11 Business Challenges in 2011: Setting Prices in the Economic Recovery

Pricing is never easy, and very few companies do it well. (I mentioned this challenge last month in a post about a new book on pricing.) The economic recovery presents some “interesting” pricing challenges to many companies. Interesting in the same way that a doctor is challenged by an unusual illness.

Business is still soft in many areas of the economy, which normally dictates keeping prices low. If you’ve been discounting, you’d continue that practice.

However, some costs are rising. Certainly there isn’t much inflation in labor costs, and real estate costs (as we mentioned elsewhere in this series) have not yet begun to rise. Interest expense is very low (either because financially healthy firms are offered low rates, or because not-healthy firms cannot borrow at all). Despite this calm in many markets, commodity prices are definitely heating up. Raw materials prices have been rising at double-digit rates for the past year.

For example, gasoline and diesel fuel prices have risen significantly, which adds costs to all businesses doing deliveries. Metals prices have also risen at an even faster pace. This squeezes the company that is buying materials in a hot market, but selling products in a chilly market.

What do you do if you are squeezed? Here’s the basic primer on price hikes in response to cost increases.

1.    Does your industry still have lots of excess capacity? If so, it will be harder to pass hikes on to customers (though not impossible). This is a smaller factor with capital intensive industries, where operating costs are less important.

2.    Do your competitors face the same cost increase? Surprisingly, that’s not always the case. I can buy a coat hanger made metal, plastic, or wood. Each of those materials has somewhat different cost trends. If most of my competitors are making wire hangers, and thus have avoided the cost increase I had for plastic resin, then I’m in a world of hurt. It’s easiest to raise prices when the competition feels the same cost trends or worse.

3.    Do your competitors use the material as much as you do? For example, consider airlines passing on fuel costs to passengers. An airline with older, gas-guzzler airplanes has a hard time passing on higher costs if its main competitor has newer, more fuel-efficient airplanes.

4.    How will your competitors react if you raise prices? If you think they’ll follow your lead, then it’s easy to raise prices. If, however, they’ll stick to their old prices and gain market share, then raising prices will be more difficult. One way for a small competitor to manage price increases is to wait for a larger competitor to raise prices, then follow their lead immediately. Do not dither, do not discuss. Have a plan in place ready to implement as soon as a major producer acts.

Managing prices is a difficult business. As with most difficult challenges, planning ahead is wise. If you are going to hold your prices steady today, what’s your plan for tomorrow? At what cost increase will you want to raise your prices? Or more easily decided, at what cost increase will you want to sit down to discuss a price change? Set a trigger point now, The worst thing you can do is to wait until you see the quarterly financials, then ask an analyst to dig down to the source of an increase in operating expenses, then learn that a key price changed two months ago. Keep on top of prices. In fact, they should be on the early warning system that you set up for economic contingency planning. (Setting up an early warning system is Chapter 6 of the best book about economics and business. An example of an economic early warning system is available on the Businomics web site.)


Read the entire series: 11 Business Challenges in 2011