Re-Framing Price Increases Leads to Stepped-Up Profits
June 12, 2006
Case categories include: Leadership Sales
By Robert Sher
Do you know how shake up your sales department? Just say, “We’re raising prices.” So when I learned about a CEO in trucking and transportation who made one such pricing move, and convinced his sales team to make it happen, and grabbed 33% more gross profit, I had to know more.
I learned that this industry has traditionally worked on a 15% markup over cost. I said, “Alan, so you raised your markup to 20 percent?” Alan Huttman, the 6-foot, 7-inch, 240-pound CEO of HA Logistics, said, “Nobody gets 20 percent markups in this business.” But, I insisted, to boost your gross profit that much, you would have to go from a 15% markup to a 20% markup. Alan retorted, “You can’t sell a 20% markup.” My brow wrinkled.
Reframing the pricing model
Alan explained. He told his team to stop shooting for a 20% markup, but instead, to shoot for a 20% gross margin. In a thin-margin business, the difference between those two 20 percents is large. On a shipment costing $1,000, Alan used to shoot for a $1,200 price – a 20% markup. Now he shoots for a 20% gross margin. That means on a $1,250 sale, he can move a shipment costing him $1,000, and make a 20% margin.
You’re thinking it’s a math game. But I’m calling it re-framing the pricing model. In the minds of his sales team, and on paper, Alan is still earning the industry standard 20%. In a world of a thousand tariffs, negotiated discounts all over the board, and every shipment having a different cost basis (weight and distance both vary), the shift in calculations is easily overlooked and is small in aggregate to most customers. But it’s huge for HA Logistics, which has a thin gross margin, not to mention a small net profit margin.
Salespeople hate increasing prices. It makes their job harder, creates irritated and angry customers, and risks losing business. They don’t want to have to justify the increase by telling their customer that it’s to pad their bottom line. (Yes, you often get a negative result with this tactic.) So it’s your job to frame the price increase in a way that makes sense, that your salespeople can face customer resistance and stand fairly resolute.
Different industries attack it in different ways. Transportation has fuel surcharges (“that’s not a price increase – oh no—that’s just passing costs along…”). Airlines break apart bundled services – charging for food, change fees, and more. The big question for each business is how they are going to do it – to get their sales team and customers to see their price increase as fair, reasonable and justified. I love the way Alan did it – it’s still 20%, but with a slightly different calculation. It worked for him. What will work for you?
Getting your people on board
Price increases are worth a lot of thought, since as always, most of the price increase flows right to the bottom line – all except for the sales incentives. And sales incentives were not forgotten by Alan Huttman. He used to pay a percentage on the dollars of gross profit each of his sales team brought in. That encouraged big deals, even if it meant shaving the gross margin percentage quite small. But with his new plan, he splits the weighting of the incentive between gross margin dollars and gross margin percentage. So the big, low-margin jobs don’t pay as well as they used to. But any job with good margins pays nicely now. Naturally, the sales team is paying much more attention to the gross margin all of a sudden. And Alan’s mix of business has tilted toward higher gross margin jobs.
Identify the beliefs and emotions around price. Get way beyond the “lower is better” starting point. How do your sales team and your customers think about pricing? What bugs them? How do most calculate your price into their business model? When there are pricing discussions, how does the conversation go?
Plan out how to convey your pricing model and how to portray a price increase. Justifying it based on rising costs is an easy way. But in many cases, it’s a tough sell to prove why you must charge more. It’s even worse if your competitors don’t raise prices. But if you change the way you price entirely – like shifting from hourly fees to fixed fee billing, the changes are much more transparent.
Understand the mechanics of cost management by your customers. Is every bill you send scrutinized, or just the big ones? The answers to this question may vary among your customers as well. There is a fine ethical line here. Certainly you should price as agreed, but you don’t want to bring up price all the time, calling it out every time you make an extra nickel. The retail concept of lost leaders may be useful to you – you may have to negotiate down to smaller margins on high profile jobs, but be able to earn your target margin or better on the everyday business.
Try to find a way to make your sales team want to fight for higher prices and higher margins. Telling them “we need the money” doesn’t go very far, even if you were 6’ 7” and 240 pounds, like Mr. Huttman. Motivate them, and give them a reason – some logic that they can use to sell the increase, and watch your margins grow.
• Even a small change in your pricing model can reap significantly higher profits.
• Get salespeople on board by incentivizing the change in the pricing model.
• Look at pricing from the point of view of your customers, and think through any changes to your pricing model accordingly.
Robert Sher is principal of CEO to CEO, specializing in assisting CEOs and business leaders as they navigate critical passages. He is the author of The Feel of the Deal; How I Built a Business through Acquisitions. He may be reached at Robert@ceotoceo.biz.
Company and Case Facts:
Company: HA Logistics, Inc.
Person: Alan Huttman, President and CEO
Alliance Member since: 1998
Business Founded: 1984
Annual Sales Volume: $45 million in 2005
Service: Transportation and supply chain management
Typical Customer: Manufacturers and retailers
Written: June, 2006
Address: HA Logistics, Inc., 5175 Johnson Drive, Pleasanton, CA 94588