly lacked formalized price training and the number proliferated.

Today, some distributors will attest to the numbers being passed down on stone tablets from a high.

“Mostly, magic numbers give away margin.”

In this particular case, let me ask this question. Why 20 percent, as opposed to 21, 22, or maybe even 22.5 percent? Pushing even further, does it really make sense to tie anything to your cost? Many distributors find themselves paying for inbound freight on at least some of their product lines. Is freight considered before or after adding the magic percentage number? And what about special deals? Distributor management teams work like crazy to boost profitability with special into stock prices. But as quickly as extra profits are created on one end, guys armed with a magic number give the potential profit away with sloppy pricing.

If all this doesn’t scare you, consider this point. The magic numbers used across entire lines of wholesale trade are tracking downwards. Who’s ever heard the comment, “Your price is too low”? Every time an order is lost at the magic number level, at least someone wonders if they should use cost plus a new (and lower) magic number. We believe this line of reasoning is ruinous to an otherwise healthy distribution business.

Click here to read the complete article.

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