The economy is in turmoil, credit markets are in terrible shape, inflation is high, and consumer confidence is low. If you just received billions of dollars in taxpayer money as a reward for your part in wrecking the world financial system, you may be partying at a 5-star resort. If not, you have some tough choices ahead. Good pricing strategy and solid execution are more important than ever, since small changes in prices will mean the difference between profit and loss. Businesses have three main choices for how to price in the downturn, each with advantages and drawbacks. Knowing which strategy you will pursue will remove a lot of uncertainty from your tasks and allow you to focus on executing successfully.
The first option is to maintain a hard line on pricing to protect margins.
Many companies’ prices have still not caught up with recent run-ups in input costs. Buyers are used to inflation and conditioned to expect price increases. One of our clients in a hard-hit sector of the economy nervously floated the idea of price increases to key partners. The response was: “We were wondering when you were going to do that. What took you so long?”
This approach works well for specialized markets where customers have little ability to substitute alternative products, such as oil field services, if everyone in the industry is willing to hold the line on prices. A defection by one vendor can trigger a collapse in prices without changing market share.
Even with a potential loss in volume, this strategy may yield the highest profit.
Action items:
- Define break even volume change.
- Identify potential cost savings if the business can shed low profit customers.
- Define a contingency plan so that if volume falls faster than expected, the business can make a measured adjustment, rather than panicking.
The second option is to be aggressive on pricing to protect volume and market share.
Companies with large fixed costs in factories and labor may find this approach most appealing.
This works well if you have structural cost advantages. However, note that if you cut your prices, competitors may follow suit, transferring profit from producers to buyers without significantly changing market share.
Action Items:
- Identify markets where you have a structural cost advantage or where competitors lack the production or distribution capacity to fully supply the market.
- Unbundle what you can to drive down costs.
The third option is to take a hybrid approach: maintain high prices in some areas and lower prices in others, depending on the profit trade-offs. Managing this level of complexity requires the appropriate tools to crunch massive amounts of data, automate pieces of the puzzle and flag others for human intervention. This approach also requires the organizational sophistication to handle product and customer portfolios with a range of pricing strategies. If you can pull it off, this approach provides the best of both worlds.
Action items:
- Identify products with large spreads of price points, indicating opportunities for more disciplined pricing and/or unbundling.
- Eliminate “out-of-sight, out-of-mind” discounts in shipping, payment terms, services, samples and other areas not subject to review.
Regardless of the approach you take, there are a few more action items you should take:
- Now is a good time to check your organizational incentives. Make sure the sales team and others get paid to execute the strategy, not to countermand it.
- Monitor customer compliance on earned discounts. Clearly communicate and enforce the consequences of not living up to commitments on purchase volumes, payment terms, or other clauses where you have traded money in return for something else.
- Clearly define the differential value you offer. Internally, this will help you set the right prices points (premium pricing when you have strong differentiators, value pricing when you offer value parity or even a small value deficit, appropriate discounting to adjust for different market conditions).
If you’re not getting a multi-billion dollar bailout, now is the time to get your pricing house in order.