I wanted to write this to have those in ag retail stop and think about something that affects every one of us every day. And that is “price”. Billions of people make price decisions every day. Many times they do so without ever consciously considering what it is they subconsciously thought about when they decide if a price someone offers them is to too high, really cheap, or what we thought it would be, or should be.
In the world of retail and sales, we have the unique opportunity to be on both sides of the pricing decision. What is it that makes selling products to customers so complicated? Why is it that some farmers will find your price to be in the realm of what they expected (and that doesn’t mean they agree with it) and another farmer will find it simply too high. How many of us have actually had farmers say, “I thought it was going to be a lot higher than that.”?
All of the working pieces behind these sometimes frustrating replies are based on a lot of moving pieces and we won’t go into all of them here. However, I wanted to touch on just a couple methods of deterring what a price will be. Perhaps this will be a simple review. I have found that when my sales staff or I am getting beat up on the price it is sometimes good to just take two steps back and start with the basics.
Let’s start with a general observation. Those of who make a living farming and those who supply farmers are in a market that is typically highly commoditized. Some farmers are niche farmers and grow food stuffs for specific markets that are not commoditized, and most of us can think of such situations. Let’s face it, a farmer selling No. 2 yellow dent corn is marketing and producing a commodity product. The farmer who has a dairy herd that produces milk for a local brand of specialty dairy products or a farmer growing specialty grains for a local artisan bread market can’t find a publically traded contract price for spelt, buckwheat, and einkorn.
In many commodity style markets, prices are not very elastic. In other words, the price can change and yet the consumption doesn’t change accordingly. Take gasoline. It is a good example of price “inelasticity”. We simply need gasoline to maintain our way of life. Have we seen mighty price swings? Absolutely. However, despite the price we still use about the same amount, from year to year. It’s a tremendous lesson in pricing. Typically, the margin per gallon for the gas station is about a couple cents a gallon and volume is the name of the game. Kind of sounds like the world of the grain farmer marketing into the supply chain. The price paid to the farmer can swing mightily in just a few years. We can all attest to that! But in the end, we all need to eat and the customers won’t quit buying that corn. As consolidations continue up and down the food chain, there will be a natural tendency toward increased price sensitivity in a rather inelastic market. That can make for frustration. How will you respond? It will also create powerful opportunities for the nimble and market savvy. Will you be one to spot the developing needs and trends?
As a professional consultant and salesperson, you need to consider the market you work in and ask yourself how you can help your customers and yourself in a tough commodity market. You may hear the question, “What’s you price?” more than you are used to. We have had these downturns before and rest assured we will have them again. The price will always be a very important part of the buying decision.
(The Government of Alberta published a nice article on all of the following models and I want to say “Thank you”, Alberta!)
From your selling price, all bills are paid and the company saves for a rainy day, makes investments, and provides a return back to the ownership and those who invested money looking for a return (like banks) on their investment. You may drop your price on a ton of fertilizer by $20 per ton to meet a competitor or, worse yet, to buy back a customer’s confidence in you or your company. It’s only $20 bucks you say. But, if you were using a Cost-based Pricing Model and marked up your fertilizer with a $60 per ton margin you have just made a rather serious decision. To begin with, you have just given away 1/3 of your profits to pay the bills. If that customer is needing several hundred tons that can add up to a very large number. Ask yourself this Retailing 101 question, “How many more tons will I need to sell to offset the profits I am giving away?”
- Volume: 500 tons
- Standard Margin: $60/ton
- Discount: $20/ton
- Total Margins on Sale: 500 x $60 = $30,000 (half the payroll of one professional employee?)
- Total Margins on Discounted Price: 500 x ($60 – $20) = $20,000
- Sacrificed Margins: $30,000 – $20,000 = $10,000
- New tons needed to make up losses at discounted margins? $10,000 / ($60 – $20) = 250 tons
Where will you find a new 250 tons to make up the sacrificed margins? What will the price need to be to make that sale to one large new grower? Do you have enough time to sell that many tons of several new customers? Probably not. When working within a Cost-Based Pricing Model margins are very structured. While it makes sense for some items, it can be rather prohibitive when establishing prices on others. You probably don’t use the same formulas for markups for seeds or chemicals. Prices and margins are the lifeblood of any company of any size. The larger the company the more complex the goals for price setting can become. People in marketing, finance, operations, sales, bankers, and stockholders, all have their own goals for price setting and the stage of life of the company itself and the market it serves can also come into play when world sized all the way to family businesses. It takes dedication to crisp communication, and clarity of goals to keep everyone on the same page.
