Margin reviews are insufficient
How can you tell if your customers are paying the right price? For most companies, the answer is by looking at margins for segments of the business. If one segment shows much of an increase or decrease, that change is investigated. But is that enough? Even if the company is profitable and earning a nice margin, does that necessarily mean the pricing is sound? The answer is no.
What if your company is more thorough and looks at the gross margins of each customer? Perhaps you stack rank them and create action items for the low-margin customers. Is that enough? The answer is maybe not.
A customer gross margin represents the average margin generated by all of that customer’s purchases in a period. But for a variety of reasons, some products have higher margins than others. For example, the gross margins on computer accessories tend to be much higher than the gross margins on the computers themselves. Suppose the average margins are 10% on computers and 30% on accessories, resulting in an overall average margin of 15%. Also assume the seller makes money with those margins. If one customer only buys accessories, perhaps as a reseller, and the margin on that customer’s purchases are 16%, is the customer paying a fair price? The answer is probably not. Even though the customer’s overall margin is better than average, the customer appears to be paying less for the products it buys than other customers pay.
The graph below plots customer gross margins on the Y-axis and customer price levels on the X-axis. In this example (which can be found in many companies and industries) there is a very low correlation between price levels of customers and their resulting gross margins. The reason for the difference is the customers buy many different mixes of products. Only by looking at relative price levels can you assess whether your customers are paying appropriate prices. Strategic Pricing Solutions can help you create the measurement processes that let you ensure that customers are paying appropriate prices.
