Wake Up Vending, Part 1

At the time of this writing, fourth-quarter economic performance was uncertain, but the economy was moving in the right direction. Despite the ominous developments that occurred in the fall of 2005 - hurricanes, $70-a-barrell oil and early signs of inflation - the nation’s productivity posted a 3.8 percent gain in gross domestic product in the third quarter. Good news for the economy,

Wall Street hailed. Yet vending operators were less than thrilled.

The “Wake Up Vending” article in the November Automatic Merchandiser addressed the disparity that had become evident in 2004 between the nation’s overall economic health and the vending industry’s lack of it. The current post-9/11 situation stands in marked contrast to the last prosperity period, the “tech boom” of the ’90s. In 1998 and 1999, vending operators’ pretax profits exceeded 8 percent of sales, as indicated in the chart on page 26.

In examining the forces affecting the vending industry’s performance, Automatic Merchandiser, in its “White Paper for Vending” concluded that the vending industry has entered a new phase in its development.

Industry faces new challenges

For the first time in history, the vending industry has not been able to share in the general economy’s prosperity, as reported in the Automatic Merchandiser State of the Vending Industry Report. Automatic Merchandiser identified the key reasons for this as: ongoing work site downsizing, continued outsourcing by large employers, continued growth of smaller work sites, and rising competition from other retail channels.

In response to this alarming situation, Automatic Merchandiser recommended a 7-point action plan in its “White Paper for Vending,” shown on page 26.

Automatic Merchandiser believes that new technology holds the key to allowing the vending industry to meet its unique challenges and realize new heights. Technology, however, creates a “chicken and egg” scenario.

While technology creates new efficiencies to improve profitability, it requires an upfront capital investment that also has the potential to reduce profitability. The key technologies identified include improved information management, more capable and versatile equipment, and more versatile payment options.

As trends identified in November’s article continued in 2006, Automatic Merchandiser begins a series of articles expanding on the seven action plan steps. This month’s article will address raising prices and reducing commissions, which are usually interdependent.

Profitability factors are interdependent

In researching these two issues, Automatic Merchandiser discovered that none of the steps can be implemented without consideration of other steps. In attempting to raise prices and reduce commissions, for instance, operators will also realize the need to partner with customers and invest in employee development.

Hence, this “Wake Up Vending” series offers operators a guide to operate successfully in a changing industry.

As noted in November, the cost of operating is rising faster than both sales and vendors’ retail price points. These factors weigh heavily on operator profits.

In comparing the cost of goods sold in the late ’90s to two recent fiscal years, a relationship can be found between cost of goods sold and operating profit, as indicated in the chart on page 26. Cost of goods sold as a percent of sales increased by more than 6 percentage points from the late ’90s to 2003 and 2004, which is about equal to the percentage point drop in operating profit.

Retail Vend prices aren’t keeping up with inflation

Another disturbing trend is that retail vending prices have not kept pace with inflation in recent years. The Automatic Merchandiser State of the Vending Industry Report for 2005, the most recent data available, indicated average annual price increases in fiscal 2004 were below 2 percent in most of the largest product categories: can beverages, 1.25 percent; bottle beverages, 1.57 percent; candy bars, 1.25 percent; and pastry, 1.425 percent. While retail price increases on a percentage basis do not usually match whole price gains, Automatic Merchandiser does not believe vending prices are rising fast enough to cover wholesale product increases, not to mention other cost increases operators incurred.

The foodservice industry, by contrast, raised retail price points by 2.9 percent in 2004, the National Restaurant Association reported. This indicates that the vending industry’s competing channels are doing a better job of recovering their costs.

While price is only one aspect of profitability, some economic indicators suggest that early 2006 is a good time for operators to focus on this challenge.

Vending and foodservice operators alike have struggled to raise prices in recent years due to relatively low inflation, as measured by the government’s Consumer Price Index (CPI). In 2005, inflation began to increase. The CPI rose 4.9 percent in the first 10 months of 2005, compared to 3.3 percent for all of 2004.

