Passing On Price Increases

It’s the written notice every jan/san distributor hates to receive:

“Dear Valued Distributor: Your business is important to us, but recent increases in raw material costs leave us no choice but to raise prices on the products you buy X percent, effective...”

While price increases aren’t welcome news, they’re an unavoidable part of doing business. But it’s a rash of recent price hikes that have distributors swallowing hard — and often. According to many SM readers, the series of recent price increases, especially in plastics and paper, is unprecedented.

“The increases in liners have been outrageous,” says Gary Bright, vice president/general manager of Mission Janitorial & Abrasive Supplies, San Diego. “I think we’ve had four or five in the past four or five months, and then we have one coming in January for another 8 percent. It’s crazy. I’ve never in my life seen this many price increases come through.”

“Prices have gone through the roof,” agrees Ken Abrams, general manager of Janet Oriole Supply, Phoenix. “Every time you turn around there’s a new price increase.”

Similar sentiments were echoed throughout the United States. Jan/san distributors have experienced price increases in 2004 of as much as 40 percent over the previous year on certain product lines.

Pass It On
It all began approximately six months ago, when manufacturers unexpectedly began raising prices on certain products, says Scott Durann, division manager of Reliable Floor Supply, Orange, N.J.

“When you had to raise the prices of wax or trash bags, people were screaming,” he says. “Now, it’s inevitable — we just point to the gas pump.” Durann says that because prices are going up for fuel and many other raw materials, the costs of consumer products are rising. Customers are becoming conditioned to both the need to raise prices and the reasons for raising them. Still, for distributors, it’s a tough sell.

“It’s hard passing those costs on all in the same time period,” says Bright. “I imagine distributors probably lost some margin with not being able to pass on those increases.”

For Janet Oriole Supply, paper prices have gone up about 10 percent in recent months, and Abrams expects them to go up another 8 to 10 percent in January. He says part of the reason for the increases is transportation costs and increased government regulations affecting drivers. Other distributors reported similar increases.

“Everybody’s raising their prices,” says Abrams. He says he has seen inventory-wide price increases in the neighborhood of 10 to 12 percent — maybe higher. “We haven’t lost any business, so we’re remaining competitive,” he says.

What’s the Cause?
So, what’s to blame for today’s price increases? According to economists and consultants, they’re attributable to a global economic “perfect storm” that’s not just affecting jan/san product prices. The rising cost of steel, plastics (resins), fuel, health care and shipping trickle down and affect the cost of jan/san supplies. Similarly, the United States must contend with the increasing raw materials demand from other countries such as China, which drives up those costs.

“There have been significant increases in commodity prices, such as steel,” says Deepak Agrawal, managing director of Gotham Consulting Partners, a New York-based management consulting firm. “It’s primarily driven by China’s appetite for all these things.”

When raw materials prices shoot up, every industry’s prices are affected, he adds.

Prices paid by U.S. manufacturers increased an average of 11.2 percent in 2004, according to a December report by the Business Survey Committee of the Institute for Supply Management (ISM), Tempe, Ariz. The study, “68th Semiannual Economic Forecast,” included results from a survey of ISM’s 45,000 purchasing and supply executive members.

According to the ISM survey, rapidly rising market prices are of great concern to manufacturers. Survey respondents listed “prices and inflation” as their most pressing economic concern, ahead of energy price increases and a weak economy.

Chain Reaction
The typical price hike notification sparks a complicated chain of events for jan/san distributors, who must update pricing schedules, deliver the unwelcome news to customers, and often, rethink the way they pass along costs. If they’re lucky, they get a month’s notice from the manufacturer before the increase takes effect. (If they don’t prepare to pass on the increase within that time, they risk sacrificing a portion of their margin.)

Each distributor takes a slightly different tack in handling an increase. For some, it’s straightforward: If a price increase is handed down from manufacturer to distributor for a specific product, the end user must pay more for that product.

“You look at the customer base and prices you have in the market, and you try to pass as much of that cost on as you can,” says Bright. In years past, he says, it was easier for distributors to absorb some or all of a price increase, but with distribution margins tighter than ever, they’re generally applied to the product — and passed on to customers — as quickly as possible.

For Bright’s company, when a price increase comes from a manufacturer, updates to the company’s database are done electronically. Price sheets and books are adjusted accordingly.

Some distributors add the percentage of the increase directly to the price they charge for a product; others attempt to spread an increase over several products — i.e., other product prices are raised to maintain overall margin without boosting one product’s price too dramatically. Either way, the process itself can be a challenge.

“It’s a pain in the butt,” Abrams says. “Making sure all your costs are updated in the computer, making sure the commissions come out right, and making sure the customer is billed correctly. It’s a daily thing.”

