No Magic Bullet

There is no magic silver bullet to “fix” inflation through pricing. What disciplined pricing can do is to maintain profitability in an inflationary market. Strategic implementation calls for the discipline to deploy the necessary offering levers and activate them at the right time for the right purposes. Carefully managed, the levers of pricing can even result in growth that eluded the enterprise under more stable economic conditions. The most critical element of discipline is organizational nimbleness. Enterprises must be capable of acting rapidly, selectively raising prices before rising costs deteriorate profitability.

For our clients struggling with inflationary challenges, we specifically recommend building muscle in the six following areas.

Know Thy Market

What's causing the market volatility in your specific sector? That's the most critical question to answer. While it's useful to understand the various causes of general inflation, it's more important to differentiate the causes specifically confronting your sector.

Just to review, there are two main causes of inflation: demand-pull and cost-push. Demand-pull inflation is seen when an increase in the demand for goods and services causes producers to raise prices to maintain profitability. Cost-push inflation occurs when producers raise prices because their costs have gone up.

Labor shortages represent another example of demand-pull inflation. We saw nationwide examples of how employers struggled with hiring in the wake of the COVID-19 pandemic. As employers recovered and needed workers, they found that the wages that were acceptable pre-pandemic were suddenly no longer sufficient to lure workers back to the job. As demand for workers outstripped supply, wages increased, adding to inflationary pressures. As labor unit costs account for, depending on the industry, as much as 70% of total business costs wages, wage instability creates enormous planning problems.

Other common causes of inflation include rising fuel and transportation costs, labor shortages, and an expanding economy. (In the latter case, inflation is considered a positive. Indeed, the Federal Reserve aims for a 2% annual core inflation rate; the only thing worse than inflation is deflation.) Analysts point to the expansion of the money supply, servicing the national debt, and government regulation as incremental causes of inflation. These are just additional instances of cost-push inflation.

So the first thing to understand is what's causing the market volatility in your sector. The follow-up is to determine whether this volatility is a short-term or long-term issue. For example, assume that the causes complicating your ability to serve your customers are labor shortages down the value chain. Now, is this a short-term or long-term issue? Your answer will dictate your response.

One of our clients, the CEO of a transportation company, has taken the position that inflation is a long-term issue. Market volatility and supply chain constraints, he estimates, will last for years. His analysis of the transportation market recognizes a structural issue: the existing supply chain that lumbered along in stable market conditions was simply not prepared for the instability caused by the pandemic. As consumers shifted buying behavior from retail stories to ecommerce sales, the supply chain could not keep up with the increasing labor market for home delivery services. This fundamental shift, the CEO concluded, was one of many factors in the labor shortage and could not be classified as a short-term issue.

Understand Your Customers

This is an opportune time to review your customers on the dimensions that matter most. And perhaps the key dimension is profitability. Businesses often grow by accepting every customer that comes along. The businesses often distort their product offerings and even sales territories to meet new customer demands. Over time and business mergers, companies inherit a disjointed customer base where it is unclear which customers are profitable to serve and which are not.

The customer review is essentially a measure of how profitable a particular customer currently is. The review compares revenue (how much revenue a specific customer generates) against costs (how much is spent on customer acquisition and every touchpoint of service, as measured in direct costs and overhead).

The review often starts by segmenting new customers versus long-term customers. Customers on contract versus those that pay as they go is another important segmentation. In either case, the central challenge is to know the profitability of your top customers. We talked about this imperative in Rule Four (Know Your Value).

A fundamental question is: Can the organization provide value aligned with the cost to serve? Understanding these elements will help determine which customers provide profit to the firm and warrant additional investment to develop. The customers that fall to the bottom 20% of profitability should create an action plan designed to improve profitability and reset expectations such as their priority to receive products and services until increased profitability warrants a step-up in service. Without movement in these areas, it occasionally becomes incumbent upon a business to part ways with a customer.

The next question is whether a specific customer poses a risk to the organization. Prioritize risky contracts and develop an action plan to remove elements of uncertainty by including new language that adjusts prices automatically based on external justifications such as indexes commercial businesses are familiar with. The Consumer Price Index (CPI) is a commonly referenced metric based on a basket of goods and services measured by the Bureau of Labor & Statistics. A less commonly known index is the Personal Consumption Expenditures (PCE) Index. The CPI measures the change in the out-of-pocket expenditures of all urban households while the PCE index measures the change in goods and services consumed by all households, and nonprofit institutions serving households. The PCE index is used by the Federal Reserve to make interest rate decisions. The Produce Price Index (PPI) is similar to CPI but measures prices of goods and services used by businesses to create goods for consumers.

