If you happen to be in sales and have some room to adjust your pricing in order to secure or win business, this article is for you.
So, just what does the title of this article mean? Most companies have some kind of gross profit or gross margin goals in place for their business units and sales force. And, if those individuals are rewarded for sales growth or margin growth, they might not be focused on maintaining a healthy sell price. In previous articles, I have attempted to demonstrate the damage that taking low profit orders can do to any company with fixed resources. This article is focused on the pricing choices of individuals and how those choices can affect their own performance. Let’s take a look at a simple fictitious example of what happens when price cutting is used to meet other goals, such as sales, margin or quantity sold targets.
A business unit (or salesperson) has established annual Sales of $1,000,000. Of this, Cost of Goods Sold is $750,000, leaving $250,000 of Gross Margin/Profit (GM). Their established Gross Margin Rate (GMR) is 25%. (Gross Margin / Sales). Just a 2% drop in GMR will drop total sales to $974,026 and drop GM to $224,026. That’s a $25,974 drop in Gross Margin. You may have noticed that is just slightly more than a 10% decline in total GM for what might have seemed to be a tiny price cut.
In addition, I have included the table below to further reinforce the numbers from the example above and show the sales and GM erosion from additional changes to GMR. Hopefully you can see just how damaging each point of GMR can be on a business unit or sales person’s performance.
While the numbers above show what you lose if you cut your profit rate, the chart below shows how you must grow your sales and margin in order to offset profit lost from dropping your GMR. In the chart below, you can also see that it shows the new (Total) Sales and Cost of Goods you will have to achieve to maintain the same margin if you start dropping your GMR. If you are not alarmed by the fact that just a 5% drop in GMR will require a 25% increase in Cost of Goods Sold to attain the same GM Production, you are probably not paid or rewarded for your production. Take a look: your new Cost of Goods Sold is now $1,000,000 which happens to be what the previous sales used to be to achieve the same Gross Margin results.
Nobody wants to work 25% harder to achieve the same results. On the other hand, if you are interested in doing the same amount of work, and reaping great rewards, increase your GMR. In layman’s terms, that means raise your prices just a little bit and make more margin.
In the real world, there are only so many opportunities for a new sale, so if you drop your GMR too deeply and too broadly across your customer base, you may not be able to win enough new business to get back to your GM goal. Compounding that problem, once you have become known in the marketplace as the one that slashes the prices, you will have a tough time growing your GMR back to acceptable levels. Think of it this way: if the rest of the market is pricing a Cadillac for the same materials or services that you are pricing a Pinto, how are you going to explain that your previous Pinto offering is now worth the same as a Cadillac?
The Alpha Sales Rep in you is probably thinking that you still want every order. Fine, there are ways to combine your sales skills and pricing expertise to grow sales and maintain your profit expectations (GMR) at the same time. For example, if you have to take a $25,000 order at 20% in order to win the business, work to offset that drop in GMR by finding $25,000 of business at 30%. It may take a few smaller orders to add up to the $25,000 to get the offset at higher GMR, but those opportunities are out there. Find those deals and in the end, you’ll keep your traditional profit rate because you used your sales skills in combination with your pricing skills to win orders and maintain your profit needs.
In short, remember the value of all of the lower GMR orders you take and find ways to have equal and offsetting amount of higher GMR orders to maintain your average. If you cannot achieve that end result, your customers might have out sold you. Better yet, grow your GMR on the offsetting orders and actually move your overall GMR up! If you have a budget of any kind and you understand the examples above and how to combat them, you have a solid foundation for success.
Finally, you have probably noticed that the math from this article’s title “If You Cut Your Price, You Must Sell It Twice” is not entirely true, but if you remember the title when you are working your deals, you will be more successful than if you simply lower your prices to buy business.