Zero-margin is the price established by the offerer whose starting point is the unit profit of the sales object equal to zero.
In mathematical terms: Initial price(n) – Initial full cost(n) = 0.
The zero-margin price can be a good alternative for increasing sales, diluting fixed costs, reducing inventories, and improving business profitability, notably in highly competitive markets, excess supply, sharp decline in demand, commoditized products, and uncompetitive items.
Although with these possible gains, the adoption of a zero-margin pricing policy needs to consider that:
1 Zero-margin pricing tends to be more advantageous and of reliable results, except in specific circumstances, when there is an idle capacity or undesirable inventories.
2 Because of the lower prices charged, zero margin usually promotes an increase in sales and production levels and a consequent reduction in the portion of overhead expenses allocated to each sales object. Therefore, the margin zero that served as the starting point for calculating the new price becomes a positive margin, albeit small.
3 The eventual growth in the activity level sponsored by the zero-margin price can promote an increase in productivity and the consequent reduction in the cost of manufacturing, further improving its profitability due to the better use of materials, labor, and facilities.
4 If the lower price charged is not more than offset by cost reductions resulting from the price change promoted, the result of the zero-margin practice will be neutral or negative.
5 From a financial point of view, by increasing sales and reducing product stocks, the zero-margin price tends to improve inflow and cash surplus but also requires more working capital.
6 Due to competitors’ reactions or the buying market’s behavior, the price reduction resulting from zero margin sometimes does not increase sales, which can eliminate its possible benefits.
7 The practice of zero margin, as it occurs in overhead manipulation, can make other negotiations more difficult.
In summary, even if idle capacity decreases, inventories fall, sales rise, productivity increases, or cost reductions occur, the care to take is that the zero-margin application is positive and does not damage other relevant transactions.
C. L. Eckhard, author of Pricing in Agribusiness: setting and managing prices for better sales margins.
Claudio Luiz Eckhard is a former professor, business consultant, and author of the books “Ajustando o Rumo”[Adjusting the Business Course], “Gestão pela Margem”[Management by Margin], “A Empresa Saudável”[The Healthy Company], and “Pricing no Agribusiness”[Pricing in Agribusiness].
