Is prolonged inflation on the horizon? Costs are undoubtedly rising, with global economic experts closely monitoring developments and pundits making predictions. Inflation has an obvious impact on consumers, but the upstream effect on distributors, manufacturers and services companies is just as profound. Acting swiftly has never been more important.
Resurgent demand post-pandemic, coupled with industry’s inability to acquire raw materials, manufacture products and stock distribution centers, has led to a “perfect storm” that is causing prices to soar on everything from diapers to steel.
While we hit a 13-year high in the consumer price index inflation rate (5%) in mid-June, so far, the federal government and Wall Street generally agree the situation is temporary. That’s cold comfort to any business currently scrambling to source steel, iron, lumber, cotton, copper, and any number of other materials that are trading at a premium price. Companies who have been less than intentional and data-driven in their pricing approach risk letting this (hopefully) short-term crisis put them at a long-term strategic disadvantage.
To that end, the average company struggles to keep up with cost changes even under more “normal” economic times. According to our recent Global B2B Industry Benchmark Report, companies lose nearly 9% of available margin annually due to inefficient and misaligned market pricing, largely caused by slow, overly broad and inefficient processes to increase prices when costs rise.
In an inflationary environment, these margin threats may balloon to full-blown crises. Compounding the trouble, surging demand and the recent Evergiven accident in the Suez Canal have also congested shipping lanes, driving up rates astronomically at the same time that prices on goods are rising across the board.
“Turns out, at current commodity prices … the dry bulk market is nowhere close to its theoretical ceiling,” said Stifel analyst Ben Nolan. “If demand exceeds supply, the primary upward constraint of ship freight cost is the point at which it absorbs the profit of the producer or shipper.”
Every link in the value chain, from manufacturer to distributor to shipper to importer/exporter, fears margin slipping away. While the right strategy for each unique company will vary, time is of the essence when it comes to adjusting pricing strategies in step with market conditions. In this article, we will discuss the importance of speed and intelligence in pricing practices, four potential strategies to combat an inflationary period, and how data science, artificial intelligence (AI) and cloud-native software can help power intelligent commerce by connecting commercial strategies with more effective execution in all go-to-market channels in real time. We will also share why abandoning manual tools − which are prone to error and are painfully slow − is critical at this juncture.
RESPONDING TO PRICING TRIGGERS FASTER AND MORE URGENTLY
The frequency and scale of what we call “pricing triggers” — external events that cause a company to execute price changes — have steadily increased in recent years. In times of market volatility, as the volume and velocity of pricing triggers increase, the inefficiencies in a company’s pricing process are exposed.
The practice of setting and updating pricing remains largely a gutfeel process in many companies, initiated as a reaction to various triggers and often handled using spreadsheets and email. When commodity prices like steel increase, speed and time are of the essence.
“By the time the decision is taken to increase prices, manually change the price lists, matrices, and customer agreements, brief the sales reps and inform customers, the market has already changed again.”
Reactive pricing strategies are slow, at least by the standards of the fast-paced digital world we now live in. By the time the decision is taken to increase prices, manually change the price lists, matrices, and customer agreements, brief the sales reps and inform customers, the market has already changed again.
There are a variety of strategies a company might employ in response to this period of hyper-volatile costs and potential inflation. Manual tools can hamstring a pricing team that is trying to execute new pricing, an executive team deploying new strategies, a sales team that must act on new strategy, and customers who expect rational pricing, sometimes regardless of macroeconomic factors.
FOUR PRICING STRATEGIES FOR AN INFLATIONARY PERIOD
When inflation hits, it’s crucial to first quantify the full impact to your finished good (if a manufacturer) or stocked inventory (distributor) and work backward. Do you manufacture food or chemicals and rely on complex product formulations? Some ingredients will be hit harder than others. If you buy 100 ingredients per month and the cost is going up on 50 of them, how quickly can you understand which formulations are affected and by how much? Are you able to factor in labor, freight and other costs that go into that final product?
If you’re a metals distributor, how effectively can you pass through steel cost increases to protect your margins? An honest look at your current capabilities is essential to executing these responses to inflation and short-supply environments.
STRATEGY NO. 1: TAKE PRICE UP
If a company is a leader in its industry, this type of visible price increase during times of inflation is preferable. As the leader, not only is there less risk in this move, but the other competitors in the market are likely looking to the leader to provide air cover. If the leader doesn’t take price up, the industry as a whole begins to leak margin.
“Your market maker really should be going first, so my advice to the leaders is: Lead,” said David Moss, consumer markets pricing and profitability practice leader at PricewaterhouseCoopers. “Go out, take price, see how the rest of the market works.”
Certainly, the mechanics of price increases are difficult and must be made thoughtfully and strategically. There is a science to taking price up in this fashion that must include each mode inside your pricing architecture (list, matrix, customer-specific, negotiated).
STRATEGY NO. 2: ADJUST DISCOUNT STRUCTURE/REBATES
If a company is not a leader, and the leader hasn’t yet increased its list prices, it is a good time to get creative by dialing back variable discount amounts and/or increasing rebate thresholds. This form of invisible price increase is a behind-the-scenes method of functionally raising price without taking a public list price increase.