Once the measure of inflation is agreed upon within the organization, proactively adjust and refine your business to maintain profitability. It might mean shuttering a plant or a product portfolio or making price adjustments in others. Not all costs change at the same rate, so be specific about which products and services are selected for increases. With all of this happening, it is important to give customers choices. They won't like being backed into a corner, so it is important to understand their budget and likely constraints and have two or three options.

When talking about these changes with customers, provide evidence, justification, and be definitive. This is the health of your company. At the same time remind them of the value you provide and your commitment to continue to provide value.

Part of understanding your market is a deep-rooted understanding of your customers. One company told us that a differentiator for them has been service levels. They found out early in this market that service levels are much more important than product value. They invested more heavily in their services and further differentiated themselves from the competition and now price services are higher than others. They were able to be proactive here because they invest time in understanding their customers' changing needs.

Align with Long-Term Customer Needs and Add Value

Customers are smart so don't use inflation as an excuse to raise prices across the board. Customers know market conditions, they are expecting higher prices, supply chain issues, and labor shortages. Be honest, transparent, and confident.

• Increase value of solutions through bundling to increase price.
• Change price metrics to better align with value accrual. Consider potential risk share agreements with high risk/profitable customers.
• Change price model to reflect when the customers' end-users may run out of budget or demand slows. For example, a country CEO at an IT distributor focused on a shift in the business model when end-user demand cooled off because the higher prices would eat up budgets at a higher rate. Next, he will get ready for end-users to move a subscription business such as hardware-as-a-service.
• Instill good governance to manage price and customer expectations.

Prepare for Growth Early

During inflationary times, there could be an opportunity for large strategic decisions through mergers and acquisitions (M&A) if the cost of capital is still reasonable. Some of our clients have taken this opportunity to get more vertically integrated by buying a key supplier. This allows for risk mitigation as well as competitive advantage. Others have chosen to buy smaller competitors to expand their portfolio and enter new markets that may potentially be less volatile. Another beneficial use of capital is to diversify your supply chain by adding more countries and doing near-shoring based on future demand clusters.

Before choosing any of these strategies, make sure that you take the time to understand your customers and what they will need over time, not just what they need today. Especially in volatile markets, a customer's value drivers tend to change more often so it is important to understand this before choosing a long-term M&A play.

Know Thy Competitor

Competitors are unavoidable in business today. It makes doing business more difficult. But, if we're honest, we will acknowledge that the competition is good for markets. It helps participants keep the focus on innovation, efficiency, and value.

The weakness we have with competitors is our attitude. We compete fairly; they cheat. Our prices are fair; their prices are predatory. We conclude that they are either fiendishly clever or behaving irrationally. In short, we vilify the competition, assigning them sinister motives for behavior not much different than our own. Does this sound familiar?

Somehow, we rarely consider that competitors think about us precisely the same way we think about them. Our attitude about competition justifies much of our destructive behavior, such as rampant price discounting. Attitude causes us to pull the price trigger too often. It causes us to get into negotiations that we should walk away from. Our attitude causes us to lose pricing power.

We need to change this sense of powerlessness and replace it with confidence. The best advice ever is 3,000 years old. “The best general enters the mind of his enemy,” wrote Lao Tzu in the Tao Te Ching. To be more successful in our markets and with our customers, we need to do a better job of understanding our competitors. We must understand what they are doing, what their next move may be, and why they are likely to make that move.

Be Proactive

One trick when you are in a deal with competitors is to be proactive. When a competitor senses you are in reactive mode, they will attack in a place where they have the most to gain and you have the most to lose. What if you stop playing catch-up and take the lead? Could you take the fight to them in another region or with a customer where they have the most to lose and you have the most to gain? Do so with nimble assurance and you are less likely to get hurt. Also, it is less likely there will be a damaging price war. To get there takes a system of understanding and responding properly to competitors. Whether by matching price or making a public announcement, the intent is to minimize the damage of price competition.

Intuit ranked number eleven on Fortune Magazine's 2021 list of the influential “100 Best Places to Work,” develops personal finance and tax software. Based in Mountain View, California, the company continues to dominate its markets despite the fact that Microsoft, among many other players, has been a competitor for years. Microsoft even made a failed bid to buy Intuit in the 1990s. Microsoft is 20 times the size of Intuit and has plenty of cash to go after Intuit's lucrative markets. Yet Intuit stays ahead by relentlessly innovating based on its understanding of its customers' needs. It does a superior job of introducing low-cost, entry-level products. It follows this with outstanding customer service. It maintains excellent relationships with the two hundred thousand accountants in the U.S. who are key buying influences.

