In my 16 years of working in pricing groups at mature companies, I’ve seen a specific management price cycle play out with some regularity. This article describes the cycle, offers advice to break free of it and gives new managers pointers on what to focus on to improve their chances of success.
The cycle starts when new managers take over. This tends to happen every 3-5 years in mature companies when the Board of Directors or senior leadership hires new managers to do what the previous managers could not: get the mature business onto a growth trajectory, preferably a unit growth trajectory.
The next 3-5 years tend to look like this (Figure 1):
- New managers are hired for growth.
- Price is the reason. The new managers come to believe the primary cause of the company’s stalled or declining unit trajectory is high price, recent price increases, or both, and decide that prices must be rolled back to grow the business.
- Lower prices. They lower price, either in tests or on a wide-scale.
- Doesn’t work. Units respond positively, but not enough to grow revenue or to substantially change the company’s unit trajectory.
- Try more price-related actions (more price stuff). They then come to believe one or more of the following:
- It will take more time for customers to respond to the price reductions.
- Their initial price drop wasn’t drastic enough to get customers’ attention, so they need to make a bigger, more noticeable price drop.
- The lower prices need to be advertised more so customers will know about them
- Move on. As these additional efforts don’t move the needle enough, the managers lose interest in price actions. Sometimes they raise prices to help meet top-line goals (and set up the cycle for the next set of managers). Some become more interested in other factors holding the business back. But, they’ve used so much of their runway trying to solve it with price, they have little left to produce results with their new efforts before being held accountable for not making substantive progress. Either the Board of Directors replaces them, or they move on to avoid a bad mark on their resume.
Why does this happen?
This happens due to a combination of mistaken gut instinct that assumes high price elasticity and a focus on easily-tracked metrics, price and units, while ignoring less obvious information.
It is common for mature businesses to have unit volume decline at close to the same rate as prices have risen. For example, “Units are down 14% over the past 3 years and prices have increased 15%.”
This confirms the new manager’s gut instinct that units and price move one-for-one opposite of each other when prices go up.
But, what really happened is that the previous manager, after completing step 5 of their cycle, raised prices just enough each year to offset the units lost to the less obvious and harder-to-track factors.
Contributing to the ‘lower prices’ conclusion are poorly synthesized market research that appears to point to high price as a big problem and pricing naysayers embedded in the organization (but those are topics for future articles).
Break the cycle
New managers can improve their chance of success by skipping steps 1 thru 5 of the management price cycle and, rather, starting their tenure with the confidence that lowering the company’s prices will not accomplish their goals. Rather, they should, at the very least, entertain the idea that the real problems might be found by a close inspection of market saturation, emerging competition, evolving substitutes and consumer preferences.
If the company’s pricing or marketing group knows the price elasticity of its products, they should use it to estimate how much of the unit trend was caused by price increases.
If price elasticity is unknown, a good estimate to start with for a mature business is -0.3.
Use price elasticity to back out the price impact from the unit trend and what remains is an extremely valuable insight: the impact of the other forces on the business.
In the previous example, where units declined 14% over three years as prices climbed 15% (see Figure 2), -0.3 price elasticity implies price increases caused -5%-points of the unit trend.
Figure 2: Easy to conclude that units decline
This means other factors shrunk the business by 9%-points to get to the total decline of -14%, as reflected in Figure 3.
Figure 3: After estimating impact of price on units, other factors have caused 9% of decline.
Another way to say this: If the business held prices flat over the past 3 years, sales and units would both have declined 9%. With the price increases, sales are up 1% and units are down 14%.
A more accurate conclusion is that raising price helped the company maintain the top-line in the presence of other erosive forces, as Figure 4 shows. To grow the business, those forces must be addressed.
Figure 4: Price increases were just enough to offset the losses from other factors.
Grow the business
New managers who successfully skip steps 1 through 5 of the management price cycle will have a head start addressing these other factors. These factors tend to be a mix of the following.
Market saturation is a key impediment of mature businesses. It means that the company’s products are easily available to nearly all the folks who value them.
When Chipotle had six stores, it could double its business by opening six more locations in new areas. Now that Chipotle has locations near much of the population, it saturated the market and growth is not easy to maintain. People can only eat so much.
Emerging Competition. Success breeds competition, and new competition consistently emerges offering slightly different versions of the same product. Sometimes these new versions start to win over customers. Blackberry’s dominant position in the smartphone market was erased by the slightly different versions of smartphones from Apple.
Substitutes are less obvious because these are often not seen as viable competitors. For example, Kodak management discounted the idea that digital photos could be good substitutes to film and photo paper, because in their early days digital quality was low. It was easy to believe digital would stay niche, something for real estate agents, for example, but not good enough to capture family vacation memories. They didn’t consider how technology advancements could change that. Few people can.
Consumer preferences continuously evolve. Twenty years ago, convenience meant making a stop at a nearby store to pick something up. Today, it means clicking a few images on your phone to have it delivered soon.
Gaining perspective on how these things are impacting the business is challenging because the information is messy, open to interpretation and nuanced. It’s not as easy as looking at 3-year price and unit history table and concluding price is the problem.
Addressing these problems requires innovation, which has a 1-in-10 chance of paying off. Managers of mature businesses often make the mistake of trying too few innovations, maybe 1-2 per year. With a 1-in-10 chance of paying off, it can take years to find something that works with that approach. But, that also, is a subject for another article.
If tasked with hiring managers for a mature business, I would look for candidates primed to skip the management price cycle and begin attacking the real problems on day one.