A distributor that knows the date of a price increase buys before it. What that costs is a transfer of price, not a loss of volume, and the quarter after it looks exactly like lost customers.
Ravensworth’s distributors agreed a 2.5 per cent increase from 1 March. At a carrying cost of 15 per cent a year, each of them does best to buy 8.67 weeks of volume at the old price first. That takes 59,840.25 out of the increase, which is exactly one fifth of the 299,201.24 the distributors were due to pay. Half of it lands with the distributors. The other half is spent on warehousing and interest and reaches nobody.
Chapter 10 of the book measures an increase that announced 5.0 per cent and realized 2.3, and it names its own largest omission without pricing it: nobody bought ahead of the announcement, “and in a distributor business somebody always does.” The model behind the chapter contains no December order at all. The first of the three cases in the companion files puts the number on that sentence, and the number is less interesting than where it turns up next: in a sales review three months later, looking like the increase drove customers away.
The increase went out at 5.0 per cent of list. Each segment negotiated its own rate and its own effective date, and the year realized what the rate and the months at the new price allowed. The distributors are 28 accounts carrying 14,361,659.44 of pocket revenue, 16,171,230.89 of invoiced revenue and 244,900 units. They settled at 2.5 per cent from 1 March, ten months of the year.
| Segment | Rate obtained | Months at the new price | Realized over the year | Money |
|---|---|---|---|---|
| OEM key accounts | 2.5% | 6 | 1.25% | 257,098.56 |
| Distributors | 2.5% | 10 | 2.08% | 299,201.24 |
| Direct industrial | 4.0% | 11 | 2.77% | 403,660.60 |
| Small direct | 5.0% | 12 | 5.00% | 332,000.86 |
| The book | 2.30% | 1,291,961.25 |
Against a variable cost increase of 1,630,980.00, the 1,291,961.25 leaves the company 339,018.75 short before commission. The increase also creates 27,423.12 of commission, charged on each segment’s own invoice, so contribution fell 366,441.87 in the year of the 5 per cent increase. That is the corrected figure; the first edition printed 366,758.97. Every number below starts from the corrected pair, and none of it assumes a single account buying early.
A distributor that brings a purchase forward saves the 2.5 per cent on it and pays to hold the stock until it would otherwise have bought it. The first week bought ahead is almost free to carry; the eighth week has to sit on the shelf for eight weeks. The last week worth buying is the one at which the carrying cost of those weeks equals the saving:
2.5 per cent × 52 ÷ 15 per cent = 8.67 weeks.
The 15 per cent is the one figure the book does not give. It stands for the distributor’s money, warehouse space and handling, it is marked ADDED wherever it appears in the workbook, and it is an input cell. Moving it moves the answer in inverse proportion, so the table is more use than the single figure.
| Distributor’s carrying cost, a year | Weeks bought ahead | Increase never realized | Kept by the distributors | Share of the distributors’ increase |
|---|---|---|---|---|
| 10 per cent | 13.00 | 89,760.37 | 44,880.19 | 30% |
| 15 per cent | 8.67 | 59,840.25 | 29,920.12 | 20% |
| 20 per cent | 6.50 | 44,880.19 | 22,440.09 | 15% |
| 30 per cent | 4.33 | 29,920.12 | 14,960.06 | 10% |
Two ratios in that table do not depend on the distributors’ size at all. The share of their increase that is lost is the rate divided by the carrying cost, times twelve over the months at the new price: 2.5 ÷ 15 × 12 ÷ 10 = 0.20. And at the break-even week the distributors keep exactly half of what the company loses, whatever the carrying cost, because the saving on each week bought is 2.5 per cent while its carrying cost rises in a straight line from nothing to 2.5 per cent. The other half is burned.
The second ratio is the one to keep in mind at a negotiation. Forward buying is not a pure gain for the distributor that the company could win back by bargaining harder. It is a transfer in which the company gives up two for every one the distributor receives, and the difference is paid to a warehouse.
The 8.67 weeks are bought at the old price, so the increase on them is never realized. Everything else follows from that one line.
| As the chapter measured it | With forward buying | |
|---|---|---|
| Realized increase | 1,291,961.25 | 1,232,121.00 |
| As a share of pocket revenue | 2.30% | 2.20% |
| Commission the lost increase would have created | 1,347.60 | |
| Effect on contribution | −366,441.87 | −424,934.52 |
The contribution line overstates the economic cost a little, because the cash for the early pails arrives early. On the invoiced value of the forward-bought weeks, brought in an average of half of 8.67 weeks ahead, at Ravensworth’s 7.0 per cent cost of money, that is worth 15,678.96. The net cost to the company is 42,813.69: 59,840.25, less 1,347.60 of commission, less 15,678.96 of earlier cash.
Neither figure is large against 56,124,433.13 of pocket revenue. Both are large against the realized increase of the distributor segment, and against the book’s own verdict on the year, which was already that contribution fell. Forward buying makes a bad year about sixteen per cent worse on the contribution line, 58,492.65 on top of 366,441.87, and the chapter’s table does not show it anywhere.
The cost is small. The distortion is not. The workbook spreads the distributors’ 244,900 units evenly across the year, 4,709.62 pails a week. Buying 8.67 weeks ahead moves 40,816.67 pails from March, April and May into February.
The first thirteen weeks at the new price would ordinarily ship 61,225 pails to distributors. With forward buying they ship 20,408.33. Distributor shipments are down 67 per cent against their run-rate in the first quarter of the new price, and not one customer has been lost. Every one of the missing pails was delivered, invoiced and paid for in February.
A review held in May that reads the fall as the increase driving volume away will reverse an increase that worked. The fall sits in the segment that negotiated the increase down to half the list rate, which makes it all the easier to read as customers leaving.
The same distortion runs the other way in February, which shows a surge that looks like demand. A monthly volume chart across the effective date, read without the forward buy taken out, gets both months wrong in opposite directions and is persuasive in both.
The book notes in Appendix A that Ravensworth grants no price protection because it has never had to. That is the position of a company that has never priced the forward buy. The case sets out two defences, and both have to be written before the announcement rather than after it:
Either one recovers the 59,840.25. Neither needs a harder negotiation, only a clause that exists before the distributors are told the date.
When the clause is not there, read the numbers net of the forward buy. The realized rate of the year is 2.20 per cent, not 2.30. The distributors’ volume in the first quarter at the new price has to be compared with February and the quarter together, not with the run-rate. And the carrying cost that sets the whole thing is the distributor’s, not the company’s: a distributor with cheap money and spare warehouse space buys further ahead and takes a larger share, 30 per cent of the segment’s increase at a carrying cost of 10 per cent a year.
The case is Case_1_The_Distributors_Buy_Ahead.xlsx, inside Three_Cases.zip. Its first sheet is the note; the arithmetic is on sheet 1. The model.
The Chapter 10 figures come from sheet Increase of The_Price_Bridge.xlsx: the distributors in row 13, the realized 2.30 per cent in G16 and the 1,291,961.25 in H16, the corrected commission of 27,423.12 in C25 and the −366,441.87 in C26. To run it on your own channel, replace the amber cells with your distributors’ revenue, the rate they negotiated, the months at the new price and your honest view of what it costs them to hold stock.
Every figure above is a live formula in the free companion files for Pricing Strategy, which also hold the list-to-pocket waterfall, the break-even volume of a discount, the rebate cliff and the price-volume-mix bridge. Each workbook ends with a checks sheet setting the printed figure beside the computed one. No account and no email address.