This is not your fathers pricing method: There are ways and there are ways
June 8, 2004
Editor's Note: This is the sixth episode in a mountaintop dialogue that Gerald has been having with a "wise business guru." They had been talking about the contract period when doubts were raised about what his sales force was really selling.
At just that moment, a line of hikers passed by on their way to the mountain peak, led by a Sherpa. My guru asked me, "Sherpa's price is how set?" I've become accustomed to his yodaisms. "Do you suppose that he counts how many paces he will step? The pitons and the lengths of rope? How many calories he will expend over a certain period of time?" my guru asked. I answered that all that was possible. "Hockey spit!" he replied.
"The shrewd salesman will make sure that the customer understands the entire value of the service and will negotiate using the value as the contract price. Otherwise, he simply battles in a price war to sell cheaper holes or welds or bends, or whatever.
"Take that Sherpa, for example. He knows his expenses, and he'll make sure they all are covered. He also knows that those flatlanders arrived in a helicopter and that all of their toys are world-class. You'd better believe the trip was not negotiated at the Sherpa's cost plus a tip! The price was set based on a guarantee that the trip would be an enjoyable success, with no major injuries and plenty of great fun. The sheep may get fleeced, but they love it. They cannot wait to grow more hair and make another trip to the barber."
"You make it sound like a psychological game where I try to get the maximum out of the dupe's pocket," I said to shame him.
"Well, duh!" he said with a smile, completely unabashed. "You cannot make a living by selling your service at your cost. Nor can you sell your service for more than your customer thinks it is worth. Your salesmen should spend less time doing time projections and more time visiting the customer," he advised."Here are some guidelines for your sales staff: Learn how the product is developed, designed, assembled, and serviced. Study the ergonomics and the packaging. Understand the customer's inventory management and cash flow goals."
He paused to take a sip from his canteen. "Your sales reps presentation should help the customer understand the entire value of the service you're offering. Then your customer will know, with great certainty, that a decision to do business with you is right, not because you sold the parts at some small percentage above your cost, but because you are trustworthy and your business dealings will be problem-free—because his success is a sure thing."
"That is very romantic, but it does not sound speedy. How does all of that reduce my cost during the contract period?" I wondered.
"Right now your salesmen wait beside the fax machine for a print to arrive. Then they spend hours analyzing the drawing, costing the bill of materials, performing time studies, and calculating markups. It does not matter what the product is. If it arrives, they quote it at cost plus markup, even if the part does not fit your shop. Even if the customer is granola."
"Granola?" I interrupted.
"That vast collection of nuts, flakes, and shriveled fruits in the business world," he exclaimed. "In the worst situation, the part will be hard for your shop to make and the customer will be slow to pay. You will waste unexpected amounts of capital and waste an excessive amount of time waiting for payment. Any hope of profit will evaporate into debt, scrap, overkill, and poor communication."
A glimmer of understanding crept through the wrinkles in my brain. He was right! Frequently we spend a lot of time trying to decide whether or not even to quote a project.
"If my sales procedure involves careful qualification of the customer and the product, virtually no time will be wasted on futile cost estimates. The margins can be openly negotiated to satisfy all parties, which means the customer can place the order almost immediately instead of always going out for competitive bids. What is more, the business relationship will be resistant to unworthy harpies because it will be based on common understanding and trust," I enthused.
"Very good, my little hoppergrass. You have the start of a plan of action for improving your time line of money," he said sagely.
I still was puzzled by his claim that my salesmen did not understand that they were "buying the project" from the customer. I got up off of the boulder I had been sitting on and began pacing while I tried to decipher what my gnomelike business adviser was saying. "Right now your salespeople do not know what they are selling," he had said. "They miss the idea that they are actually buying the project from the customer!" echoed in my ears.
I squatted to see the little guy better as he sat in the shade of his bristlecone pine. "Oh, small sage in the shade, I understand that my salesmen are supposed to help customers to see the true value of our service to them. But what do you mean by 'buying' the project?" I probed.
Before he could answer, the line of hikers passed by as they returned from their trip to the peak of the mountain. The Sherpa commented on the litter that the guru and I had strewn about during our conversation, and he offered to tidy up our site and haul the trash down the mountain—for a fee, of course. Shrewd Sherpa. I was very much occupied trying to understand my guru, so I accepted his offer. He did his spiffy chore and went on his way with a bit of my money in his pocket.
"Bought the contract from you, he did," observed my guru.
I decided to try to understand this nugget of wisdom. "Ok, the contract was to clean up the campsite, right?" The guru nodded in agreement. "I paid him to do the chore."
The guru shook his head and said, "You considered the chore 'in-house.' He gave you an opportunity to spend your time more profitably. His price was lower than your internal cost, so he won the contract. One of the reasons he offered to do the chore at that price was because he felt he could make a profit. Another reason might have been that he enjoyed the work and cares about the appearance of the mountain. At any rate, he bought the contract from you at his price."
I pondered that for a moment. "You mean, he did not sell me his service of hauling trash?" I asked.
"There are many ways to perceive! Describing the transaction as he selling and you buying is OK. On the other hand, realizing that he bought an opportunity to profit is more apt for a timeline-of-money scholar."
I began to feel intimidated. "I still don't get it," I complained.
"OK. Let's try it a different way. You've heard of the stock market?" he asked. I wobbled my noggin affirmatively. "Some stocks are worth more than others. Why is that?" he prodded.
"All kinds of reasons—dividends, market growth, demand," I replied.
"Very good answer! To the investor those are perceived as an opportunity to profit. The greater the opportunity, the higher the price. What primary factor keeps the price down?"
I watched a small cloud drifting in the brilliant blue sky. "Risk?" I ventured.
"Good guess! Risky ventures are worth less, even if the opportunity for profit may seem high." He looked at me expectantly, as if this should have clearly explained the buying-the-project concept.
"Your company buys a contract from a customer with the expectation of making a profit. The amount of that profit and the degree of risk should regulate the amount that you are willing to pay for the contract. For a really sweet deal, you should be willing to pay more," he explained.
"Aha!" I shouted. "I pay more for the contract by lowering my quoted price!"
He smiled. "Now, how many of your salespeople understand what they are doing?"
I began to realize that our sales force had more skill at interpreting mechanical drawings than training in economics. They could produce excellent manufacturing plans and predict to within minutes exactly how long it would take to produce a machined piece of metal. Unfortunately, the idea that they were buying contracts and using perceived value as the driving force in negotiation was not emphasized in training or performance reviews.
Next month's issue uncovers more of the sage guru saga.