Competition-based Pricing is another commonly used practice. This is used in many types of markets. We will hear from our customers how our price is too high. Those of us who have been around a while know that paying attention to the customer pays the bills. And right behind that is knowing what your competition’s price is on a very select list of items. Use of the Competition-based pricing model allows one to decide their place in the market. It is the way to decide your place relative to market share based on price alone. By the way, if you are are using a Cost-Based Pricing Model for a product and your competitor decides to make a stand on that product and use a Competitor-based Price you can find yourself all the sudden defending your price to a lot of your customers.
Customer-based Pricing is one that we see more and more of over the years. Way back in the day, agronomy retailers dealt in just a few fertilizers. Ammoniated fertilizers were the product. You had a few grades and everyone used the same few grades. That was definitely a Cost-Based scenario. Then came blend plants and customization of fertilizer blends. Customer-based Pricing was immediately something to consider. It supported the service of custom blending. It allowed for differences in quality and allowed the customer to help the “value” in your product. It allowed for flexibility of product offerings and in the process allowed a for a broader price range for the products handled. Today, blend plants are the norm and many farmers typically buy straight ingredients when quantities allow it. Has what was Customer-based opportunity turned back into a Cost-based or Competitor-based scenario? It is IMPERATIVE to know your costs of production. I knew what it cost me to ship a ton of fertilizer, including all fixed and variable expense lines.
Establishing prices can sometimes be a blending of all the above. And when this method is successfully implemented the results can be absolutely stellar for your company and devastating to your competition. Used with success in the fashion industry, heuristic pricing schemes use a blend of intuition, cost-based, competition-based blending the “art” or pricing with more of a scientific approach by blending experience, market prowess, and a whole host of secondary information from various sources to come up with what can become a very effective pricing scheme. It was said that former Chairman of the Federal Reserve, Allan Greenspan, would observe and monitor in excess of 30 different streams of information, what could be termed, Secondary Sources, as he and the rest of the Board went about setting policy and rates. And when you able to link with manufacturers for market exclusivity of new products, you need to consider carefully how to properly price the product. I have seen both too low and, without proper overall business support, prices being too high.
Regardless of your method to determine your price rest assured of the following:
When Value of Product is less in the mind of the customer than the Product Cost you will quickly find yourself losing the sale.
In all situations it is an If/then scenario:
If Product Cost > Perceived Product Value then Decreases in revenues will ensue
Protect your brand
In a world that is sharing everything, perceptions can quickly form about your brand. How important is your brand to price? To quote a certain politician, “It is huge.” The brand is the lightning rod that attracts all customer perceptions of you and your company. If your brand is tarnished you will quickly find yourself playing all sorts of damage control and trying to buy back some of your customer loyalty by sacrificing price. You discount your prices to buy back loyalty and need to sell more to offset the discounts. A marketing cycle is created and you spiral a business into the ground through the mathematical process of discounting. And this will feed into the old saying, “you get what you pay for”. Brand perceptions are created that you are desperate for business and willing to buy your way back into the marketplace. And once that perception is formed, your brand is cast into this role. Without radical change, it will grind into eventual ruin and possibly never be able to re-enter the marketplace.
Support your price.
In times of tight low commodity prices, customers become more price conscious. It is times like these that you need to keep in constant contact with management. If your management is like I was they will like to hear what you hear and what you are thinking. Communication is key. Your customer KNOWS that you must make a profit. Good business people want to deal with good business people. They want to know they have a dealer who will be there today and tomorrow to supply them with the intelligence and products to get them through to better days.
What is the number one contributor to profits? Your business is a very capital-intensive type of business with a lot of money in “bricks and mortar”, rolling stock and inventory. Controlling costs may be tops on your list. It’s certainly is a big one, with payroll alone typically making up the majority of all expenses. So, controlling costs is key. However, the single biggest factor to increasing profits is to maintain margins and maintain revenues. It reminds me of the veterinarian coming to our farm one time when we had a very bad case of coliform mastitis spreading in the herd. He pointed to the pipeline and said, “What flows through that (pipeline) is what pays your bills”. All the expense control in the world will not pave the way to ultimate success. Short term survival? Absolutely. Sales are the engine that powers your business into the future. Expenses are the fuel that powers it. When you are able to balance margins and reduce costs you will see a greater cumulative effect on profits. That’s called Return on Investment, profits, stable jobs, satisfied bosses, and most importantly, satisfied customers.
Writer’s note: I want to put a freely offered promotion out there to Coursera distance learning. Folks, to stay sharp as professionals we need to exercise our talents and stay sharp. Coursera does a great job of bringing together short education sessions for professionals to allow us to stay sharp with the help of instructors from all over the globe. You can even help a farm boy brush up on marketing, pricing for agriculture by showing examples from the fashion world. Now that’s saying something!