Does Your Business Leave Gross Margin on the Table?
Gross margin control has always intrigued me, so when I decided to write my first book, I chose the title Gross Margin: 26 Factors Affecting Your Bottom Line. Based on my research, there are a minimum of 26 factors owners, managers and salespeople must be aware of and pay attention to in order to optimize gross margin.
GROSS MARGIN CONTROL IS REALLY ATTITUDE.
An attitude that can best be summarized by the realization that there are tactics and techniques businesses can implement to maintain an acceptable gross margin while still remaining competitive in a dog-eat-dog marketplace. To compete and compete successfully, all key players in a business have no choice but to become experts at gross margin control.
Gross margin control starts at the top...and it's not easy. There are no simple answers. It takes hard work on the part of all employees in the business, but gross margins rarely increase unless management is fully committed to improving gross margin. It can be done, and you and your business can do it too. The following are several of my favorite factors affecting gross margin:
MARKUP RUT
Many businesses have over the years gotten into a rut of marking up products a set percentage over and above cost. Yet one of the most basic rules is that cost should have nothing to do with the price a product is sold for. One of the symptoms I look for to determine if a business is in a markup rut is round numbers. When I see a significant number of products that are marked up 20 percent, 25 percent, 30 percent, 35 percent, 40 percent, 45 percent, 50 percent or even 100 percent the odds are excellent that the business suffers from the markup rut.
WHAT THE MARKET WILL BEAR
If you attended a top-notch business school and were to read a textbook on pricing, you would discover that there's only one criterion for determining where to price a product or service and the answer is "what the market will bear." What the marketplace is willing to pay for an item is the only intelligent way to price it. The difficulty lies in determining what the market will bear. The secret is to test, test and retest the market. Strictly as an example, if you are marketing up an item 40 percent — and assuming that the product is not commodity in nature like gasoline that displays its price so everyone who passes by can see it — try 40.6 percent or 41 percent or 41.2 percent. The market will tell you what it will bear.
MARKUP UP ON COST VS. GROSS MARGIN
I am always amazed at how many salespeople don't know the difference. When they markup a product 50 percent, they many times believe they are earning a 50 percent gross margin. Markup is arrived at mathematically by dividing gross profit by cost, but gross margin is determined by dividing gross profit by sell price.
SELLING UP
As a rule of thumb, the more premium the product, the higher the gross margin the product can command. So salespeople who possess the product knowledge and the selling skills to persuade customers to purchase higher quality products will almost always earn higher gross margins than the salespeople who are convinced that all customers are looking for is a low-ball price.
ADD-ON SELLING
Another rule of thumb is that accessory products almost always carry higher gross margins than core products. As an example, brushes and rollers, drop clothes, masking tape and ladders will generally earn a significantly higher gross margin than a can of paint. The challenge is to teach salespeople to be diligent about reminding customers to buy the accessory products that go along with core products.
ELIMINATE EMPLOYEE GUILT
Perhaps the biggest shock my research revealed was when I discovered that virtually all salespeople who have pricing authority feel "guilty" when they earn gross margin over a specific number they have somehow determined to be "fair." Any amount over and above the "fair margin" they deem to be gouging the customer. And this magic number varies significantly among salespeople. It has been my experience that few businesses earn a high enough gross margin to come even close to gouging the customer, especially when you consider the anemic before tax margins most businesses earn.
DEFENDING YOUR PRICES
I believe the most important gross margin factor is the ability of salespeople to defend their company's prices. It's natural for customers to test salespeople to find out if they will reduce the price by flinching when they quote, so if salespeople don't recognize the flinch as a tactic rather than a reaction based on fact, they will forever be insecure that their prices are not competitive. Successful businesses generate sales and please customers because their customers perceive the prices they charge to represent a fair value for the company's goods or services. Salespeople must realize this to have confidence in the competitiveness of their prices. I recommend at your next sales meeting you discuss these gross margin factors with your salespeople, key management team members and anyone else who has any influence on pricing.