Most wood flooring businesses operate under ongoing price pressures.
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Most wood flooring businesses operate under ongoing price pressures.
Even in strong economic times, customers always push for some sort of price reduction. Ultimately, far too many companies simply lower the price, get the job and move on. In such cases, they may be sacrificing much more profit than they think.
In this article, first I'll look at the price/volume relationship with the "Sales Volume Challenge," a numerical examination of the volume increases required by the typical NWFA member to offset a price decrease. I use information taken directly from the "NWFA Dealer/Contractor Profit Report" to demonstrate the futility of chasing additional volume.
The second aspect of the price/volume relationship is holding the line on pricing, in which I have specific procedures to help retailers and contractors avoid cutting prices just to get sales. These suggestions are more qualitative and examine the areas of action that are likely to have the largest payoff in controlling price reductions.
The Sales Volume Challenge
Far too many decision makers view price cutting benignly or even favorably. In part, this is a function of the continual pressures on margins faced by companies every day. If everybody is asking for price reductions, the concept becomes a way of life. It is also due to the fact that some high-profile corporations have successfully used price as a competitive tool. In particular, WalMart and Dell Computer are commonly presented in the business press as role models for successfully using the low-price approach.
The truth is that wood flooring companies face a very different cost structure from either WalMart or Dell. The unique structure of expenses in the industry makes it extremely difficult to successfully employ price cutting without a significant change in operations.
A typical perspective is that "sales solve all problems." The reality is that profitable sales solve most problems. Unprofitable sales create more problems than they solve.
The "Sales vs. Price" graph below looks at the relationship between price cutting and increases in sales volume for the typical NWFA member. This typical business operates on a gross margin of 30 percent of sales and produces a profit before taxes of 3 percent of sales.
What the graph plots is the increase in dollar sales (along the vertical axis) that is required to exactly offset a price reduction (along the horizontal axis). Exactly offset means that the dollar profits will stay the same. For a company with $2,000,000 in sales, profits would remain at $60,000.
The calculations behind the graph are not obvious and space limitations do not allow for a thorough explanation of how the graph was derived. Suffice it to say the graph is an accurate representation of the typical company in the industry and is based on the operating characteristics of NWFA members.
The first thing that should be noted is that the graph is curved. That is, small price reductions do not require large increases in sales. However, the larger the price reduction, the more dramatic the sales increase must be.
For example, a 2 percent price reduction only requires sales to increase by 7.7 percent to still make the same dollar profit. However, when the price reduction is 10 percent, then the sales increase required to maintain the same dollar profit is 63.6 percent. In essence, the company has to run faster just to stay in the same place.
The graph puts price reductions in the most favorable light possible. Specifically, it assumes that sales increases can be achieved with no increase in overhead expenses. At the extreme, that means a 10 percent price cut requires a 63.6 percent increase in sales that can be achieved with the same level of rent, administrative salaries and the like.
If this were true, it would mean that the typical firm has 63.6 percent idle capacity. Most companies aren't even approaching this level. In short, even under the most optimistic assumptions, the sales volume increase required to offset a price reduction is huge.
It is important to note that the graph does not show that the typical wood flooring company should never cut prices.
Every company has to decide that individually. Some firms will conclude that a sales increase is attainable; others will conclude that it is not.
The graph indicates that additional volume requirements tend to be substantial when price cuts get into a truly meaningful range, such as 10 percent. Ultimately, the graph will turn straight up and no amount of additional sales volume can offset the reduction in price.
Holding the Line on Pricing
Understanding the challenges associated with price cutting can create a proper mindset for pricing. However, it doesn't make the competitive world any easier. Creating an environment of price integrity within the company requires three specific actions:
1) Sales Force Controls. The sales force is continually bombarded with requests to lower prices. Ultimately, the course of least resistance becomes inevitable, even among the best sales personnel. Specific controls are necessary to help maintain pricing discipline. Such controls usually come in the form of absolute minimum price levels or sliding commission scales. This control over sales-force pricing needs to be enforced, not simply discussed.
2) Market Focus. Most wood flooring businesses tend to view themselves as high-quality businesses. They tend to have strong guarantee programs, emphasize the durability and craftsmanship of the work they do, and utilize highquality materials and trained employees. If the company is selling quality, it should focus on those customers who want to buy on a quality basis. Seeking any and all customers is a losing proposition. On the other hand, you need to be aware of the market and adjust your work and pricing accordingly. Keep your workers busy during slow times, but be sure you don't sacrifice your bottom line.
3) Employee Education. There is sometimes the tendency to view the pricing challenge as being entirely the responsibility of the sales force. In point of fact, numerous employees impact margin in actions varying from buying materials more effectively to scheduling labor properly to controlling callbacks. Every employee needs to be aware of the margin issue.
Moving Forward
Price pressures are not going away any time soon. To continue to be successful, wood flooring businesses must make sure that every decision maker in the company understands the impact that price cutting has on performance and the rather massive sales increase that it mandates. If the entire company is moving in the same direction, the ability to maintain price integrity becomes much easier.