Intuit proactively anticipates what Microsoft and its other competitors will do next. It tries to make sure its own development resources are focused in the most desirable areas. Intuit realizes that Microsoft will continue to target the small business accounting market. It has developed a number of scenarios on the potential impact Microsoft can make. This intelligence allows Intuit to keep developing and pre-announcing new products that keep Microsoft off-balance. It uses nimbleness as an advantage. Intuit has entered the mind of its competitor and has prospered.

Intuit doesn't just react to Microsoft; it out-innovates Microsoft. Intuit knows that if it were forced to go head-to-head with Microsoft, it would lose. The goal is to keep its larger competitor off-balance and in perpetual catch-up mode. And they do it not with price but with relentless innovation of their products and services. Intuit's nimbleness limits Microsoft's ability to use price alone to elbow its way into the market. It's an example of how to use product and service innovations to stay ahead of competitors that you can't beat in a price-driven conflict.

In summary, when competitive action is needed, make it quick. Have well-considered game plans for expected contingencies that are focused not on beating competitors but on getting them off your back. Take the example of PeopleSoft and Oracle. The two competitors tried to beat each other in every way, including price. They both gave massive discounts to customers who adopted their high-value enterprise software, but in doing so, they both left lots of money on the table. As a last resort, one competitor acquires the other. PeopleSoft eventually lost the battle when Oracle acquired it. What happened next? Oracle promptly raised prices.

Market Changes from the Coronavirus

The Wall Street Journal has had numerous reports about businesses struggling with pricing during the pandemic. Like many pricing consultancies, we are receiving numerous calls from companies struggling with declining sales they attribute to inflation. They want to know if they can solve the problem of declining sales by increasing prices. In general, we tell them, the answer is “no.” Blindly increasing prices across-the-board in a vacuum just makes the problem worse.

Consider a business whose customers are intensely sensitive to pricing: the aviation industry. Inflation hammers airlines as their two most significant cost centers—fuel and labor—are rising faster than general inflation. Many airlines are concluding that their current revenue management models aren't working anymore. Why? Because demand has dropped. The pandemic has caused an important segment of the flying public—leisure travelers—to dramatically reduce the number of flights they book.

To make matters worse, the pandemic caused the most profitable segment of flying customers—business travelers—to change their behaviors. Remote work and videoconferencing have replaced many in-person events that required business travel. The benefits are so compelling that even as the pandemic wanes, many business events will continue to be delivered virtually. These changes in consumer buying behavior represent an existential threat to the airline industry unless it changes the way it models its business analytics. Airlines traditionally look at historical data coming out of a limited number of geographical segments. But historical market segmentation data isn't going to help airlines deal with pandemic-driven exceptional circumstances.

Dax Cross, CEO of Revenue Analytics, likens relying on historical data to flying with “blinders on.” The solution requires a better understanding, in real time, of customers, their fears, their desires, and how they behave. Traditional segmentation doesn't work because it groups dissimilar customers without distinction. What's required is for airlines to do analytics on smaller, more relevant groups of customers or cohorts. With good analytics and dashboards summarizing the results, the market segments can be evaluated to see how they respond to pricing variables. The mathematicians refer to this process as “stochastic analysis.” We prefer the term “cohort analysis.” It's remarkably effective at teasing out the differences in the behavior of discrete customer segments.

We are impressed with a number of businesses, which responded well to the challenges of the pandemic when agility is worth its weight in gold. A raw materials supplier impressed us with its ability to make price changes in sub-second timing. The company's entire business model relies on managing risks by being able to implement quick price changes based on real-time market volatility.

The executive here told us the key to being able to manage pricing during periods of price volatility is by using a portfolio methodology. The executive identified the elements of the portfolio: channel, pricing strategies, product, and services pricing, as well as price types (e.g., flat pricing, indexed pricing, and multi-variable pricing). The executive recommended tools to spread the market risks by partnering with other providers in the channel facing similar risks. This kind of collaboration helps mitigate risks and increases the value to the end-user.

Such collaboration with channel partners not only mitigates risk but represents real differentiation. Throughout this process, the executive reminded us of the importance of lowering costs through a combination of automation. Finally, businesses must invest in their most profitable customers and divest, at all costs, those customers who cannot be served at a profit.

Customer Response to Price Change

When thinking about a market, start with customers. It's true that some customers in mature B2B relationships will switch their suppliers based on price, but they don't increase their volumes as a result. If pricers plan to drop price to increase demand they will frequently be disappointed. Customers make it look like they are willing to switch for a lower price, but they don't actually buy any more products. This reality frustrates suppliers who think they are lowering prices as a competitive advantage. The discounting merely results in price wars in which the only winner is the customer.

