MYOB: Do Your Customers Understand the Importance of Pricing for Profit?

In every installer’s business, there’s always one person who wants to cut prices. Their reasoning is that if business is good, a lower price will help capture an even greater share of the market. And if business is bad, cutting prices will help retain the existing share of the market.

The number one fact of an installer’s business must be clearly understood: installers cannot cut prices without cutting service or quality. Cutting service or quality has a dramatic impact on the shop’s long-term credibility with its customer base, and credibility is everything when it comes to building business in automotive maintenance and repairs.

The fact is that most installers do not charge enough for their products or services. When business is good, you need cash to fuel growth, cash that could be generated by higher margins. When business is bad, cutting prices often makes matters worse. You have to increase sales significantly to recover the dollars lost by the cuts. This results in the installer working harder instead of smarter.

Cutting prices or charging too little can have a disastrous affect on any business. For example, suppose that you sell 100 of a certain item a month at $1.00 each. They cost you 55 cents each, giving you a gross profit of $45 and a gross profit margin of 45%. If you cut your price by 15% and your unit volume stayed the same, your sales would drop to $85, your gross profit to $30, and your gross profit margin to 35%. If you want to maintain your original $45 gross profit after the price cut, you will have to increase your monthly sales by 50%.

The mathematical formula to determine the results goes like this, with GPM representing Gross Profit Margin: GPM% (GPM% +/- price change %) – 1 = unit volume % change.

In our example in the paragraph above, for ease of calculation, the percentage is changed to a decimal.

Example: .45 (.45 – .15) – 1 = .50

In other words, your original margin of 45% discounted by 15% representing your price cut, means your unit volume would have to increase by 50%. You would now need to sell 150 units to maintain the same dollar gross profit you were making when you were selling the 100 units.

Mathematics is a very precise science.

It would make more sense to have a price hike. If instead of lowering the price of an item, you raised it by 15%, and your unit volume stayed the same, your sales would now go up to $115 and your gross profit to $60.

To figure out how much your sales would have to fall off before your gross profit dollars would drop below the original $45, you use the same formula, but this time you add, rather than subtract, the price change percentage:

.45 (.45 – .15) – 1 = .25

You interpret the results from the mathematical formula this way: before, you were selling 100 units, and now with a price increase of 15%, as long as your unit volume does not go below 75 units (25% less volume), you are making more money. The price increase would improve your gross profit in dollars from the original $45 even with a sales drop. The math proves that you can sell less and make more.

In the installer business, selling less volume and making more gives the installer the new-found time to spend with the customer to educate, enhance his credibility, and build the trust factor that is required to get all the customer’s business.

By using this formula constantly, you can quickly calculate the changes needed in sales volume to maintain gross profits after a price increase or decrease. This exercise should be necessary before any installer lowers his/her prices or has a sale. You will see that price cuts must generate large–often impossibly large–increases in unit volume for the installer to regain lost gross profit dollars. On the other hand, price increases can sustain large decreases in unit volume and still improve gross profit. Improved gross profit means improved net profit!

In spite of these facts, many installers continue to under-price their products and services. Here are some of the reasons why:

Laziness: When prices are low, staff and management don’t have to sell, they need only take orders. This volume does not allow any installer to develop a relationship and build the number of clients, only operate a customer business based on price. The installer perceives nearly any marketing campaign is a satisfactory one, but he has sacrificed margins along with potential opportunities. This installer runs his business based on price rather than service and quality, cannot pay his suppliers in full or on time, is not profitable, and cannot afford to grow the business or hire the most competent staff in the market area. This installer’s future is bleak.

Fear: Installers experience many fears when they think about raising prices, such as higher prices won’t stick, or that customers will leave and the business will go broke. As I have mentioned in past articles, in my 26 years in working with installers, I have never seen one installer go broke for charging too much, but I have seen more than my fair share go broke for not charging enough.

Inattention: With so much going on, many installers often ignore their pricing strategy. Then all of a sudden they realize they must make a substantial change to their pricing to catch up. Customers prefer price increases that are frequent but small to those that are infrequent but large. Certainly, a policy of frequent price increases allows the shop to maintain every bit of margin it can.

Inappropriate Objectives: Many installers fail to look at their pricing objectives and determine what they are trying to accomplish. Is their objective to maximize current profits? To penetrate new markets? To capture market share? To discourage entrants? Or something else? The installer’s pricing policies must have an objective. Most, however, do not as they simply run their business by their bank account balance and blame their supplier for the reasons they are broke.

When sales are slower than desired, it takes knowledge and creativity to turn the situation around without sacrificing margins. It is the knowledge component of the business that is weak with many installers, as our surveys show the average installer has grade 12 or less formal education. As their jobber, you should have a strategy to disseminate current business knowledge to them so you are offering an enhanced value added service, a type of service they cannot get anywhere else. Bring value to the installer that grows their net profit and your business will grow its net profit, too. Educate your installers on the value of pricing for profit.

Robert (Bob) Greenwood is president & C.E.O. of E. K. Williams & Co. (Ontario) Ltd., which has six offices across Ontario specializing in business consulting and training in the independent installer sector of the automotive aftermarket. Bob also works with jobbers to understand the installer side of the industry and address what is required from both parties to set up a relationship that grows future business. E. K. Williams (Ontario) Ltd. is on the Internet at www.ekw.ca. Questions and inquiries can be made in full confidence via fax c/o Jobber News (416) 442-2213 or via e-mail to aross@southam.ca.