Sales Force Pricing: The Stockholm Syndrome

In 1973, a bank robbery went very wrong in a suburb of Stockholm, Sweden. The two robbers took four people hostage and held them for nearly a week. During that time the hostages began to identify emotionally with the hostage takers rather than the police who were trying to free them. Social scientists have named such a transfer of allegiance the Stockholm Syndrome.

A more recent and better publicized version of the event took place in the United States when Patty Hearst was kidnapped by terrorists from the so-called Symbionese Liberation Army. She demonstrated classic Stockholm Syndrome behavior by identifying with the terrorists and assisting them in their activities.

Currently, virtually every sales force in distribution demonstrates almost identical behavior by cutting prices for customers. They do so, not because they have been physically kidnapped, but because they are swayed by a strong identification with customers. The negative financial impact on distributors is nothing short of enormous.

This report will examine the Stockholm Syndrome from the perspective of the typical GAWDA member. It will do so by considering three major issues:

  • Sources of the Syndrome – Why the sales force is so susceptible to pricing pressures from customers.
  • Impact on the Bottom Line – How very modest price reductions can dramatically lower profits.
  • Suggested Actions – Appropriate measures to overcome the syndrome.

Sources of the Syndrome
The pricing problem arises from two factors, one positive and one negative. The positive factor is that distributor salespeople are customer oriented. Their role in life is to help customers have a great purchasing experience. Normally, this is an extremely beneficial perspective for salespeople to have.

In practice, though, the most common complaint that the sales force receives is that prices are too high. When the sales force is literally hammered with this perspective day after day, they begin to believe it. Slowly, allegiance shifts from the distributor to the customer.

The negative factor is that the sales force does not fully appreciate the importance of margins in driving distributor profitability. As a result, the sales force is not aware of what margins are needed on individual items to meet profit needs. Inevitably, they begin to believe that “our prices are too high.”

Interestingly, the Stockholm Syndrome is not a factor for faster-moving, commodity-type items. These are already priced on a market basis. Prices are almost always assumed to be fair.

The problem manifests itself on slow-moving items—the classic C and D items in a matrix pricing arrangement. These items have high margins because they are slow selling. However, the sales force sometimes loses sight of the fact that the item may have sat in inventory for a year waiting for the customer to need it. Instead of the current price being fair, it is often stated that “we are overcharging our customers.” Such a perspective is a significant margin drain.

Exhibit 1            
The Impact of Price Cutting on Slower-Selling Item
Impact of a 10% Price Cut on all D Items
Velocity
Code
        Net
        Sales
Gross
Margin
Percentage
      Gross
      Margin
      Revised
      Sales
      Revised
      Margin
Revised
Margin
Percentage
A $6,000,000 40.0 $2,400,000 $6,000,000 $2,400,000 40.0
B 2,000,000 45.0 900,000 2,000,000 900,000 45.0
C 1,500,000 55.0 825,000 1,500,000 825,000 55.0
D 500,000 75.0 375,000 450,000 325,000 72.2
Total $ 10,000,000 45.0 $4,500,000 $9,950,000 $4,450,000 44.7
Impact of a 10% Price Cut on all C and D Items
A $6,000,000 40.0 $2,400,000 $6,000,000 $2,400,000 40.0
B 2,000,000 45.0 900,000 2,000,000 900,000 45.0
C 1,500,000 55.0 825,000 1,350,000 675,000 50.0
D 500,000 75.0 375,000 450,000 325,000 72.2
Total $ 10,000,000 45.0 $4,500,000 $9,800,000 $4,300,000 43.9
             


Impact on the Bottom Line
Oftentimes management is not fully aware of how serious the pricing problem can be. After all, it simply affects slower-moving items that are a small part of the sales mix. Further, the margins after the price cutting are still “pretty good,” so why worry?

Exhibit 1 reflects a pricing matrix for a representative GAWDA member. It may not follow the exact pattern of every firm, but it demonstrates the fact that the A items are low-margin, tonnage products. The C and D items are at the high-margin, slow-selling end of the matrix. Overall, the margin for the entire firm is 45.0%, which is typical according to the PROFIT report.

The top part of Exhibit 1 demonstrates the impact of a 10% price cut on D items only. The impact as shown is on the sale of all D items during the entire year. Each individual transaction involving D items would have the same sort of impact. Looking at the aggregate of all sales is simply quicker and easier.

As can be seen, the price cut lowers the total firm gross margin from 45.0% to 44.7%. For a firm with $10,000,000 in sales, this is a gross margin loss of $50,000, as the sale of these items will not be influenced by the price cut. Since expenses for the firm are the same, this comes right off of the bottom line.

The bottom part of the exhibit looks at the same 10% price cut, but on all C and D items. Here the results are much more dramatic. The firm has suffered a gross margin loss of 1.1 percentage points or $200,000.

It is important to remember that the typical GAWDA member only has a bottom line profit of 5.0%. From that perspective, a reduction of 1.1 points is a major issue to be addressed. Of equal importance, it is probably a reduction that could be avoided in its entirety.

Suggested Actions
Slower-moving items are ones where there should be huge opportunities for margin enhancement, not margin degradation. Generating the needed margin requires education, monitoring and discipline.

Education must focus on the fact that a 75.0% gross margin on a D item is not high, but extremely fair. Again, this item may have been held in inventory for one or two years waiting for a specific customer to need it. Product availability on slow-selling items is not just a good value added, it is a great value added. Salespeople must be convinced of that themselves before they can convince customers.

Margin Enhancement Opportunities

 

Knowing when prices have to be cut and when they don’t is an ongoing challenge for distributors. While there is nothing that can make the issue entirely scientific, there are a few general guidelines. Specifically, items with three or more of these characteristics are virtually guaranteed to be price insensitive:

  • Slow Selling – Generally D items.
  • Not Promoted – A lack of readily available price information.
  • Low Dollar Value – Items that sell for $2 as opposed to $2,000, or even $200.
  • Infrequently Purchased – Items that are bought episodically.
  • Bought Only When Absolutely Needed – Items that are purchased only when specific needs arise.
  • Unique Items – Items that are not readily available from other sources of supply.
  • Repair/Service Parts – Small-dollar purchases that allow the buyer to forego a larger purchase.

Monitoring requires systems to ensure that irresponsible price cutting is not taking place. Virtually every management system has the ability to trigger exception reports on pricing activity by each salesperson. Such reports must be monitored with vigor.

Discipline reflects the reality that every salesperson may be trained and believe that prices really are fair, but not all of them will follow through in the proper manner. Discipline can be implemented by setting minimum margins on individual D items. If sales are made below that margin level, then commissions are not paid. Discipline can also take the form of fixed pricing on non-commodity items. In that case, pricing issues are removed from the sales environment.

Moving Forward
Gross margin management continues to be the main profit driver for GAWDA members. There is no gross margin opportunity that should be overlooked. Outside margin pressures are a reality and pricing must be fair and honest. However, if the problem is an internal one where the staff thinks “our prices are too high,” it is a perception problem that must be addressed firmly.

Gases and Welding Distributors Association
Al Bates Meet the Author
Albert D. Bates, Ph.D., is founder and president of Profit Planning Group, a distribution research firm headquartered in Boulder, Colorado, and on the Web at www.profitplanninggroup.com.