We expect a strong recovery (at last) in our corner
of the Plastics Industry, beginning 4Q 2003
and continuing into 2004. It is well to point out
some critical strategies on the eve of such a turnaround
after almost three years of sluggish to no growth.
One of the key factors must be pricing for a recovery
and some key issues must be considered.
It sounds easy for a distributor to give bigger discounts
as a convenient way to increase sales. It makes customers
“like” doing business with that distributor. Sometimes a
company feels compelled to a lower price to be in line with
the “going rate” of what competitors are charging. These
are all understandable motives. Yet, rampant price cutting
is one of the quickest ways for a company to drive itself
out of business.
Constantly lowering prices can kill profits:
Let’s do a little arithmetic. Suppose a distributor
charges $100 for a particular product for which he paid
$75 per unit. The gross profit is therefore $25.
$100 Selling Price - $75 Cost = $25 Gross Profit
Competition has now heated up, however. In order to
remain competitive, suppose that distributor decides to
lower the price by 10%. The selling price is now $90. The
distributor still had to pay $75 for the product, so the distributor's
gross profit falls to $15.
$90 Selling Price - $75 Cost = $15 Gross Profit
There’s a stunning imbalance hidden in those numbers.
The distributor lowered the price by 10%, but as result
lost 40% of the gross profit dollars.
$15 Gross Profit
$25 Gross Profit = $60%, or 40% less profit
Making it up in volume is a fallacy
It’s quite possible that by reducing prices 10% a distributor
might well increase sales of those products. But it’s
unlikely sales would rise enough to make up the difference
in gross profit dollars.
If you look at it in terms of dollar volume, instead of selling
$10,000 worth of products (100 x $100 each), the
distributor would have to sell $15,030 worth (167 x $90)
to achieve the same gross profit dollars. That is an
increase of more than 50% in dollar volume, along with a
67% increase in the number of units that must be sold.
In conclusion – watch your bottom line before discounting
– even in this competitive market!
For more information, click on the Author Biography link at the top of this page.