How to generate more profit in a low margin industry
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Do you work in an industry that is described as commodity?
I worked in an industry such as that, and it’s the industry of materials handling, or forklifts. Quite a number of years ago I was asked to help set up the pricing and pricing strategy for a forklift company and it struck me when I started to pull it apart and look at the numbers and the detail that it was a cost plus culture.
We’d get the forklift from overseas from the factory, there’d be a cost and a mark up percentage put on it, and it didn’t matter what the forklift was, the capacity, model or type, the same percentage mark up would be applied. I started to dig a little bit deeper and I stared to notice some anomalies.
I found an anomaly in one of the forklift capacities, which was the 7 tonne forklift capacity. Where is your 7 tonne forklift?
In other words, is there a particular product or service in your portfolio that is being grossly under priced that you could increase the price substantially and not lose a single unit of volume?
Or alternatively, actually sell more. In fact, that is exactly what happened in the case of an alcohol company where they rebranded and rebadged some brandy from $700 a bottle to $1500 a bottle and they sold out. That kind of pricing power is not necessarily apparent in materials handling but substantial earnings improvement is possible. I am going to show you. The traditional most popular forklift is the 2.5 tonne capacity forklift. You generally make around 15% margin on sell for those types of materials handling equipment. The 2.5 tonner is the benchmark product in this industry.
So if you think of the Bell weather or leading keystone product in your industry or portfolio, the 2.5 tonner is the equivalent and the gross margin is around 15% margin on sell. When you go down in capacity the margins actually contract, also. So when you look at the smaller capacity forklift, the 1.5 tonner, you end up with margins of between 5 and 7%. Very slim, and that is a high volume game also, and sometimes it’s a leader into selling the higher capacities.
So you would think there is a possible trend here, that higher capacities do equal higher margins. Well that’s true in some cases, but when it came to the 7 tonne forklift we found the margins substantially greater. We were able to sell them for 25% margins. Now we are talking about a forklift that at 1.5 tonne is around $20 000, at 2.5 tonne at around $25 000 and a 7 tonne at around $80 000. But with these particular gross margins.
What I learnt from that is;
- never apply a mark up to a category [to set prices]
- always identify at a micro level the value proposition of each of your products and
- reverse engineer your sell price not based on the margin that you are going to make but on the value that that product or service represents to the customer.
Now in keeping with our framework of value in use and value at risk, which you may have seen in one of other whitepapers or videos on the core value management system, the reason this 7 tonne forklift can demand such high margins and high $ value is because it’s used often in the timber industry or the mining industry and they cannot afford to have down time and they cannot afford to have any kind of breakage in that equipment.
It needs to be sturdy equipment. And so they are prepared to pay a premium to avoid that value at risk component that we talk about and ensure maximum up time. That’s what drives that particular margin outcome.
So in summary, avoid cost plus at all costs, you’ll end up over pricing your product and possibly losing volume or under pricing your product and losing margin.
And always price your product according to value to the customer not traditional mark up or margin on sell per category.