Are Your Customers Buying On Price?

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“There is nothing in the world that some man cannot make a little worse and sell a little cheaper, and he who considers price only is that man’s lawful prey.”

I remember first seeing this quote by John Ruskin in a Baskin Robbins Ice Cream store when I was a kid. It stuck with me. I was reminded of this quote by several recent events.

Over the years as I have spoken to and worked with executives in many companies, one of the common questions I am asked is how not to compete on price. My answer forever has been that to not compete on price you have to understand what customers can buy from you they can’t get from anyone else, or at least don’t believe they can. This takes an effort to learn, but keeps you from needing to compete on price. And if your answer to the question is truly “nothing,” then the actual answer is the same as they can get from others but at a lower price. And if you can’t be profitable at that lower price, then either your company, or one or more competitors will cease to exist. Why would anyone want to pay more for the same thing?



All that being said, a common push back I hear from executives is that purchasing has all the power in companies and they only want to talk about price. Firstly, that is rarely true and if it is, in my experience those companies are in for trouble and you might want to serve their competitors instead. My best example of that is Ford vs General Motors. For many years it was common to be a supplier to only one of the so-called Big Three automakers as they wanted a supplier that could help them get an advantage. Thus, suppliers wanted to serve General Motors as they were the far larger company.

In the early 1990s General Motors appointed Jose Ignacio Lopez de Arriortua head of their procurement function. One of his first actions was to demand substantial (up to 25%) price reductions from GM’s suppliers. Many of the best ones moved to Ford. Over time, Ford surpassed GM as the premier auto supplier in the U.S.

Why do purchasing people focus so much on price? Simple: the management maxim which says “what gets measured, gets managed.” Too many purchasing people, still today, are measured on how much money they save the company year over year by price reductions. Nobody looks to see, at what cost.

Three recent examples come to the fore, one private sector and two public sector.

Chipotle suffered a 30% drop in sales during December of last year as a direct result of food contamination. That slide continues. They are closing all restaurants for several hours in early February to have an all hands meeting to discuss “food safety.” PR tactic I believe. It is fairly clear, in my opinion, that the root cause problem here was the food supplier. How much money did Chipotle actually save buying from the low bidder? Well none, or negative. How much of a bonus did the buyer get for his/her good work in finding the lower cost supplier and saving Chipotle so much money? (Unknown). And has anyone in procurement lost their job over this? (Again unknown).

However, it’s pretty clear that you will continue to get more of the behavior you reward. True with kids, dogs, and employees. How are you rewarding your purchasing people? How much power do they have in vendor selection?



My second example is Flint, MI. They have declared a state of emergency and the National Guard is helping pass out bottled water since their municipal water supply is contaminated with lead. How did that happen? Simple, two years ago the State changed water suppliers to save money. How much money have they actually saved? None or negative. Who’s been fired over this? Not sure anyone has. Who’s going to pay for this? The taxpayers of Flint for sure and probably of Michigan as well.

My final example is from here in Silicon Valley. They have been working since 2009 to upgrade the county hospital. The low bidder (though a firm with a good reputation) won the job for a bid of $290MM with a completion date of March 2013. To date the county has spent $347MM and the project is not finished. It looks like it will take another $100MM and a year to finish … hopefully.

An outside consulting firm (at additional cost) was brought in to review how this happened. Being politically astute (in my opinion) they did not fix the cost over-run on the contractor or the county directly. Their finding was that the county’s management of the project was flawed. (You think?)

Who’s getting fired over this? Nobody I suspect, and the taxpayers of Santa Clara County will be stuck with the bill.

How much is it costing your firm to reward purchasing for the wrong things? How are you dealing with customers who try to commoditize your products or services? What can customers buy from your company they can’t buy, or don’t believe they can buy from anybody else. The only way to stay out of the commodity trap is to have a useful answer to that question.

Mitch



3 COMMENTS

  1. Fully support the theme of this post. If an organization is competing principally on price, rather than making it one component of the overall value proposition, then its products or services are pushed into unidimensionality and commoditization. Any company that does business on ‘deal’ will, as you note, get the customer behavior they reward. The retail scene, for instance, is littered with ‘one trick pony’ companies that have followed this path and failed – Bradlees, Caldor, Jamesway, Ames, Syms, Korvette’s, etc.

  2. Your article reminded me of the darkly funny comment that astronaut John Glenn made: “As I hurtled through space, one thought kept crossing my mind – every part of this rocket was supplied by the lowest bidder.”

    And yes, I too remember the John Ruskin quote, prominently framed in every Baskin Robbins franchise I went to. In their case, I always found it a tad defensive. (If you’re confident about the value you provide, why do you need to remind people in this way?) B-R’s prices always seemed so high, and often, my family and I would bypass their outlet, and choose a less-expensive and perfectly comparable store a block or two away. A scenario not lost on their competitors, who no doubt, knew how to exploit B-R’s steadfast adherence to their high prices.

    The advice you offer about not competing on price is sound for many companies. But not all. That understanding made some retail entrepreneurs (E. J. Ferkauf, Sam Walton, Sy Syms, F. W. Woolworth) fabulously successful and fabulously wealthy. In the B2B space, price competition through discounting can be strategically valuable for multiple reasons. I’m often surprised when senior managers proscribe this practice from their tactical arsenal. The top question to be answered: “who has predominant power in this value chain?” If you’re a supplier, and it’s not you, then the purchasing department at your prospective customer will probably be calling the pricing shots.

    As abhorrent as price competition may be for some people, supply chains and entire economies depend on this practice. Manufacturers, distributors, and suppliers accept great risks in carrying inventory. Competing on price is a viable alternative to holding obsolescing or slow-moving products. Without this risk ‘shock-absorber,’ new product introductions would be stifled considerably.

    Agreed – it’s difficult to build an entire business on the ‘lowest price, always’ platform as WalMart has. But businesses could not operate without engaging in strategic price competition.

  3. Andrew, excellent points and you remind us that someone can be the low price leader and if done well, it is a profitable position. Removing costs that do not add value is always a smart strategy at every price points.

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