Currency depreciation creates a tough environment for pricers, especially those operating in multiple international markets, but there is a plus side in terms of maintaining profitability rather than slashing prices. Unless a competitor has a very different production structure, it is unlikely it has a substantial competitive advantage under currency depreciation, which means they are facing the same challenges that you are. All in all, the price pressures caused by a depreciating currency are fairly favorable for avoiding a price war if you know how to handle the situation, as the author explains. Kyle Thompson-Westra is a Senior Pricing Analyst at Wiglaf Pricing. He can be reached at kthompsonwestra@wiglafpricing.com.

The Pricing Advisor, May 2016

The Colombian peso has had a rough 18 months. During this period, it has lost over 70% of its value relative to the US dollar (see figure 1).

A good deal of this can be explained by the collapsing market price of oil, as Colombia is a major regional exporter of oil, especially to the US. Oil is also being blamed for Colombia’s creeping inflation, which has reached a seven-year high. Both from depreciation and inflation, the Colombian peso is being hit hard.

This makes life especially tough for businesses within Colombia that must deal in foreign currencies. If you are importing goods, your costs have shot up quickly and in a manner that is completely outside of your control.

Risks of Price War

With contracting margins due to rising costs, some companies face the temptation to lash out with lower prices in order to chase market share. They sense trouble, and the only way to make the company look strong is to take share away from a competitor.

They may also mistakenly believe that they can easily make up for lower margins with higher volumes. But this is easier imagined than executed. The amount of increased quantity you must sell at a lower price to make more profit than without a price change is calculated with the volume hurdle equation:

Where:

Q = Quantity
P = Price
CMi = Initial contribution margin

Just a few minutes of playing around with the differences demonstrates that a small decrease in price requires quite a large increase in quantity to be justifiable in terms of profit.

Either way, decreasing price, especially in such currency conditions, is hard to justify. Winning market share at the expense of profitability is a great way to destroy your company’s value.

Aggressive price cutting will also likely spark retaliatory action from your competitors, resulting in market share trending toward the status quo with nothing to show but destroyed industry profits.

Figure 1: Graphic from (www.xe.com/currencycharts/?from=USD&to=COP&view=2Y)

How to Avoid the Price War

Currency depreciation creates a tough environment, but there is a plus side in terms of maintaining profitability. All in all, the price pressures caused by a depreciating currency are fairly favorable for avoiding a price war.

Remember, your competitors are facing the same currency pressures. Everyone importing feels the squeeze of a weakening currency. The cost of doing business increases across the line. Unless a competitor has a very different production structure, it is unlikely it has a substantial competitive advantage under currency depreciation.

Additionally, your customers are well aware of the ongoing depreciation. They are primed to acknowledge that higher costs are affecting the entire economy and that businesses must adapt. That does not mean that they would enjoy being asked to pay their share of rising costs, but they will have a much better and more comprehensive understanding of why prices must rise than if it were for a reason particular to your individual company.

This should make it relatively easier to maintain or increase prices. The hardest position from which to justify price increases due to cost increases is if the costs are affecting only your company. After all, your company cost structure is your problem, not your customers’.

However, under depreciation, costs are rising for everyone. This increases the likelihood that companies will be able to pass on at least some of the cost increase to customers in the form of higher prices.

Outcome

It is preferable to maintain or carefully increase prices in a clear, methodical way, only decreasing cost slowly and with much consideration. Careful analysis is required to take into account different SKUs, product lines, geographies, and customer segments, adjusting prices in the way that fits best each unique category.

All the while, it is important to communicate with your customers why prices need to change. By emphasizing value and the systemic nature of the cost increases facing your company, you can help to maintain good customer relationships and price advantage despite the downturn. This also gives a much better position from which to take advantage of market conditions once they do improve.

Remember: the goal of a company is to be profitable, not to own the market. Better to be systematic and resilient, keep the target on profit, and maintain a structure of excellence, rather than react in a disorganized and destructive manner to situations outside of your industry’s control.

Depreciation is tough, but it is no excuse to cede pricing power.