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Case Study 1 – Management of Product Discount Groupings

 

Situation

• In this example, both purchase prices from the manufacturer and sales prices to the customer are based on a discount from a published Trade Price. There are however many exceptions for both purchase and sales transactions, where specific net prices are negotiated. To make discounting simpler, products are grouped so that a single discount applies to all parts in a discount group. These buy side and sell side discount groupings are usually managed independently as it is a key commercial tool for the wholesaler to manage customer pricing. For example, if a special purchase deal has been agreed on a range of fast moving product within a manufacturer’s range, the wholesaler may wish to separate this range to allow more competitive discounts to be offered without compromising the margin on the remainder of the range.
• This de-coupling of the buy side and sell side product groupings is a strategic tool, but can be a serious profit risk if not managed carefully. The danger is that products within the same sell side discount grouping can have a very different ratio of cost price to trade price. This means that a sensible discount for one part may result in an unreasonably low margin on another.
• Some manufacturers manage their prices on a net priced basis and some also publish extraordinary trade prices, attracting discounts in excess of 95%!
• The real example below is not unusual:-

• Therefore applying a sensible discount for Product 1 would result in trying to achieve a 94% gross margin for Product 80. This is unrealistic for this product and the price will probably get overridden and only serve to further reduce the credibility of the system held prices. Conversely, a sensible discount for Product 2 would result in a gross margin of -732% for Product 1. Hopefully this will be overridden upwards by the sales staff. The other 78 products in between have varying degrees of the same issues.

Consequently, many sales ended up being sold at low or negative margin. Even those sales set to make a high margin were often overridden too far and ended up making a low margin.

Challenge

• Clearly we needed to challenge the make-up of the discount groupings. Fewer broader groupings makes for simpler discount negotiations, but leads to many inappropriate prices. A large number of groupings allows for greater precision but increased complexity, and could result in several thousand groupings. Therefore a balance needed to be found. If the grouping is based solely on the type and technology of the product, then profit levels on specific products can be compromised. 

Approach

• Analysis was carried out to identify the number of negative margin deals that were in place as a result of grouped discounts.

There were 44 Million negative Customer / Part Number combinations set to make a loss.

• This sounds terrible, until you put it into the context of 0.4% of the 12 billion possible combinations. However, it is still 44 million opportunities to make a loss if the system held discounted prices were used at the point of sale.
• Analysis by part number showed how many customers had a discount set that would make a loss. Hot spots were then clearly visible within the discount groupings. Action was taken to resolve these.

 Results

• There were 20,000 products that had re-coding action taken as a result of the analysis. This reduced the number of negative margin pricing combinations by 24 Million. The profitability of these parts was plotted against the remaining parts.

Action was taken between June and November and returned a 3.6% increase in Gross margin resulting in a profit increase of £600K per annum.

 

 Further Work

• Even though the return from this project was considerable, it was a broad brush review. There is more benefit to be obtained from more detailed and specific reviews.

 

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