Getting the right pricing of your business on all the products and lines can be quite a challenge. Especially when the economic climate isn’t great. It requires reading the market, negotiating with customers and responding to changes in raw materials prices. But above all it requires courage!
proCFO recently completed an assignment with a company whose profits were sinking, gross profit margins were up and down (but mostly down) and, not surprisingly, cash flow was terrible (Read 7 Ways to Improve Cash Flow for Your Business). They had a debt to the ATO of more than six figures and could see no way of paying it back. Without serious intervention, they were at serious risk of going under.
The company was an impressive plumbing parts supplier with several products that were not widely available elsewhere. They had a very diverse range of customers including major players like Bunnings and many independent plumbers. The business had been successful for over 10years but since a change of ownership, things had started to go downhill. The new owner was very experienced in the manufacture of the products but he had no prior experience owning and running his own business. This inexperience meant he did not keep an eye on the critical Key Performance Indicators for his business and frankly, the business would be broke within 6 – 12 months if they didn’t do something different. It was up to the virtual CFO to understand and resolve the problem so that the company didn’t collapse.
Finding a solution
After checking several years of financials and customer sales records our virtual CFO came to a few conclusions. Firstly, the gross margins were declining year after year which was causing major problems in the business cash flow. When discussing the reason for this with the business owner, the virtual CFO learned that whilst increases in raw material prices were very common, the selling price of the products had never been adjusted to account for them. He was still selling the products for the same price as five years earlier. Check our previous blog post on How To Develop A Pricing Strategy.
Even worse, the customers with the lowest volumes were getting the biggest discounts. These customers were the ones who complained the loudest and the business owner always gave a discount, even though they did not deserve them.
The virtual CFO decided to put in a tiered pricing structure. Each volume level of purchasing would be entitled to a certain discount. As the purchase volume grew, so did the discount. This matched the value of each client with the discount they got and encouraged loyalty.
In addition to tiered pricing structure, an across the board increase of 10% was made to account for all the supplier price rises that had been absorbed. This price rise and new pricing structure meant that some customers, those who complained a lot, were going to get a hefty price hike.
The business owner was very concerned about losing customers but he understood that the business was doomed without it. The customers were all informed in writing of the price changes and when they were to take effect. The business owner waited for the phone to ring with complaints. But it was silent. Not a single customer complained about the new prices. They clearly knew that they had been getting products for below market rates. Once prices were raised to fall in line with the competitors, they simply accepted those changes as the price of doing business.
Additionally, the business set up a system to re-evaluate prices every six months to see if they were still in line with the market and raw material costs. If not, they would again write to the customers and explain the reasons why there was a need for a further price rise. The business raised prices four times in the next two years to align with the market. Again, customers continued to accept these changes as the they were in line with the market.
Overall, these changes had a dramatic impact. Not only did the company not lose any customers or market share, it completely reworked its financial position. They again had a profitable business and the cash flow to pay off their ATO debt.
Those improved financial statements made the firm much more attractive to banks, investors and partners interested in working with them. They relocated to larger premises with more automated equipment and won some long-term contracts.
The virtual CFO and the owner worked closely together to get the business back to profitability. They dodged a bullet and saved this family from financial ruin. Sadly, many other businesses don’t because they leave it far too late to ask for help.