Price cutting is a fact of life, but that doesn't make it any easier to take.



During my first stint with this magazine in the late 1970s and early '80s, every management guru in the industry preached price integrity. "Demdam Pricecutters" was the name given to every other wholesaler in town by the one doing the talking.

When I rejoined the wholesaler side of the industry in 2001, a profound change had taken place. Wholesalers have all but given up trying to hold the line on pricing. The focal point nowadays is squeezing costs out of operations so you can afford the price chopping that's regarded as an immutable fact of life. Today's marketplace is characterized by a never-ending price war with no winners but plenty of casualties.

The numbers in the chart below are adapted from the ASA Educational Foundation's "Essentials of Profitable PHCP Distribution" training manual, which I wrote. The book is aimed at educating industry newcomers, but veterans and novices alike would do well to remind themselves of the bleak arithmetic of price cutting.

Margins are calculated in percentages, but percentages are abstractions. In the real world you pay your bills, your people and yourselves with gross profit dollars (GPD), and hopefully have a little left over as net profit dollars for capital investment or mad money. The overall health of a business is largely determined by the amount of GPD it generates. Here's where the big volume companies can wield their pricing power, because they can generate more GPD even with smaller margins than a small competitor. It's suicidal for a small firm to get into a price war with large competitors.

Yet, for large and small companies alike, there are disproportionate penalties to pay for trimming margins. As the chart shows, to make up for GPD lost by reducing gross margin a mere 5%, a wholesaler needs to increase unit sales by 25%. Think of it like a 25-year prison sentence for stealing a loaf of bread. Discounts of 20% -- not unheard of in the industry -- entail the daunting task of trying to sell FIVE TIMES! as many goods to make up the GPD shortfall.

Alas, this is the arithmetic that prevails throughout the industry, especially in the commercial bid and spec sector. Wholesalers and their vendors are willing to trim margins almost to zero to land a big order. The quest for volume trumps GPD, even though sales volume has about as much to do with business success as a ballplayer's weight has to do with his batting average.

I know. "Ya gotta do what ya gotta do" to get the order in many cases. I just think it's a good service to our readers to point out on occasion the dire consequences of doin' what ya gotta do.