Senior Partner & Managing Director
A recession is no time for pricing as usual. In a cycle of collapsing demand, volatile sourcing costs, and increasingly intense competition, you need all hands on deck to protect prices. And because these conditions are likely to remain (to some extent) throughout the anticipated slow recovery, it is imperative that companies stay in crisis-alert mode well into the new normal.
Most companies are uncertain about managing pricing as they come out of a downturn. Few plan for a recovery or pull the right pricing levers at the right time. They aren’t prepared to price—either up or down—in response to changing market conditions or competitive dynamics. The companies that emerge from this recession as winners will be battle ready to defend their prices with disciplined processes that give them a competitive advantage when the economy turns around.
The forces of a recession can attack a company’s pricing plans on a number of fronts. Three of the most critical are the following:
Managers must prepare themselves to operate under “wartime” conditions for the duration of the financial crisis as well as after. That means being more vigilant, aggressive, and disciplined in their fundamental approach to pricing. They need to mobilize a SWAT team to make pricing a strategic weapon.
Consider the example of an industrial-goods manufacturing company that has set up a “war room” to implement strategic pricing with military rigor. Using wall-to-wall charts and complex graphs, a sequence of cross-functional teams meet in the room daily to dispel the “fog of war” by monitoring the flow of leads, quotes, and signed deals; targeting customers; and watching the win rate. These teams regularly collect information, purge it of inaccuracies, investigate anomalies, identify short-term indicators, and discuss longer-term trends. A dashboard, updated weekly, provides transparency for executives on overall sales volume, discounting trends, and the status of key accounts. As leads become deals, attention turns from winning customers to maximizing the contribution margin and cost-to-serve issues, such as how orders are scheduled for production in the factory and how they are stacked to ship.
Wars are fought with imperfect information. In contrast, the purpose of the industrial-goods manufacturer’s war room is to make sure the information gathered is as complete and timely as possible in order to avoid costly overdiscounting. Additionally, the war room helps the company price competitively to maintain or gain market share, which ensures that the sales force has the best possible advantage when bidding against competitors for particular customers or products. Finally, the war room provides early information to marketing about emerging product gaps or distribution issues. Such rigor in managing the sales funnel and pricing structure is rare, but its value has been obvious to other parts of the organization: they have set up their own war rooms to better manage through these turbulent times.
Companies can take three sets of quick, yet effective actions to defend prices, win unavoidable price wars, and position themselves for victory in the recovery.
Napoleon Bonaparte famously noted that an army marches on its stomach. In other words, troops depend on the support of a supply line to provide them with food and clothing, as well as logistics, information, and battle plans. Similarly, a pricing organization can be only as good as the support it receives, so that is the place to mobilize first.
Although you can maintain profit margins in a downturn by lowering perceived prices, the risk is high that competitors will reduce their actual prices, thereby starting a price war. Price wars—the tank battles of pricing strategy—can easily turn into wars of attrition in which everyone loses. Several factors determine the risk of a price war, so you should be on the lookout for the following signs of impending battle in each of your markets and areas of business:
When price wars are inevitable, a company has a few choices. One option is to face up to the fight but pick its battles: assess each of the businesses threatened and decide where it makes most sense to play offense or defense. Another option is to avoid confrontation by changing the rules of engagement with innovative pricing models that don’t force head-to-head competition. In fact, new pricing models often emerge during moments of crisis. Companies can pursue one or more of these options when faced with a price war:
Some companies are reducing prices to new lows in order to stimulate consumer demand, but cutting prices in a downturn can be risky. In many cases, promotions fail to generate sufficient incremental volume to offset the margin reduction on sales that would otherwise have been made at the regular price. (See the exhibit “Cutting Prices Is Tricky—Do the Math.”) A CEO of a large department-store chain recently reported remarkable sell-through on drastically marked-down items, but he was unable to generate sufficient sales to make up for the margins he sacrificed. What is more, price reductions can simply pull demand forward from the future—at much lower margin levels—rather than create new demand.
A better way to address the price-volume tradeoff is to lower perceived price points rather than actual prices. Consider this a stealth tactic that helps to maintain or increase volume without actually lowering prices. A BCG survey conducted in Europe earlier this year found that the retailers that consumers identified as having lower prices in fact had prices that were 1 to 2 percent above average. There are many ways to lower perceived prices while maintaining margins similar to those of competitors with higher perceived prices:
There is no way around the fact that pricing is complex—too complex to rely solely on quick fixes. Yet the current economic environment demands immediate action. If you have not already set in motion the protective actions we have suggested, time is running out. Quick fixes are better than no fixes. Furthermore, because consumer frugality and fluctuating commodity prices are likely to continue into the recovery and even beyond, you should hard-wire these activities into the organization for the long term—they will be an indispensable pricing advantage in the new normal.
Although most companies have concentrated on cost reduction during the economic slowdown, a focus on pricing can be a much more powerful way of improving growth, profits, market share, and competitive position. And winning on all four measures is the best position to be in when the recovery comes around at last.