Is it better to keep business at $9 than lose it at $10? It seems like an easy decision, but be careful. A company’s growth is dependent on net income, not gross profit. When it comes to price concessions, winning sales people know that sometimes $1 is just too much to give. So how profitable are your sales?
As sales people, we’re trained to think in terms of gross profit. For most distributor sales reps it is gross profit, not top line sales, that is the measure of their success. Their commissions are almost always guided by it. So when the difference between winning and losing comes down to price, we look at the opportunity through a gross profit lens.
Almost every sales rep believes that it’s better to keep business at 20% gross profit than lose it at 35%. Yet, while gross profit is a powerful indicator of sales performance, it is net income that pays the bills. The best sales people know that today’s average distributors show a net income of just 5%. And so they look beyond gross profit. They know that with the best of intentions, price concessions turn net profits to net losses more often than you might think.
Think Income, Not Margin
Consider the $10 example above. Let’s say your cost was $6.50, for a gross margin $3.50 (or 35%). That’s about average for the paper and plastics distribution industry. So far, so good. If you’re like most companies, you have fixed and variable operating expenses (salaries, light bills, insurance, rent, etc.) of about 30% of sales. That leaves you with 50¢. (For the sake of simplicity, assume that your company has no debt or depreciation to consider). Congratulations, your sales just produced a 5% profit. Before taxes, of course.
As this story continues, imagine that competitive price pressures come into play. In turn, you now feel that $9 will carry the day. OK, let’s assume it will. Will that business remain profitable? Let’s see. With your cost remaining at $6.50, your gross margin drops to $2.50, or 28%. Not bad. However, your operating expenses are still 30% of sales, or in this case $2.70. That’s a loss of 20¢. The good news is you won’t be paying any taxes. The bad news is you might not pay all your bills either.
Follow the Dollar
The example above illustrates a common misconception about price concessions: that price deviations are somehow diluted by the time they reach the bottom line. Intuitively, most sales people sense that one dollar given in the form of price concessions at the top of an income statement will impact the bottom line to a much lesser extent. Not true! Generally speaking, a dollar lost at the top is a dollar lost at the bottom line.
Win the Price Battle
Net profit is the most important reason to prevail in a price negotiation. And there is good news in this story. Today’s packaging distributors have emerged as terrifically capable strategic partners. They provide a greater customization of a broader product and program bundle than ever before. Never has the selling proposition of total cost been more justified nor the defense of net profit been better served.
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