Economic trends support higher prices

In evaluating the impact of the CPI on retail prices, retailers need to consider two things: 1) what impact CPI has on the price environment, and 2) what impact it has on consumer confidence. On both counts, the present situation bodes well for retailers raising prices.

In relation to the overall price environment, consumers are aware that retail prices have increased more in the last year. Hence, higher vending prices do not look out of step in comparison to changes in other venues.

As for consumer confidence, confidence levels have been volatile in the past several months, due in large measure to post-hurricane spikes in fuel prices. Nevertheless, in the month of November, confidence surged, according to the Conference Board, a Washington, D.C.-based organization that tracks economic trends. In addition to slight declines in fuel prices, consumers became more optimistic about the economy and employment prospects.

U.S. businesses in general were finding it easier to pass along higher costs to consumers and planned to keep pushing prices up in the coming months, according to a survey of businesses released that also showed steady economic growth despite recent hurricanes. The survey by the Washington, D.C.-based National Association of Business Economics found 40 percent had raised prices in the third quarter of 2005, compared with only 2 percent that had cut them. The resulting net rising index of 38 percent - the difference between the two - was the second-highest in the survey’s 24-year history.

In addition, 46 percent of the firms said they expected to push prices up over the next three months, in contrast to only 4 percent that said they were likely to lower them.

The recent survey and one conducted after the close of the second quarter of 2005 also indicated businesses were having an easier time making price increases stick than at the beginning of the year.

Vending faces unique challenges

While the environment for raising prices may have improved, vending operators face some unique challenges in this area. Historically, operators have based the decision to change prices on their overall profitability, which includes several other factors in addition to prices: taxes, commissions, cost of goods sold, equipment depreciation, shrinkage, spoilage, service costs and overhead. These factors all belong to the traditional “pro forma,” which vending operators use to determine account profitability.

The decision to raise prices continues to be made in relation to these other factors. Several operators interviewed recently acknowledged that account decision makers are more agreeable to accepting price increases than they have been in the past. Hence, operator experience supports the option to raise prices in the current climate.

Operators should monitor the profitability of all locations on a regular basis, and consider all profit saving options before deciding to raise prices. Other options include: reducing commission, removing a piece of equipment, charging an equipment rental, reducing the level of service, and lengthening service intervals.

To decide which option to pursue, it is necessary for the operator to have an accurate accounting of the location’s sales and expenses. If removing a machine will make the account profitable, this might be an easier change than seeking a price or commission concession.

State-of-the-art software packages make it easier than ever to keep track of account financials; however, they require accurate accounting at the route and supervisory levels. Here is where investment in employees, another action step, comes into play.

Commissions: the easiest change to make

Most operators agree that reducing commission, where it exists, is the easiest change to make, usually for both the operator and the account. There is no labor involved in changing the commission, and it doesn’t have to be adjusted in nickel increments.

More importantly, it will oftentimes have the least impact on the consumers at the account. It is important, however, for the operator to understand what the customer does with the commission money. If it is used to support a popular employee benefit, it might not be the best option.

In seeking any profit-saving concession from an account, it is always best to offer options. Even if the operator has decided which concession he wants, the customer will appreciate having options. The operator can place conditions on options he doesn’t want in order to discourage the customer from choosing them.

Operators can improve their chances for winning a concession by offering something extra to the customer.

How to win concessions

Some accounts might find great value in a catered holiday party that the operator can provide at low cost.

An account might be excited to have special product promotions every other month that the operator can provide at minimum cost with support from his product suppliers; or the chance to win tickets to sporting or entertainment events.

Here is where strong customer communication makes a difference. It is usually necessary for the customer to believe in the value of the service, and it is always necessary for the vending operator to know the customer’s mind-set on this subject.

In seeking concessions on pricing and commissions, veteran operators agree it is critical that someone in management - be it a supervisor or manager - maintain ongoing communication with the account decision makers on a regular basis.

Operators also have noticed that detailed information about the account’s performance has a major influence over decision-makers’ willingness to accept a change in service, be it a price increase or another action that will improve the account’s profitability.

This sharing of information should include operator invoices demonstrating increases in product costs, healthcare premiums, utility charges, fuel costs, etc.

