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September 2013

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Profit Improvement Report Taking It To The Street It's tempting to pass along supplier discounts to gain a pricing advantage in the market – here's why you must resist the discount reflex. By Dr. Albert D. Bates The economy still seems to be taking the proverbial two steps forward and one step backward on a daily basis. In such an environment, important opportunities to purchase merchandise opportunistically are widespread. Such opportunities should result in a strong improvement in profitability for distributors. However, in too many cases enhanced buying leads to stagnant or even declining profit. The problem is that distributors simply can't seem to overcome the urge to take lower supplier prices directly "to the street." That is, they reflexively pass through lower prices to their customers. This report examines the nature of the take-it-tothe-street issue. It will do so from two important perspectives: n Price Reduction Rationales – A discussion of the two different thought processes that cause firms to pass along price reductions in a seemingly automatic fashion n Profit Implications – An analysis of the economic impact of supplier price reductions, both good and bad. Price Reduction Rationales There are two major reasons that firms pass along price reductions routinely. One of the reasons is strategic, the other operational. Strategic – The strategic rationale is that price competition is endemic in distribution. A supplier price reduction provides the opportunity for firms to demonstrate their price aggressiveness to their customers. Since the supplier price reduction is often short lived, some distributors view the price reduction as an opportunity to be "on sale." That is, they can develop a price position that will provide a competitive advantage over competition. This rather blissfully ignores the fact that every other distributor has also had the same opportunity to purchase at lower prices. Operational – The operational factor is that firms are still addicted to standardized mark-ups despite the rather substantial increase in pricing sophistication over the last 10 years or so. If an item generated a 21.5 percent gross margin before the supplier price reduction, then it should generate about the same gross margin after the price reduction. Gross margin targets vary by product velocity, of course. They also usually vary by customer type. However, once the margin is locked in, it tends to remain somewhat sacrosanct as product costs change. The crux of the problem is that firms have to put prices on thousands of SKUs, the cost of which may rise and fall several times during the year. Few firms have the luxury of leisurely contemplating each individual pricing change. Unfortunately, the advent of new technology has not changed the culture of standardized mark-ups. Again, the sheer magnitude of the pricing decisions to be made gets in the way. Such technology has made static-margin pricing decisions faster, but not better. Whether the decision to pass along price reductions (continued on page 40) 38 | www.cedmag.com | Construction Equipment Distribution | September 2013 38_Bates_Profit_Feature_KP.indd 38 8/28/13 12:31 PM

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