This strategy requires precise orchestration of a company’s discounting and incentive strategies, which almost certainly cannot be executed quickly enough with manual pricing tools.
STRATEGY #3 – ALLOCATION, ALLOCATION, ALLOCATION
With many industries facing a low-supply situation, companies will undoubtedly put some of their products on allocation. The key here is to be judicious in deciding which customers are subject to allocation and where to set the optimal price thresholds.
One building products manufacturer is weathering the rise in steel costs by making intelligent allocation decisions informed by optimized customer-specific prices (CSP). With CSP guidance implemented, the company can enact a policy in which customers can buy up to their average purchase amount at the current month’s price, but if they want to buy more, the additional spend is transacted at next month’s (increased) price. This also allows for more granular controls, wherein exceptions can be made for the most strategic customers to protect those relationships, while the company can pick and choose the best spots to pass costs through.
STRATEGY #4 – CHANGE SALES INCENTIVES, CHANGE BEHAVIOR
Communication in a crisis can make all the difference between success and failure. Money talks for any sales team, so the best way to drive effective communication is to financially reward the necessary behavior. To do this right requires agility, responsiveness and, ultimately, sales team adoption of your crisis response tactics. Companies must lean on the tried-and-true carrot (incentives) and stick (reporting) methods in a data-driven fashion.
If you are the aforementioned manufacturer and there is literally no more steel available to you outside of your shrinking inventory, a sound strategy is to heavily incentivize margin percentage. Considering there is limited downward pressure on margins, coupled with the highly public knowledge that there is little to no volume to be had, it is crucial to change the sales reps’ behavior quickly. Now is the time to limit discounting behavior.
Communicate a limited-time margin incentive, track adoption with real-time visual analytics to hold sellers accountable, and continually reinforce the urgency.
THE KICKER: YOU NEED TO BE SURGICAL AND SPEEDY
Time is of the essence, as costs are rising each week. But a heavy-handed “peanut-butter spread” of price increases, wherein a price increase is imposed uniformly across all customers and products, has a way of sacrificing sales. Companies can’t afford to be fast and wrong or slow and right, it is clear. Yet, as we’ve established, the manual pricing tools that make up the status quo for many organizations have become active impediments to executing an effective price increase strategy.
Companies that utilize modern price optimization, price management and deal management software have discovered that it is possible to be surgical and speedy, at scale.
Surgical Price Increases
Rather than passing on costs by increasing prices uniformly across the board, companies need to take a more specific, granular approach. Price optimization powered by artificial intelligence (AI) identifies and then calculates the price elasticity of each micro-segment. By doing so, it’s possible to ascertain which customers are more and less sensitive to price changes for a given selling circumstance and adjust pricing strategies for each. Even better, these systems can predict the outcome of pricing strategies before new prices are published. Now, for example, it’s possible to see clearly how a 1% price increase will impact revenue and margin in one segment versus a 5% price increase in another. It might make sense to claim twice the cost increase on your differentiated products because you know you must take less on other commoditized items. The result of this surgical and asymmetric strategy is a more optimized balance of price increases that limit volume loss.
When world-class data science and AI are combined with cloud-native software and expertise in pricing, sales and the business dynamics in play, it’s possible to mine massive data sets at scale and spot patterns that can be used to inform decision-making at incredible rates. Leading price optimization and management solutions can identify and execute those decisions across multiple systems at similarly impressive speeds. When it comes to pricing, this means that price-change decisions and their implementation no longer need to be behind the curve.
It’s not uncommon for manual price increase processes to take up to 90 days (in some cases up to four months) from decision to execution. As author and pricing evangelist Stephan Liozu said in a recent podcast, “90 days in an inflationary period is deadly.”
These platforms can aggregate vast amounts of data from unlimited sources without any impact on speed, as well as compare and collate disparate data sets to generate novel and unique insights at a granular level. Even the most experienced team of analysts couldn’t scale to this level with manual tools. In the case of cost volatility like we are seeing today, users can compare in-house data sets with raw material cost indexes and competitive pricing to inform pricing strategies, all within an intuitive visual analytics interface. Imagine incorporating external cost indices into a pricing model to set pricing, conduct “what-if” pricing strategy simulations, and accurately visualize the impacts to margin and revenue before publishing prices.
The common question whenever the market is forcing a company to raise its prices is, “What’s the right balance that will protect us from margin erosion without sacrificing revenue?”
Whether inflation is transitory or here to stay for a while, companies should seize the opportunity to be prepared with an intelligent and measured response either way. Smart pricing and agreement management tools are rapidly replacing the old status quo. When companies can understand price elasticity at a granular level, guesswork is gone. Instead, practitioners and stakeholders know in advance the level of price increase that each customer segment will tolerate without taking their business elsewhere. Once identified, those increases can be automatically updated throughout a company’s entire pricing architecture and account list, while pricing formulas and discount logic are operationalized across the business.
These systems can then rapidly execute whichever of the above inflation-response strategies a company decides on. This is how leading organizations are making pricing competency synonymous with business resiliency, allowing them to act and react quickly when market triggers cause prices to move.