What Does A Price Concession Really Mean?

By August 21, 2010Differentiation

Scenario 1:

Sales Rep: “With a 3% price cut, they’ll buy.  Without it we lose.  It’s a $100,000 deal and we cannot risk losing it for a paltry $3,000 of the company’s take.  We must give them the price decrease they want.”

Sales Manager: “No.”

Sales Rep: (after leaving the manager’s office)  “That @%#&* idiot!  How can he possibly be so dumb.  I’m going back in there tomorrow to straighten him out.”

Scenario 2:

Sales Manager: “We’re going to cut your commission rate by 10%.  It might sound like a negative thing at first, but you’ll easily be able to more than make it up on volume.”

Sales Rep: (after leaving the manager’s office)  “That @%#&* idiot!  How can he possibly be so dumb.  I’m going back in there tomorrow to straighten him out.”

Scenario 3:

Sales Manager: “We’re going to increase your sales quota by just a bit more than 11%.  It might sound like a negative thing at first, but you’ll easily be able to more than make it up on volume.”

Sales Rep: (after leaving the manager’s office)  “That %#&* idiot!  How can he possibly be so dumb.  I’m going back in there tomorrow to straighten him out.”

The rep’s response is not the only thing that’s identical about the three scenarios.

Avoid thinking through the following math at your own peril!  It doesn’t matter if you’re a rep or a manager.  You’ll need to adjust the assumptions according to your own situation, but that won’t affect the fundamental message.  Here are the assumptions for example above:

  • The rep’s sales quota is $2,000,000
  • The average gross profit margin is 30%
  • Commission is 20% of gross margin

Here’s the math for a 3% price decrease vs. a 10% commission cut:

  • $2,000,000 sales minus $1,400,000 cost = $600,000 gross profit (a 30% margin)
  • $600,000 gross profit X 20% = $120,000 in commission
  • $1,940,000 sales minus $1,400,000 cost = $540,000 gross profit (a 3% price cut)
  • $540,000 gross profit X 20% = $108,000 in commission
  • ($120K – $108K) / $120K = 10% commission cut (or, another way to look at it, 90% of a 20% commission on the original $600K gross profit is $108K)

The 3% price cut that the rep demands is exactly equal to a 10% commission rate cut that the rep decries.

Here’s the math for a price decrease vs. a sales quota increase:

  • $2,000,000 X 30% gross margin X 20% commission = $120,000 in rep earnings
  • $2,222,222 X 27% gross margin X 20% commission = $120,000 in rep earnings
  • ($2,222,222 – $2,000,000) / $2,000,000 = 11.1% quota increase

The 3% price cut that the rep demands is exactly the same as an 11.1% sales quota increase that the rep decries.

If you’re a rep, beware of what you ask for!  If you’re a sales manager, beware of doing “favors” for your reps.  If a price cut is a smart thing today, it’s a smart thing tomorrow, …but then a 10% commission rate cut is just as smart; …and so is an 11.1% quota increase.  What is it that you want?  What is it that you need?

Is a price cut the right tactic?  Or is it just an easy way to avoid the hard work of crafting a compelling value proposition?  When is a price concession a good idea?  When is it a bad idea?  I’m just asking you to…

Think About It…

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