Author: Stephan M. Liozu, Ph.D.
The U.S. and global economies are going to slow down, and it is not the end of the waves of disruption we have seen over the past 5 years. Companies must develop costing and pricing skills to manage constant business volatility, as the author explains. Stephan M. Liozu, Ph.D. (email@example.com), is the Founder of Value Innoruption Advisors, a consulting boutique specializing in value-based pricing, industrial pricing, digital and subscription-based pricing. He is also a Research Fellow at the Case Western Reserve University Weatherhead School of Management. He is a Certified Pricing Professional (CPP), a Prosci® certified Change Manager, a certified Price-to-Win instructor, and a Strategyzer Business Model Innovation Coach. He has authored seven books: The Industrial Subscription Economy (2022), B2G Pricing (2020), Monetizing Data (2018), Value Mindset (2017), Dollarizing Differentiation Value (2016), The Pricing Journey (2015), and Pricing and Human Capital (2015). Stephan sits on the Advisory Board of the Professional Pricing Society. He is a Strategic Advisor at DecisionLink and a Senior Advisor at BCG.
The Pricing Advisor, February 2023
We are heading into a global recession. Some economists predict that it is inevitable. It is not a matter of if but of when and how abrupt it might be. While the economy is still healthy, the combination of higher interest rates, labor shortage, and the first sign of GDP slowdown confirm this prediction. These indicators mean that we can expect some turbulence ahead. We have to brace for some downward trends across the board. They also mean that some of the bubbles that were created since COVID might burst quickly. We can already see this phenomenon with some of the commodity prices for oil and wood, for example. I anticipate that with both an economic slowdown and the improvement of supply chains, we might see abrupt downward price pressures in the next six to nine months. Now, I am neither a fortune teller nor a qualified economist. In general, though, what comes up must come down. And sometimes it doesn’t come down slowly – it crashes. Some of the most visible business categories have already crashed, including freight costs, lumber and steel prices, and some chemicals for example.
It is also true that corporate profits have never been so high. Companies have taken advantage of the scarcity of supplies to adjust prices, restructure their product portfolio, and make some of the structural changes they never dared to make in the past. Pricing, which was a fairly taboo subject in the past for some of these industries, has been front and center for the past twelve months. But with good news comes bad news. Commodity, raw materials, and labor costs never stay too high for too long. They eventually crash. And that means that customers, buyers, and end users are waiting for price relief. They will demand price concessions based on very visible cost reductions. Are you equipped to handle the potential collapse of your costs and your prices? Are you ready for the potential tsunami of pricing decrease requests? Chances are you are not!
How do you Prepare?
The best defense is a strong offense. That means getting ready now for a potential collapse of some markets and/or some ups and downs over the next few quarters. I propose eight actions to take now to prepare yourself for a downward price spiral.
- Deeply understand your supply chain and your raw materials mix: You need to assemble a tiger team with procurement, R&D, supply chain, and finance to take a serious inventory of your current stock levels, expected raw materials in transit, and committed purchases so that you can establish the situation of the quantities and value of all current stocks. This is an important component for calculating an eventual lower-cost pass-through lag.
- Analyze your costs in detail: Make sure you estimate your cost situation based on point number one. Often, customers do not understand the questions of lag and mix. For example, oil goes down and they call you for a price decrease. You have to be an expert in understanding your costs through the supply chain and your cost mix so that you can have data-driven answers.
- Leverage data to connect, cost, supply chain, and pricing: Based on points one and two, you can estimate your true cost situation and propose data-supported responses to pressing customers.
- Communicate transparently with the market: It is essential to educate the market on supply chain cost dynamics, volatility in costs, and the concepts of lag and mix. Regularly communicating in a transparent fashion is a way to avoid surprises and anticipate reactions.
- Get the teams ready and mobilize: When raw materials move up or down, I recommend setting up a war room for 90 days. Mobilize experts from finance, supply chain, pricing, and sales to interact weekly and make sure people are aligned and ready to act.
- Beef up your value-based pricing muscle: Apply a value-based approach when deciding if prices must come down and by how much. You can use value maps and customer value models to estimate if discounts are necessary and at what levels. Remember that across-the-board price decreases are not the best way to go.
- Train your salespeople for the tsunami of price decrease requests: Train them to handle pricing objections, price concession requests, and other pricing pressures. Make sure they understand the rules and guidelines so that they can respond quickly and professionally. After months of price increases, customers might be more aggressive on the way down.
- Adopt a fair and speedy response philosophy: Do not upset customers by failing to respond to their price concession requests. They have long-term memory. The way you treat customers at this stage might play in your favor when costs and prices go up in the future.
It is not Black and White
The new reality is that we are moving away from traditional inflationary and deflationary periods. We are entering a period of “hybrid-flation” consisting of some costs going up while others are coming down.”
Pricing teams are generally better equipped to manage costs and prices going up. They must now get better at managing price changes during deflationary periods and periods of “hybrid-flation.” One might say that that this is not the first time companies have faced this phenomenon. I would argue that right now the speed and intensity of cost changes and the level of unpredictability is unprecedented. Add to this the beginning of a recession, the risk of additional geo-political conflicts, and the unknowns related to the COVID crisis in China, and we might be heading for turbulent times for another two to three years.
This will require a big change in how companies manage the pricing process, how pricing interacts with other functions, and how businesses communicate with their customer base. I predict that the pricing function will be front and center in collaborating with procurement teams, supply chain teams, and sales teams for the foreseeable future. There is no other way to effectively manage your businesses when things go up and down so dynamically. Current conditions make collaboration and coordination a must. The issue with “hybrid-flation” is that it requires granular internal monitoring and management of costs combined with external management of customer knowledge and expectations. Customers and buyers might not be holistically aware of the cost drivers. They may read about commodity prices going down. They might not be aware of insurance costs, labor costs, or energy costs exploding at the same time.
This is a reality. The U.S. and global economies are going to slow down, and it is not the end of the waves of disruption we have seen over the past 5 years. Who knows what is coming next? With that in mind, companies must develop costing and pricing skills to manage constant business volatility. They must do so not just when everything increases – managing on the way down is equally important. They must also manage costs internally while managing value externally. Cost excellence is not a strategy, it is a requirement for staying competitive. The complexity of “hybrid-flation” is the capacity to be excellent at cost management while being excellent at maintaining premiums and still selling on value. This is where your pricing team can provide real expertise. Do not improvise. Mobilize your pricing experts.