Inflation And The Big Pricing Dilemma For Corporations
Five ways to rethink your pricing strategy in tough times
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With escalating raw material, labor, and logistics costs across all major commodities and components in 2021 and more to come in 2022, the C-suite of most B2B chemicals and industrials companies face harsh choices when it comes to pricing. In these challenging market conditions, there’s a fine balance involved in offering customers the most favorable prices to remain competitive and ensuring your business isn’t being damaged by inflation. If prices are pushed too high, the risk of customer attrition is very real, or worse they may opt for alternative technologies or solutions.

Salespeople in these companies are simultaneously facing uncomfortable pricing conversations with customers and battling poor service levels due to supply chain disruptions. Shareholders and board members are questioning C-suite to explain falling margin percentages despite record sales growth.

Take the situation facing one large multibillion-dollar global industrial manufacturer. Its bottom line has been damaged by a 10%-plus inflation raising its operating costs, but the company is unable to increase prices on some large customers without reopening long-term contracts. Management has already challenged the contract with its largest customer and passed on two hefty price increases to mitigate cost increases in 2021.

To make matters worse, the impact of current geopolitical tensions on supply chain portends more volatility ahead — with another 10% jump in costs projected for this company in 2022.

As a result, this global industrial manufacturer now faces a pricing dilemma. One major question is the tipping point at which important customers will switch to competitors when subjected to another price increase. Likewise, leaders must figure out if agreeing to a contractual price is a realistic strategy in these times, and at what cadence contracts should be renegotiated. And when costs eventually turn, should pricing gains be held on to?

These are very real, and often make-or-break, questions facing corporations that can markedly define their post-pandemic destiny.

Having advised several corporations that have successfully navigated these very questions, here are five recommendations that can bring clarity to this dilemma:

1. Remember, you are not in this alone

The first point to remember in times like these is that customers and competitors are also struggling with the same inflation pressures. Rising prices and invoking escalation clauses in contracts are very commonplace today, but a key element is not surprising customers with unexpected increases. Rather than implementing one annual price increase, consider introducing these on a quarterly basis. This allows customers to plan ahead and digest hikes in increments.

Some key questions to consider: Are you able to systematically mine your customer contracts to know timing and constraints on price increase frequency? Have you challenged annual price increase cadences and introduced language to cover for more frequent increases in your contracts?

2. Don’t forget ‘value-selling 101’

During periods like these, customer-supplier relationships tend to become transactional and marginalized to talking about costs, pricing, lead times, and supply risk. Conversely, this is exactly the time to have conversations with customers about the value propositions of products and services. It’s important to remind customers (and keep reminding them) about the tangible and intangible value of the partnership between supplier and buyer. Value-adds can be a business’ key differentiator, and so documenting and communicating these often forgotten or ‘taken for granted’ value areas could be the competitive edge in a sale.  

Some key questions to consider: Is the salesforce equipped to articulate the company’s value proposition? Is value generation being systematically quantified and documented for customers?

3. View inflation as an opportunity to open conversations with customers

As counter intuitive as this may sound, inflation provides businesses with an opportunity to inject product value into pricing and simultaneously boost margins. We helped a large client demonstrate to its customers the value of its products and services so well that it was able to expand its margins by more than 500 basis points over and above the inflation it sought to neutralize. In this instance, its salesforce believed they needed to get this additional margin because they navigated these tumultuous times and served customers better than competitors. The key learning here is that inflation opens the negotiations that allow sellers to make a case for higher prices, not just based on inflation. This is not about gouging customers on price (which will have negative implications in long-run), but more about discovering the value potential of products and services, and pricing for perceived value.

Some key questions to consider: Is the aim to keep margin percentage neutral or improve further in the face of inflation? Is at least 35-40% contingency being incorporated in price execution plans?

4. Avoid “lazy pricing”

Many businesses question if they should be moving to an index-based contract and if there are any “market-based index” that could be used in negotiations. This could be regarded as “lazy pricing” and purely a way for companies to avoid the uncomfortable pricing conversations with their customers in the facade of de-risking their bottom-line. While index-based pricing contracts have their place, companies should avoid going down this route, instead going back to customers frequently for price adjustments. Another form of “lazy pricing” is spreading the inflation impact across all product lines to pass on a broad-brush price increase. Over the long run, following such a practice versus a more surgical approach throws the price versus value equation out of order and is not recommended.

Some key questions to consider: Is the impact of inflation understood at a granular level and are price plans being designed surgically to avoid a broad-brush approach?

5. Lastly, use price adjustments versus surcharges smartly

The question arises if companies should put in temporary “inflation surcharges” that can be lifted when the cost of raw materials reverses as a way out of the administrative (and psychological) burden of multiple price increases. The simple answer is ‘no’. Use surcharges for temporary situations, such as when a contract negotiation for a price increase is stalling or being deferred. The inflation we are currently seeing is far from temporary (or transitionary as the Fed initially termed it), and so this certainly warrants price adjustments of the first order, not temporary surcharges.

Some key questions to consider: Are surcharge versus price adjustment mechanisms being used responsibly? Are unnecessary expectations being set with customers that prices will be reduced when certain market indices start trending downwards?

Following these recommendations will make that looming, and rather intimidating pricing dilemma more manageable and more productive. It is also likely to make it more profitable. Remember that multibillion dollar industrial company mentioned at the beginning? Although it faced 10% inflation, that business just executed its highest ever price increase based on its value proposition and is on its way to expanding its margin percentages in the worst inflationary period the company has seen. Most importantly, the company’s relationship with its largest customers remains as strong as ever.