February 2004
Fuzzy math . . . By Stan Pohmer

Determining value requires a look at consumers and your business.

Over the past few years we’ve seen an emphasis, no, more like a religious-like crusade, to focus on lower costs to achieve lower retails so that some retailers can claim that they are the lowest cost providers to the American consumer. And, yes, it’s true that our economy has been lagging and consumers have had to tighten their proverbial spending belts to maintain a standard of living during a period of self-doubt over job security, so it may have been the right strategy at the right time.

Wal-Mart has single-handedly changed the consumer mindset about the definition of value with its relentless message focused on low prices, building its entire image on price value. Its logic and business model has been that, by lowering retails, it can increase unit sales velocity. Increased unit velocity allows improvement of distribution and logistics efficiencies, achieving lower operational costs. These operational savings can then be used to again lower its retails while maintaining its margins to again increase the unit velocity and achieve even more operational savings . . .and then this process is repeated again and again.

And accounting for over 8 percent of all retail sales in the United States, Wal-Mart’s sheer size and its dominant business philosophy has forced many retailers to change their emphasis to price value in order to compete for the consumers’ minds, hearts and dollars.

Now don’t get me wrong . . . I’m not a Wal-Mart or big box basher by any stretch of the imagination. I truly believe that they have done more for our industry to expose new consumers to our category than the traditional retailers could have ever thought possible. And I also believe that they have issued the wake up call to our industry that we needed to approach our production and distribution in a more business-like way, forcing us to look for smarter, more efficient ways of operating.

But the challenge producers and independent retailers face is that we can’t necessarily achieve the same operational cost savings based on increased volume that the mass market retailers can. There are many producers and retailers who have invested tremendous amounts of capital into building new state-of-the-art facilities outfitted with the most advanced computerized systems and labor-saving technology in an attempt to reduce their costs of doing business, and, if done for the right reasons and they can staunch the profit erosion caused by being the lowest cost/retail provider, it’s a prudent investment. Too often, however, I hear “I’ll work on lower margins, but I’ll make the profit up in increased volume” as the justification for these investments. But wait a minute . . .these investments should be made to achieve cost containment, not profit containment! The reality is that there’s a definite point of diminishing returns on just how much cost savings a grower can realize by operating and producing more efficiently; if, after exhausting all of the cost containment activities and investments, he wants to continue feeding the Wal-Mart-like decreasing price spiral business model, the only way to participate is by reducing profit. And in my way of thinking, this is not a place one wants to be for the long term.

Determining Value

Something we often forget is that it’s the consumer who ultimately determines the value of a product, not some accountant or business analyst who is focused on crunching numbers. And price, though important in the value determination process, is not the sole criteria. My personal view is that we, ourselves, devalue the perception of our products much more than the consumer does. We, ourselves, place the limits on the intrinsic value we offer the consumer. We, ourselves, are the ones that are overly engrossed with the “how low can we go” mentality.

A study performed in more than 2,400 companies from various industries by McKinsey, one of the few major consulting groups that I have respect for, researched the impact pricing decision strategies have on profitability. What they found was that:

* A 1-percent reduction in fixed costs alone improved profitability by 2.3 percent;

* a 1-percent increase in volume alone will result in a 3.3-percent increase in profit;

* a 1-percent reduction in variable costs alone will prompt a 7.8-percent increase in the bottom line;

* but . . . A 1-percent hike in selling price alone can boost profitability by 11 percent.

What we often fail to remember with our myopic focus on reducing costs is that all of the expenses are measured as percents . . . percents to sales. Raising the selling price incrementally by 1 percent should not have a material effect on unit velocity, so higher net sales dollars should result; this automatically reduces the percent to sales for all of the other business expenses . . . fixed costs, variable costs, etc. And just think of the bottom line impact if you can raise your selling price and achieve real dollar cost savings in fixed and variable costs simultaneously . . . here’s where the multiplier effect really comes into play.

Okay, right about now some of you may be thinking that I’m chasing windmills and not playing in the real world that we all are living in, that I must be living on Walden Pond or in Utopia. But there are concrete actions you can take to make these dreams into realities, but it’s going to require real change and true alliances. Retailers can provide some of the solutions, but producers or manufacturers need to provide the rest; individually you can achieve part of the benefit, but working together you can make it happen.

Here are some things to consider:

* Take our primary focus off of cost, and put the focus on ways to improve real consumer value. This might include the consumer’s in-store purchase experience, the presentations, the displays, the signage, the information and education provided . . . and yes, the product itself.

* Remember what we are really selling . . . satisfaction, success, enjoyment, fun, home/yard decorating; the products we sell are the means to the end, not the end unto themselves.

* Market the consumer end result, not just advertise product at a price.

* Suppliers need to become service and product providers, to help the retailers deliver this value to the consumer.

The mass market has done a lot for us by forcing us to become better operators. Now it’s up to us to leverage what we’ve accomplished and take it to new levels that benefit the industry and our consumer. Remember, it’s the consumer who determines our value!

Stan Pohmer

Stan Pohmer is president of Pohmer Consulting Group in Minnetonka, Minn. He can be reached at [email protected] or 612.605.8799.


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