Remember the discussion of derived demand in Rule Five: Strategy Sets the Direction? When competitors keep lowering price to accommodate the willingness of customers to switch, they reduce their revenue and, in many cases, eliminate any profits. The problem is that many managers confuse that activity for market elasticity, where markets actually grow as a result of the lower prices. In this case, the customer did not offer the vendors any additional volume. They offered nothing in return for the lower price. When employing a discount, the payoff should be to get something of value for the concession: a Give-Gets (See Rule Eight: Build Your Give-Gets Muscles). Any other use of a discount just reduces revenue and often eliminates profits.

Yes, sometimes a company decides to drop prices to close an order. But when it does, two adverse things invariably result. First, customers are now trained to negotiate even harder next time. Second, the company leaves money on the table. So, before using price discounts, consider whether customers are going to incrementally buy more of your products or services. If not, the company may be better off not discounting and relying on better selling of tangible value. In this case, it should create trusses for more backbone in the selling process.

Are You Playing Chess or Checkers?

Pricing dynamics can be thought of in the context of games. For example, one of our clients reacted when a competitor made a move into their market space. The client's initial inclination was to play checkers; that is, to respond by simply matching the competitor's prices. When clients are in reactive mode and tactically focus on only the move ahead of them, we call that playing checkers.

In these cases, we generally counsel patience to avoid the over-reaction that comes with taking action for the sake of taking action. After persuading the client to get over the need to “do something and do it fast,” we had the space to perform a proper analysis of the true implications of the competitive intrusion. Our analysis demonstrated that the intrusion was not as much of a threat as the client believed. The competitor's products were inferior. More importantly, the market perceived the competitor's distribution system as inadequate and problematic. We recognized that the proper response was not to match the prices of the competitor. The better response for the client was to strengthen its value messaging and protect its supply chain.

That realization led the client to shore up that supply chain with extended contracts that included price and revenue guarantees that resulted in long-term exclusive commitments. This made conditions precarious for the competitor. Rather than weakening their position by trying to compete on price, our client protected its position. The upshot? Wonderful increases in both revenue and profitability.

By taking an analytical approach, our client graduated to playing chess. They came to understand the potential moves of a competitor and responded in a holistic way. They minimized the damage of the competitive intrusion, limited the options of the competitor, and strengthened their own position for the near future.

As you consider the implications of Know Thy Market in the context of your own pricing dynamics, ask yourself this question. Are you playing checkers or chess? Along the way, be aware of disruptions to your pricing strategy from any number of random shocks, some of which can be anticipated, while others—Black Swan events—cannot be predicted. Regardless, managers who respond quickly and effectively minimize the damage.

Building the Global Chessboard

To price with confidence, companies target the right customers and the right segments. Once the strategy is set, there is a simple tool that can be used to communicate the direction the commercial team can take to execute effectively. We call it the Global Price Strategy Chessboard. The chessboard helps managers map their efforts to checkmate a competitor in a manner that is agreed on by company leaders. It reduces conflict and anxiety and gets everyone working in the same direction with their time and discount resources.

Figure 7.1 is an example of the discount grid. The grid provides the backdrop understanding that is critical for effective competitive information management. It contains the information on what to say and what to do with pricing and selling efforts. In its simplest form, as shown here, it takes a firm's primary segments or geographies and customers (in this case based on size) and prioritizes them.

In this case, there are four simple priorities. Let's consider four segments called current strong, grow, move product, and ignore.

• In the current strong segments, the company has a strong market position and there is little it can do to extend its market position without causing a price war. The decision is to take care of this segment and defend, if necessary.
• The grow segments receive the majority of the discounts. The company might be growing, or it might be in an area where competitors are stronger. So the intent is to grow penetration in that segment.
• The move product segments highlight where the company can move product at low prices without upsetting the competitive balance in the industry. It should be made up primarily of price buyers, attractive only when the company has a bunch of excess capacity.
• The ignore segments represent customers who may be served if they want to meet the price. But if they want a discount, forget about it!

Look at what this grid does for everyone in the company. It identifies in a simple manner where and how to deal with customers—all of them. It puts a stake in the ground for where to discount. The grid shows managers where they should be spending their time and, perhaps more importantly, where they shouldn't be spending their time. It can be put together fairly quickly by the leadership of the firm. It meets one of the primary requirements of leadership: providing people direction. If managers don't do this, they will not effectively deal with conflicting agendas in the silos within the company. Companies that do this tend to execute strategy much more precisely.

Successful companies have a good understanding of who their competitors are and their strengths and weaknesses. Managers take those insights and instead of reacting directly to a competitor's moves, they determine strategically where and when to respond to those moves. They understand how to best respond in a way that doesn't turn the interaction into a customer or industry-level price war. When those insights and actions are turned into effective competitive information, they provide long-term competitive advantage that stops leaving money on the table in ineffective price battles in the wrong markets with the wrong competitors.