The current market environment is challenging for businesses as cost pressures combined with weakening consumer demand, due to the cost-of-living crisis, force businesses to make difficult choices. L.E.K. Consulting’s recent consumer survey (Consumer Cost-of-Living Survey 2022) suggests that most respondents expected to reduce their discretionary spend in the short term as a result of inflationary pressures, with 25% of respondents expecting to make major changes. On average, respondents indicated an intention to reduce their overall spend by more than 5%, with a higher expected reduction in discretionary spend categories.
A separate L.E.K. survey of c.1,000 businesses across the UK, France and Germany (Inflation Resilience Survey 2022) revealed that overall costs for those businesses had increased on average by more than 15% over two years. The same survey confirmed that most of the businesses (c.65%) expected a deterioration in the margin performance of their business.
Pricing is a critical business lever in the current environment
Pricing is always an important revenue and profit improvement lever for any business. Our experience, however, suggests that it is a lever that businesses are often reluctant to pull, primarily due to concerns about the potential negative impact on the business’s competitive position, customer relationships and volume performance. As a result, in a historically low inflation environment, most businesses tended to implement infrequent price increases primarily to protect margins and without a clear strategic framework to guide these increases.
In the current market context, however, reviewing pricing is a necessity and, to some extent, made easier by the general environment that shapes customer expectations. Our research suggests that almost all businesses (90% of respondents to our Inflation Resilience Survey 2022) had implemented a price increase in the previous 12 months. About 45% of the businesses that had implemented a price increase reported that the increase was between 5% and 10%, while 8% of the businesses reported increases between 10% and 20%.
Ensuring that changes to prices are based on a carefully thought-through strategy and implementation plan should be a critical prerequisite. Price changes can pose significant risks because of the unintended consequences of weak planning or execution. With appropriate preparation, however, they also offer significant benefits beyond short-term margin enhancement, enabling, for example, a business to improve its sales mix, strengthen its market position versus competitors or reset key customer relationships.
Even when inflation subsides, reviewing the pricing choices made in the recent past, in order to confirm that they are aligned with the business’s market position and strategic priorities, remains of critical importance.
Minimising risks and maximising benefits of pricing in the current environment
Based on our experience, thinking about pricing choices holistically, in line with a clearly articulated strategy, is key to minimising the risks and maximising the benefits of pricing changes. We have outlined eight imperatives that business leaders should consider when planning and implementing pricing changes.
-
Pricing decisions must be based on up-to-date elasticity data, requiring customer and competitive research
The pressure on a business to ‘pass on increased costs to customers’ can be relentless. However, assessing the extent to which this is possible requires careful modelling of the profit margin impact of a price increase based on sensible estimates of customer price elasticity. These estimates need to account for the ongoing effect of the cost-of-living crisis on customer affordability and purchasing priorities, which may result in volume impacts that are more pronounced than normally anticipated. Understanding competitor pricing strategies is also key: in an environment of significant price volatility, the relative price positioning of a business can change rapidly depending on competitor actions and being slow to adapt can result in loss of significant market share.
-
The integrity of the price architecture must be maintained to avoid downtrading and to protect the sales mix
Most businesses allocate considerable effort and investment to develop a sensible range architecture to address different price segments, including both volume-driving ‘good’ products at the low end and margin-enhancing ‘better’ or ‘best’ products at the higher end. Rushed pricing decisions can distort this architecture, e.g. fixed percentage price increases across products increase the absolute price differential between lower- and higher-priced products and may lead to downtrading. This can further be exacerbated by decisions to implement no or lower price increases on ‘price fighter’ products to maintain price competitiveness. In a market context where in several categories up to 60% of consumers (based on L.E.K.’s research) have resorted to downtrading as a way to reduce their expenditure, protecting volumes of premium products or ranges is key for margin preservation.
-
Promotional programmes can facilitate or de-risk the implementation of price increases
Many businesses use promotions when implementing significant price changes by announcing, for example, a new price but offering a temporary promotional discount to ease customers to the new price point. Price promotions can also act as an important safety net when volumes of higher-margin products are disproportionately impacted by price increases due to customer downtrading. In all cases, the impact on margin, rather than just on volume or revenue, needs to be carefully assessed. Loyalty or other end-customer programmes that promote cross-purchasing can be important contributors to both customer retention and margin enhancement.
-
Strong brand equity and highly effective marketing activities are more important than ever
Stronger brand equity lessens competitive constraints on pricing and increases headroom for price increases. The current business environment unavoidably puts pressure on marketing budgets. As marketing budgets are reduced, identifying the high return-on-investment marketing activities to maintain or increase will be key. Based on our experience, this often favours trade-led activities (‘below the line’) at the expense of more expensive awareness building (‘above the line’) investments.
-
Rationalise or optimise your commercial terms to customers
Customer discounts and rebates are often considered as sources of margin leakage but, when properly designed, can become powerful incentives for customers that will drive the growth of the joint business or reduce the cost to serve them. Reviewing customer terms can be challenging under normal circumstances. The current market disruption offers a unique opportunity to initiate a terms review discussion with customers, which is naturally much more likely to succeed if the offer is to keep the overall level of spend constant while implementing conditionality and new ‘pay for performance’ targets.
-
Take the opportunity to deepen or reset your relationship with key accounts
Your business’s customers are probably faced with challenges very similar to those your business is facing. They are likely to be more receptive to new ideas to reinvigorate their business in the short term. These could include, for example, new listings or point-of-sale merchandising or joint promotional or trade marketing activities. More fundamentally, the current crisis can provide an opportunity to develop new collaborative strategies to drive the growth of the joint business in the long term, significantly strengthening your business’s competitive position in the account.
-
Make the right trade-offs using reliable data and analytics
Multiple pricing levers are available in the short term, but a business cannot pull too many levers at the same time without risking disrupting its market position. Assessing the bottom-line impacts of different levers can be complex, requiring a range of important assumptions. Decisions regarding the few levers to focus on, and the right approach for each, must be based on a reliable view of product and customer profitability and on robust modelling of the financial impact of the options available.
-
Use the opportunity to build lasting organisational capabilities
Even after the markets normalise, pricing will continue to be a critical lever of business performance, either as a driver of profitability or of growth. Investments made now to build better pricing capabilities (e.g. new roles, processes, tools, reports) can help a business deal with the market turbulence in the short term as well as continue to make the right pricing decisions in the future.
Managing pricing in the current economic environment is undoubtedly challenging. The right strategy can make the difference between a business that successfully navigates the economic downturn and lays strong foundations for future growth versus one that falls behind competitors and struggles to protect market shares and margins.
- A re-validation of the brand or range architecture across price segments based on up-to-date customer and competitor research
- A review of pricing across ranges or individual products to improve margins while protecting or enhancing mix
- A new approach to account management and customer terms, leveraging short-term opportunities for increased pay-for-performance and joint strategic planning
- An investment in new roles, processes or systems that will build lasting organisational capabilities in pricing management
The above change agenda is significantly more complex than simpler ‘fixed rate and across the board’ price increases, but the potential benefits from such an initiative, both in terms of risk mitigation and profitable growth enablement, are considerable and fully justify the effort.
