If you're not careful, sales of non-stock items can kill bottom-line profits. Here is some practical advice for distributors to recover added costs in non-stock pricing.

by Scott Benfield

If your mix of business is typical of most distributors, your non-stock/out-of-stock sales continue to grow. As product proliferation continues, catalogs become larger, electronic cataloging (CD-ROM, e-commerce) grows and distributors watch inventories, more pressure will come to bear on the increasing sale of non-stock items. It is not uncommon to find some distributors selling over 50 percent of their volume in non-stock items.

One of the problems with non-stock sales is that they are often priced without consideration of their extra costs. The purpose of this article is to give some practical tools to the industrial distributor to recover added costs in their non-stock pricing.

Added costs of non-stocks
The extra costs of non-stock items are numerous. Increased freight, purchasing, receiving and payment costs are commonly realized in non-stock items. For instance, if the average stock purchase order/receiver/payable transaction costs $100 and lands $2,000 worth of inventory, then the cost ratio is $2,000 to $100, or 20:1. For non-stock items, however, the cost is still $100 to process the paperwork but the inventory value is often $500 or less, making the cost ratio $500 to $100, or 5:1.

Inbound freight is another consideration for non-stock items. Freight and handling for stock inventory typically runs 1 percent to 2 percent of inventory value. For non-stocks, the figure is 3 percent to 5 percent of sales. Many distributors are surprised that non-stock orders of $100 or less have inbound freight and handling in the double digits as a percent of value.

Doing the math, most non-stock items cost five times or more to process than stock items. For most distributors, this translates into the need to get 7 percent to 10 percent more margin on non-stock items. If you are not realizing gains in this range, you should take a careful look at your non-stock pricing mechanism.

Non-stock pricing mistakes
Most non-stocks are ordered by the inside sales group. Customers make an inquiry about a non-stock item, secure the cost from the inside seller, and place the order, often at a later date. The request for a non-stock price and availability is followed by the inside seller consulting a manufacturers catalog for model number and a cost figure.

In most instances, the inside seller cost-plus prices, or bumps, the cost by a factor. For instance, the customer wants a super zip drive cutting tool that costs $200. Your seller wants a 25 percent markup, so he multiplies $200 by 1.25 for a price of $250. In the previous transaction, your seller probably made several mistakes.

First, cost-plus pricing is a lousy way to maximize margin. Cost factors are often rules of thumb used by your sellers and are very limited. Most inside sellers use less than a handful of cost-plus factors that serve all non-stock orders.

Secondly, cost-plus pricing makes the assumption that buyers are sensitive to your costs or that costs determine market value.

Third, in the case of contractors or other resellers, price requests often are part of a larger bid so the end customer can be quoted a price. Most inside sellers interpret these requests as the customer shopping price, when in reality they (the immediate customer) are getting a price to quote their customer. And last, the price often does not consider the extra costs of processing and freight to be recovered.

To overcome these mistakes, the marketing manager needs to institute changes in pricing policy on non-stock items to procure needed margin.

Fixing non-stock pricing
The first step in fixing non-stock pricing is to change the cost-plus pricing rules of thumb. Understand that covering the increased costs of non-stock processing is not an endorsement of cost-plus pricing. Extra processing costs can be covered by mechanisms other than cost-plus pricing.

The best means to cover non-stock pricing is by using a list and discount mechanism. The simple use of a list price less a discount often yields higher margins than cost-plus pricing. Why? The reasons are complex but have to do with the ability of the marketer to control discount structures through programmed pricing matrices and the loftier markups afforded by price lists. Often, the inside seller has access to costs, not list prices. If this is the case, as it often is, recovering extra processing costs is paramount.

To recover processing charges in cost-plus pricing, try placing a cost adder on the item before it is bumped. For example, if the item costs $100 and the cost adders are 5 percent, then program your pricing system to cost the item at $105. If the typical markup is 25 percent, then the cost-plus price will be approximately $130, which reflects the extra processing costs. In programming this cost adder, be sure not to link the inflated cost to the purchasing or payables files.

If you are not keen on a cost adder, you may choose to bill the added costs as shipping and handling charges. Depending on the customer segment and industry practice, shipping and handling charges for non-stocks may be a cinch or an impossibility.

I recommend billing a reasonable percentage, calling it inbound freight and handling charge and informing the customer of the charge.

I also dont advise gouging customers on freight and handling charges. Too many managers see the category as a chance to make a premium and dont realize the customer is easily offended by exorbitant charges.

In my experience, many customers dont think twice about paying reasonable inbound freight and handling charges. They view the non-stock purchase as a value-added service. Its always better to test pricing assumptions, however, before global implementation.

Future challenges
As the categories of non-stocks and directs grow, so will the need to monitor and manage their pricing. Too often, inside sales or outside sales are left with these responsibilities. If you are letting sales command pricing, then dont be surprised when profitability suffers. Most salespeople dont have the analytical tools and segment perspective to maximize pricing margin. Whenever possible, use your MIS system to automate pricing. Use list and discount structures over cost-plus mechanisms and assign overall responsibility of pricing to marketing and finance. Also, have a well-documented policy of pricing discounts and keep a tight lid on exceptions to maximum discounts.

These simple rules are often the difference between an acceptable year and a bad year on your bottom line.

Scott Benfield works as a distribution marketing manager and as a consultant. His firm, Benfield Consulting, can be reached at .

This article originally appeared in the May/June '99 issue of Progressive Distributor. Copyright 1999.

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