Here is where some of the other action steps in the action plan come into play: Partner with customers, BUT FOR REAL; and commit to technology on some level. A brief explanation of both of these points is in order.

Partner with your customers

Historically, operators have not shared their financial information with accounts. Successful operators have found that by allowing the customer to understand the economics of servicing the account, he or she will be more willing to meet the operator’s needs.

One tool that facilitates this sharing of information is gathering line-item sales, which DEX technology provides. Operators have found line-item sales data very helpful in getting the account manager to agree to remove unprofitable items that have been requested by certain individuals.

In raising prices, operators need to consider the reaction of not only the decision maker, but also the consumer. Traditionally, unit sales suffer for a few weeks following a price increase.

In communicating a price increase to an account manager, it helps to put the increase in as large a context as possible. There are different strategies to consider.

If there were two price adjustments this year but only three in the last five years, the operator can point out that he has kept price increases to less than one per year. Most likely, this will be less than what has occurred at retail outlets.

The operator can also point out that he has only raised prices on a minority of his stock keeping units (SKUs), even if these are the higher volume units.

Another tactic is to offer some price reductions on lower volume movers. Veteran operators, it should be noted, have mixed views on whether this tempers resistance to a price increase.

Some operators find that it always helps to offer some type of concession to the account, be it a price reduction on some slow moving items or free products.

Consider the price/value relationship

One tactic that operators have begun using recently is upsizing products to win higher prices. As noted in the October 2005 article on candy price increases, many operators have replaced regular-size chocolate candy bars with larger-size bars at a higher price point. The article reviewed specific strategies for selling larger-size candy bars.

Operators need to keep in mind, however, that they do not want to compromise meeting consumer demands in the interest of winning acceptance for higher prices. Consumers might resist purchasing their favorite items when they first encounter higher prices, but, as noted, this is a temporary reaction. The top selling products will yield the highest sales and highest levels of customer satisfaction over the long run.

Here is where another action step - investing in technology - comes into play. Vending operators should rely on market data, including their own sales data, in deciding what products to menu. State-of-the-art vending software allows operators to analyze their sales by location, by machine and by line-item.

How much of an increase?

Once the operator has decided to raise prices, he wants to raise them as much he needs to while minimizing customer resistance. This might seem like common sense, however, many operators choose to raise prices as little as possible in order to minimize customer resistance. This will prove counterproductive if the price increase fails to return the account to profitability. Another price increase will be needed, and the second one will have less chance of acceptance.

Operators should base the increase on how it will affect profitability once unit sales return to normal velocity.

Competitive prices need to be considered as well. Prices that are radically out of line with the market will alienate customers and invite competitive proposals.

Utilize market research

For guidance on pricing, operators should also consider market data from product suppliers or market research services such as Streamware’s InfoVend and Management Science Associates’ ProVen™.

Determining the most profitable price point oftentimes requires trial and error.

Operators should keep in mind that the most profitable price point is not always the highest price customers will accept. Velocity has as much bearing on profitability as price point. Here is another area where state-of-the-art software gives operators the ability to determine the most profitable solution.

In cases where the operator cannot raise the price to achieve the necessary financial results, the operator needs to consider other options. In some cases, it is possible to achieve some gains by introducing new, less price sensitive items or raising prices on existing less sensitive products.

Veterans agree that price increases on secondary sellers will not compensate for low margins on the core sellers. However, if higher margins can be achieved on several secondary items, the total gain can be significant.

How many price increases?

As product costs have increased recently, operators have considered whether it is best to raise prices on several different products at once, or to seek them on an as-needed basis. The more these changes can be grouped together, the less work needed on the operator’s part and the more he will be able to minimize customer resistance, but this is not typically the best choice.

Suppliers do not raise their prices in unison, and passing on higher prices for different products all at once will involve predicting future costs on some of the products, which is extremely difficult.

Price and commission are only two aspects of profitability, and all factors need to be reviewed regularly. Operators who have a good working relationship with customers will be more likely to review these factors regularly and maintain profitability.

As the cost of doing business continues to rise and operators face limited opportunities to add customers, operational efficiency becomes more critical. Operators hoping to succeed in the future have to plan for it.