It's Not Luck - Eliyahu M. Goldratt [26]
Don thinks for a minute. Pete and I wait for him.
Finally he says, “Let me see. The buyers expect that the larger the volume, the lower the price per unit.
“Correct,” Pete encourages him, “this is the key.”
“That means,” Don continues somewhat more confidently, “that the buyer not only compares your prices to the competitors, he compares your price per unit for larger orders to your price per unit on smaller orders. Now I see the problem. If you reduce your price per unit on the large quantities, the buyer will demand a proportional reduction on the small quantities, even if for those quantities you currently offer lower prices than the competition.”
“You got it,” Pete smiles. “The habits of the buyers would cause pressure to lower prices across the board. This would ruin the business.”
“That’s clear,” Don agrees. “I don’t see another solution. Alex, do you?”
“Let me try,” I start. “The arrow we are examining is ‘in order to get the best financial deal from the vendor, the buyer must order large quantities,’ because large quantities enable lower prices, which improves profitability. How can I challenge that?”
For a moment I don’t see any way, but then I find the soft spot, the words “financial performance” and “profitability.” Profit is only one of the financial performances a company is concerned about. There is another one, which sometimes is even more important than profit-cash flow.
“Pete,” I ask, “do some of your clients have severe cash flow problems?”
“Some,” Pete answers. “Cash flow is a major concern for a few of my clients, certainly not all. But I don’t see how I can use it to cause them to pay higher prices.”
“Don’t you see? Ordering more frequently in small quantities ties up less cash in inventory. Even if the buyer has to pay higher prices for small orders, he is much better off on his cash flow.”
“But only for the short term.” Pete doesn’t fully agree.
“Pete,” I say, “don’t you know that when cash flow is pressing, only short-term considerations exist.”
Pete thinks about it. “Yes, it might work . . . sometimes . . . for some of my clients. I don’t think I can base my business on it. But in any event, it will strengthen the arguments for my proposal to the buyers. Thank you.”
“You’re welcome.”
“Want to try another idea?” he asks.
“No, Pete,” I laugh, “even if I had one, which I don’t, I’m too eager to hear yours.”
“Our solution,” Pete begins, “is based on a direct attack on the assumption that ordering in large quantities gives the buyer a cheaper price-per-unit.”
“Isn’t that the case in your industry?” Don asks.
“No, it is not,” is Pete’s surprising answer.
“How come?” I’m baffled.
Pete is apparently delighted. “Let’s take a recent case where we lost a sale to one of our competitors.” He takes out a bunch of pages from his folder, and pointing to the top page he says: “This is what we quoted. The first column is the quantity and the second is the price.” Turning to the next page, “And here is what the competition quoted.”
We compare the two pages. At the top, where the quantities are small, Pete’s prices are significantly lower, but as the quantities grow, it gradually changes. Toward the bottom of the pages, Pete’s prices are almost 15% higher. No wonder. Due to Pete’s quicker set-up, we are cheaper for small quantities, but due to the competitor’s faster printing press, he is cheaper for larger quantities.
“I don’t understand you at all,” Don says. “You just claimed that large quantity doesn’t give a lower price-per-unit, and now you give us real price lists that prove the exact opposite. Your list and your competitor’s list have only one thing in common: in both quotes, price-per-unit goes down when the size of the order increases.”
“Continue,” I say to Pete.
“The client elected to order this quantity;” Pete is pointing to a number near the bottom of the page. “And, of course, since for this quantity the competitor is much cheaper than us, we lost the order. But,” he adds in