The Price is Rigged?

Last month I broached a topic that engenders emotions from many viewpoints of the industry; overage.

Overage is a practice unique to lighting reps whereby they inflate the cumulative price of their package of lighting vendors’ quoted prices to enhance their profitability. This is a long-tenured practice which has become entrenched in the industry; despite many objections to the practice: ethics, morals, greed, fairness or even legality. My commentary is purely observational. But as the practice has grown over the years, I feel it necessary to help explain the origins of the practice.

Overage has been in practice in the lighting project market for at least 50 years; and probably longer. In the earlier days of the practice, it was an opportunity for a lighting rep to specify

products that weren’t easily substituted by competing rep lines which gave them a ‘locked spec’. But as the practice grew, there were opportunities for growing overage via value engineering, or by manipulating the quotes team from specific vendors to lower prices to ‘meet competition’ and then moving that price decrease into overage… placed on another vendor line.

Reps became strong vocal promoters of overage as proof of their value to the manufacturers, that they could upsell the manufacturer’s products by writing stronger specifications or being closer to the contractor or specifier. As such, they advertised themselves as price opportunists and argued for higher commission structures and higher overage splits.

In the 80’s and 90’s overage became commonplace; and I believe the trigger was that the larger manufacturers were lowering commission levels to enhance their gross margins. The major players in those days (Cooper, Acuity, Hubbell, Philips, Genlyte) were consolidating brands and moving into strong packaging practices whereby the majors controlled a significant volume of every project. It was a race for market share across the Big 5 at that time. The reps were faced with a project package price that was heavily weighted to their major vendor. As quoted prices dropped, so did the commissions. With declining commissions, pricing became an ‘art’. That opened the door to driving the major down to where the package is below what is needed to win the bid and with a handshake with the electrical contractor, the total price could accommodate a sizable overage fee for the rep. The overage could be added to a niche manufacturer or be billed as a service fee through the distributor.

Why would a major manufacturer lower commissions? Two reasons:

1. Their reps were relatively ‘captive’ as a majority of their total revenues were to the major; despite lowered commissions.
2. Cost of sales to the majors was significantly lower for independent reps than using direct field reps; with more feet on the street and larger coverage. A field rep in the 90’s would have commanded over $100K in fully loaded compensation (salary, bonus, car, benefits, entertainment, employer taxes). In that time, $1M of sales/salesman was ‘average’; which would have meant a 10+% cost of sales. Independent reps would generate $1M/head at 5-6%.

A rep firm requires a lot of manpower to be successful; and 5-6% doesn’t provide for attracting quality people. As such, the reps began to add more and more specialty products to make it more difficult to break their spec. Architectural companies provide higher commissions; and many have very favorable overage policies in place, as well.

I ran a quick survey of lighting principals and asked what the core commission rate was for their major vendor. The range of commissions for the majors was from 5-7%; below operating profit levels for a decent size rep firm. In short, overage was a response to dwindling commissions from the majors.

Overage also tends to get glossed over in the industry as if it doesn’t impact anyone. But who ‘pays’ the overage?

The building owner. Overage is buried and invisible to the general contractor, architect and owner. In the spirit of fairness and openness, it’s a shameful practice that unfairly burdens the owner of the building. In percent of total construction cost; it’s negligible. But I feel confident if the owners knew of the practice, they’d have a difference of opinion on the ethics of that transaction.

Eventually, when you decide to exit your company, you will find that overage is complex:

1. It shows up in different areas on Income Statements.
2. Buyers can be baffled by it; especially PE firms and investment banks i.e. your ‘selling agent’.

If you’re considering a sale and would like to talk about the implications of overage on selling your company… give me a call!

Your comments are always welcome.