Distribution Pricing is More Complex Than Retail Pricing
The approach that many experts take to pricing optimization is based on the worlds of retail and manufacturing. Unfortunately, retail pricing is much less complex than distribution pricing. In retail, there is a fairly consistent linear relationship between volume and margin. If I lower my prices, I’m likely to sell more products. Retail sales are based on individual purchases, wants and needs and so each purchase decision is much more price sensitive than in distribution. A retail buyer might buy more products at lower prices. Some buyers might not make a buying decision until the price is right. So volume increases as price decreases. And this common experience influences the way everyone thinks about pricing.
Unfortunately, pricing in the distribution industry behaves very differently than in retail. Business-to-business buyers make purchases to fuel a particular business need. Unlike the retail buyer who purchases to satisfy individual desires, the business buyer must meet a particular and immediate need. In distribution, many sales are driven by projects and jobs. A distribution customer often seeks to satisfy a project need that was scoped either through a capital or MRO expenditure and the bill of materials is fairly fixed regardless of price. They have already decided on the specific types of products they need and plan to purchase, although they may be flexible in terms of who manufactures or sells the product. But the function of the product is specified because there is a particular outcome they are trying to achieve within the scope of that particular project.
Distribution customers have also set a particular budget for the overall project and their goal is to come within or under that budget. So unlike the retail buyer who is making individual decisions about individual products, the distribution buyer is trying to satisfy the needs of their entire project within a budget range. So the relationship of price or margin to volume is much more complex in distribution. Instead of a straight linear relationship like you have in retail, it is more of an all-or-nothing situation. A distribution buyer might be seeking to purchase 100 items from you up until the point where the price is over their budget and then they will buy zero. If your price is too high for a particular bundle of products needed for their project, you will lose the entire order. Even worse, you could potentially lose all of your business with that customer. If your price is too low you might keep the customer but lose money.
From the distributor’s perspective regarding gross profit, the relationship between margin and volume can seem totally unrelated because of these project or job purchases. When our epaCUBE pricing experts examine a particular distributor’s sales history, it is not uncommon for us to find many small volume customers who receive the same pricing as large volume customers. Pricing can be all over the map.