Some consultants recommend an individualized approach — treating each customer differently, according to profitability. “Most [distributors] would do well to segment customers and look at them through the profitability lens,” says Bruce Merrifield, president of Merrifield Consulting Group, Chapel Hill, N.C. “Absorb costs for the few customers who are outrageously profitable,” he suggests. “With the others, use it to negotiate.” Merrifield calls this “business process re-engineering,” or finding ways to eliminate transactional costs to minimize price increases.

Informing the customer of the increase is no easy task, either. While occasional price increases are expected, nobody wants to pay more. Customers will often demand an explanation and request evidence of the original price hike from the manufacturer.

“Most customers realize [prices] are going to go up, but when they go up many times in a short period of time, that looks suspicious,” says Bright.

Durann says his company does everything possible to make price increases more palatable for customers. Sometimes, that means settling for a lower margin on one product, while increasing another product’s price to make up for it. Durann says that although he always attempts to pass on price increases, there is a point where there is a perceived value associated with a product, and the customer simply won’t pay more than that.

“In some cases, I’ve had to lower my margins, but we’re trying to make money, of course,” he says. “I may have to do something where I increase the price on an accompanying product,” he says.

“Maybe I might get my full margin on say, wax, but then I’ll run special on it if they buy a case of mopheads. I try to tie an item in.”

The key for Durann and other distributors is holding on to customers, in spite of the need to adjust pricing.

“Everything is negotiable,” says Durann. “If a guy is really buying the right stuff, we’re going to do what we have to do to keep them.”

Durann’s advice: distributors can get a better handle on prices by understanding the big picture — how one item’s price influences another’s.

Not So Bad After All?
Because of the sheer number of price increases distributors have experienced recently, it’s only natural that they question their legitimacy. Are manufacturers raising prices simply because they feel they can? Most likely, manufacturer increases are justifiable, contends Agrawal. In many cases, distributors are getting off relatively easy — manufacturers are bearing the brunt of today’s price increases. U.S. manufacturers, in general, are faced with increasing commodity prices and low-cost competition, two factors that make passing along price increases more difficult.

“There’s little room for manufacturers trying to increase pricing,” he says. “They’re trying to increase prices 3 percent to 5 percent, but they’re not in the position to increase them by as much as commodity prices are going up.”

Norbert Ore, chair of the committee that published the ISM study, agrees. He says inflationary pressures on manufacturers are taking their toll.

“In most cases, manufacturers have had to absorb many of those costs as opposed to passing them on to consumers,” he says. “Everything you use has suffered some form of inflationary pricing,” he continues.

“In general, manufacturers have better margins than distributors do, so distributors are less able to absorb [price increases],” Ore adds.

In some cases, manufacturer-distributor supply contracts have made it more difficult for manufacturers to pass along price increases.

“We’ve gone through 10 to 12 years with low inflation and people began to take that for granted,” says Ore. Some supply contracts didn’t adequately account for the possibility of high inflation. “They may not have had revisions in their contracts that protect [manufacturers] and give them relief from price increases.”

That said, there is little distributors can do when the entire marketplace is experiencing rapid price increases. While manufacturers may absorb a greater portion than distributors may have guessed, distributors don’t have much choice but to accept what their manufacturers pass down in the way of increases.

“Distributors, in most cases, don’t have a good defense. The distributor’s job is to buy from the manufacturer at whatever the market price is, then pass it on to the customer,” says Ore.

Shopping Around
One consequence of raising end users’ prices can be increased instances of price “shopping” to the competition. Though this can be nerve-wracking for distributors who worry about their competitors undercutting their pricing, in today’s economy, end users are finding that similar price increases have gone into effect for other distributors, as well.

“They’re running a business just like we are,” Bright says. “Two things can happen: Your competitor takes advantage of you and comes back with lower pricing, or they have the same price increases as you do.

“We’ve had people question price increases and go out and check prices to make sure they’re getting a fair price,” he continues. “Price increases do create a kind of shop-and-price mode more than any other time.”

Are Things Looking Up?
Believe it or not, there is an upside to price increases. They can allow for meatier distributor margins (the same mark-up on a higher price yields more revenue). “If they can pass through the price increase, they’ll make a bigger margin,” Ore says.

Price increases also give the distributor the opportunity to sit down with a customer and talk about issues they do not normally discuss once a good business relationship has been established. Distributors have the opportunity to reiterate the value they bring to the customer.

“It’s a chance to sit down with a customer and try to present the value-added service you give,” says Bright. “The salespeople can use this as an opportunity to look at the value-added services we offer: delivery, problem solving, whatever the customer feels is important to them.”

Distributors can also look forward to fewer price increases. It seems 2005 is shaping up to offer more pricing stability. Distributors will see the anticipated January price increases, but prices may not go up much from there. ISM’s study predicts that most of 2005’s price increases for manufacturers will come between January and April. The study also predicts a 4.4 percent total increase for prices paid in 2005 — welcome news after 2004’s 11.2 percent average increase over 2003.