How an SMB can achieve Pricing Power & earn above industry margins
Pricing Power 2x the value of my business
Want to turbocharge the value of your business? Then you really should be focusing on achieving pricing power through niche strategies designed to give you an edge to a particular set of customers or unique demand tranches within your industry. It’s easier said than done but is well worth the effort and will keep you out of shark infested waters.
First off, what is pricing power? Simply put, it’s your ability to raise your prices with minimal impact on customer demand (aka: price inelastic demand) and/or little fear from how a competitor will react. It also related to above average industry gross margin %.
Here is my path & process on how I earned pricing power when competing against multi-billion dollar industry giants like SYSCO, US Foods and GFS.
So I bought a business… As a GP, I had raised capital from 2 family offices and friends/family to acquire a food distribution company via an asset purchase. We acquired the building, trucks, inventory & the book of business, while retaining all employees. We saw that ownership, who had founded the company in 1993, had lost passion for the business, while still running day to day operations with fax machines and a dot matrix printer. However, they had a loyal group of customers who were as slow to innovate as they were. Just a few tech upgrades and a sales process could easily triple sales. This seemed like a slam dunk.
It didn’t turn out to be that easy… After just a few months of ownership, our “algorithm” started to break down. The power of the personal relationships prior ownership had built over 25+ years couldn’t be replicated so easily & new competitors promising lower prices knew they could chip away at our market share (keep in mind, during due diligence we interviewed the top 10 customers who said they were happy to work with us, after the sale). Essentially what we bought was a bakery distribution company, supplying flour, sugar, yeast and dozens of other very commoditized products. By the end of year 1, we went from a 35% to 20% margin business on some of our best SKU’s because we had no pricing power or “edge” on procuring our supplies. We had to do something!!
Finding a new niche was the answer… finding an area that was more blue ocean and less shark infested was the only answer to reestablishing our margins but more importantly know that we can forecast with confidence those margins into the future. Here was our process to find a new niche…
Customer interviews —> what areas of your business are you underserviced?
Supplier assessment —> can we procure enough supply to meet the demand? can we get exclusivities or buying power over any products in this niche?
Demand assessment —> was the market large enough to at least keep our margin dollars whole (vs the bakery distribution business)
Competitor assessment —> why was the market underservicing this niche?
Internal assessment —> if we entered this niche, can we do a better job? what did we need in terms of process/ assets to do a good job?
Financial assessment —> if we owned this niche, how would that look on our cash flow projections? do we need more working capital or assets to pull this off?
Here were the results…
Customer Interviews —> anything in the freezer was either very expensive, poor fill rates or low SKU selection (meaning every other business has exactly what I carry so I can’t distinguish myself).
Supplier assessment —> low SKU selection meant that many frozen foods companies couldn’t break into the north east market and were willing to give us great marketing support/ pricing for the chance to enter. We also negotiated exclusivity with many items.
Demand assessment —> every commercial kitchen has a freezer and needs some type of frozen food. Our new motto was to “own the freezer” and “we love the cold”. Despite the negative connotations of frozen foods it’s still a multi-billion dollar market.
Competitor assessment —> no one specialized in frozen foods. GFS/SYSCO has small parts of their trucks dedicated to a) room temp b) refrigerated temp c) frozen temp zones but would/could never do all frozen. They would always be at a disadvantage. You can’t ship spinach or cleaning supplies in minus degree temperatures.
Internal assessment —> this was the big leap, we had to build out commercial sized freezers and retro fit the trucks to properly transport frozen products. The hardest part was finding new warehouse workers comfortable spending hours on end in 0 degree F temps. Not easy but we knew this was our competitive advantage & why we can command pricing power!!
Financial assessment —> the margins we could command were actually in the 35-45% range and produced a whole new set of products to our sales team. Small wins here could easily make our business free cash flow positive within 3 months, recovering all the costs. It was a calculated risk.
In conclusion, pivoting to a niche where we could check off these 6 boxes allowed us to earn significant pricing power where our sales staff were no longer talking price all day but communicating new products to help kitchens across the north east get more profitable. Our pricing power was so alluring that it drew in dozens of buyers for the business and allowed us to sell the company, after 5 years, at a nice profit.