Over the last 18 months, businesses have been faced with three major challenges. Labor shortages, procuring materials, and the inflation in their cost of goods, which for some specific products has hit numbers in the low to mid-double digits – increases that have been unprecedented in the last fifteen years.
How can companies manage rising inflation and a shortfall in goods without experiencing degradation in margins or revenue (especially when products can’t be produced due to commodity shortages)? Over the last three months, we’ve begun to see revenues rise and demand flatten as the pricing decisions made a year and a half ago work their way down to customers.
We meet regularly with the world’s top pricing executives to discuss these problems and other pricing challenges associated with the current economic climate. The biggest question is “how should we think about managing pricing strategies as we deal with high inflation and brace for the possibility of a recession?” Here are six key takeaways.
Plan for All Scenarios
Of course, no one has the power to forecast inflation or a recession. Like interest rates and currency rates, these things are just too unpredictable to be forecasted. The next best thing is scenario planning, a critical step to ensure your company is as prepared as possible for any combination of these uncontrollable scenarios.
The volatility of market conditions belies any clear or definite solution. However, as C-suite executives place an increasing emphasis on profitability, there are a number of pricing strategies businesses can implement to deal with falling demand, commodity increases, supply chain strains, and the need for agile pricing practices.
Keep an Eye on Key Pricing Indicators
Backlog is an early indicator that’s important to watch during this uncertain time. For most businesses, demand isn’t necessarily going down. However, the backlog for products caused by supply shortages is starting to shorten. A healthy backlog can provide a lot of cover to raise prices but remember to look for orders that are extended or canceled. These are early indicators that demand has peaked and is now coming down.
When backlog shortens or returns to “normal” levels, be mindful of price increases, which will be subject to and more directly impacted by changes in demand. With backlog down and no one in the queue to pick up the next order, financial performance may take a hit.
The age of annual cost adjustments is over as many businesses have come to realize that customers will accept multiple price increases throughout the year. Customers don’t like unpredictability, so pricing transparency is critical when navigating these increases. Make the connection between pricing decisions and input costs visible during times of inflation, especially in a climate where companies are experiencing tightening liquidity and rising costs. Sales teams must be prepared to discuss why surcharges and price adjustments are being made – and why they are “fair.”
Increase Pricing Agility
While some companies are able to act quickly when reacting to business opportunities, there’s usually little-to-no agility when managing pricing. Some businesses now find themselves in a troubling situation as they see demand flatten even though they still have cost increases that they haven’t passed through to their customers. Pricing agility is critical right now as customers are experiencing “pricing fatigue.” Companies who wait too long to increase prices risk customers rejecting the increase altogether.
Understand Your Customer Segments and Know Your Value
With customers shopping around due to market volatility, understanding each customer segment and how the economic disruption is affecting them is more important than ever. Now, more than ever, companies must identify the unique value they offer each customer group, relative to competitive alternatives, and then use that knowledge to make surgical pricing decisions.
Take a Surgical Approach to Price Increases
Companies must move away from broad pricing increases and instead use the knowledge around customer segments and unique value offerings to make surgical decisions about pricing in three core areas:
- List prices: Use your understanding of financial value to determine which products will receive greater list price increases.
- Discounting – Reduce or eliminate discounts for objective factors like terms, volume, and loyalty. A company can avoid having to increase list prices by adjusting these types of discount policies down – positively impacting net price.
- Fees – Know where the business incurs costs and delivers value and charges accordingly. Scenarios like small orders, change orders, and express orders are areas where companies incur costs and deliver significant value. Companies can add or increase fees in these areas without impacting list prices or discounts.
Businesses that can maintain a surgical approach in these areas will be more prepared to weather the storm of economic volatility.