GM and Employee Discount Pricing
So General Motors (GM:NYSE) has decided to cut prices dramatically in order to reduce inventories. In my previous article, I advised increasing margins, but unfortunately, their action will reduce gross margins further. Of course, getting rid of excess inventory and turning it into cash is always high on the turnaround specialist's agenda. Reducing gross profit margins is generally negative unless you can increase inventory turns dramatically.
From a marketing perspective, the "employee discount pricing" is a great technique. Employee pricing is considered to be the best pricing available by many, and it is easy to understand. Since they are not publishing the resultant pricing, it is hard to compare it to other promotions, but it has been pretty effective at increasing revenues and reducing inventories thus far.
On the negative side, decreasing prices to increase sales leaves everyone thinking that the cars are pretty much worth the "employee price", and the price they normally have to pay is a premium. Perhaps other promotions could have been tried to decrease inventory without such a high reduction in prices and gross profit margin. A multi-million dollar lottery/sweepstakes comes to mind, as well as other scenarios such as free additional gifts. The advantage of these techniques is that they are seen as additions, and the prices of the cars are maintained in the consumer's mind.
In the mid-term, GM has to increase its gross profit margins unless it finds a way to increase inventory turns dramatically. In order to give a clearer picture of the interaction of these ratios, lets use an ice cream example. Think of gross profit margin as the size of your spoon, a larger gross profit margin equals a larger spoon. Now think of the inventory turns as the number of scoops per hour. The bigger the spoon and the more often you scoop, the more ice cream you scoop into your bowl. The higher your gross profit margin (the larger your spoon), and the more inventory turns (the number of scoops per hour) the more profit that flows down to cover operating expenses, with the surplus being profit. The smaller the spoon, and the less scoops you take per hour, the small amount of ice cream that flows down to cover operating expenses. It is easy to think that you just want to always increase both your gross profit margin and your inventory turns, but some businesses such as grocery chains, and warehouse stores such as COSTCO, work by maintaining a small gross profit margin (small spoon), but a very high inventory turn rate (scoops per hour). Because they turn their inventory very rapidly they yield high gross profit dollars to cover operating costs and produce a profit.
Hopefully this short-term discount sales strategy will work well for GM, but in the mid-term, it will need to focus on higher margins due to more desirable products. I don't believe that lower pricing alone can increase the inventory turns enough to counter act the lower gross profit margin. Obviously, if you reduce the gross profit margin in half, you will need to double your inventory turns in order to maintain the same gross profit dollars. Of course, this type of increased activity generally yields much higher operating expenses which will mean reduced profit or losses.
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