All levels of the aftermarket are feeling enormous pressure from the margin squeeze on hard goods. The entire industry is in a race to the bottom in its pricing, including some service shops and jobber stores. They perceive that if business is good, a lower price will help capture an even greater share of the marketplace. They also reason that if business is bad, cutting their prices will help retain their existing share of the market.
Shops and jobbers must clearly acknowledge that they cannot cut prices without cutting their level of service or quality. It is impossible in our sector of the industry to be the very best and be the cheapest. In the service provider business, we counsel that there are three things to develop a business on: price, service or quality — pick two. At the jobber end, we counsel on price, fast or right — pick two.
The fact is, most shop and jobber owners do not charge enough for their products or services. When business is good, you need cash to fuel growth — cash that could be generated by higher margins. When business is bad, cutting prices often makes matters worse. You have to increase sales significantly just to recover the lost dollars.
Shops and jobbers are talking percentages, not dollars. If the dollars aren't there, businesses cannot pay the bills and grow. Cutting prices or charging too little can have a disastrous effect. Please consider the following example and study the math.
Suppose you sell 100 units of a certain item per month at $1 each. They cost you 55 cents each, giving you a total gross profit of $45 and a gross profit margin of 45 percent. Now, suppose you cut the price by 15 percent and your unit volume stayed the same. Your sales would now drop to $85, your gross profit to $30 and your gross profit margin to 35 percent.
To maintain your original $45 gross profit dollars after a price cut of 15 percent, you would have to increase sales by 50 percent. Is it easy to increase sales by 50 percent in this industry? I don't think so.
This is the mathematical formula to calculate the unit volume increase required if you reduce price, with GPM representing gross profit margin:
GPM% divided by GPM% +/- Price Change - 1 = Unit Volume % Change or .45 divided by (.45 - .15) - 1 = .50
With this price-chopper scenario, you would need to sell 150 units instead of the 100 units per month you are currently selling to stand still. This is working harder rather than working smarter.
Slow down and do the math. It would make more sense to invoke a price hike. If instead of lowering the price of the item you raised it by 15 percent and your unit volume stayed the same, your sales would go up to $115 and your gross profit to $60. To calculate how much your sales would have to fall before your gross profit dollars would drop below the original $45, use the same formula, but this time add, rather than subtract, the price change percentage.
.45 divided by (.45 + .15) - 1 = .25
In other words, you were selling 100 units before the price increase, and the mathematical formula is now telling you that you could let your unit volume drop to 75 units (100 - 25 = 75) if need be to make the same gross profit dollars by selling less.
Price cuts must generate large increases in unit volume to regain lost gross profit dollars. In our example, if the unit volume dropped to 80 units after the price increase, you are actually making more by selling less with the price increase.
By using this formula, business owners can quickly calculate the changes needed in sales volume to maintain the gross profit dollars after a price increase or decrease. Shop owners and jobbers should complete this exercise before lowering any prices.
Bob Greenwood is president and CEO of the Automotive Aftermarket E-Learning Centre Ltd. (AAEC — www.aaec.com), a technology company based in Ottawa, Ontario. He has over 30 years of business management experience in the independent sector of the automotive aftermarket industry.
