Episode #0089 - How inflation impacts price rise strategy in 2021

In today’s episode, Joanna and Aidan discuss the return of inflation and how it impacts the price rise strategy in 2021.

Inflation affects businesses and consumer purchasing power

In today's episode, we want to cover something that has been in many news articles in one way or another and that is I suppose the return of inflation which was a monster we associated with maybe times like the 1970s in the 1980s but inflation appears to be back. A lot of the financial press is talking about it and from a pricing perspective it's leading obviously to cost or price increases for nearly all products and in the pricing community, I'm sure some quite tough conversations with customers.

I know from a B2B consulting work, a number of clients are dealing with the impacts of inflation in terms of pricing but you may have even observed this in your day to day life in terms of food price hikes over the last few months. It's not just food, it's clothing, it's B2B, it's everything. It's across the board now and it's quite a significant problem for both businesses and consumers. I suppose to keep it simple, inflation basically means that the price of goods and services is going up and when that happens, there's a tendency that people and businesses lose their purchasing power, which basically means that you're not getting as much for your money. So, in turn, a lot of businesses are in a way panicking with this and finding that they have to implement quick sharp price increases to align with this new inflation but not really knowing if their price increase is correct, or whether they're applying their price increase in the right part of their product portfolio. 

I think we've been through a historical period probably from the late 80s to the early 90s, wherein Western countries become used to an inflation rate of a negligible rate of like 1%, 2% that sort of thing. I think a recent study I saw was forecasting maybe next year up to 5% in the US, and the old saying, if the US catches a cold the rest of the world gets the sniffles, which probably isn't appropriate at the age of COVID, etc. But we're not in a position where if you're a B2B business or any business that’s selling to customers but in B2B, it's more appropriate where you have input costs. It could be petrol, it could be timber, it could be sugar cane, it could be anything really. If you’re input costs and then you're selling to a customer, you could be caught in the middle. At the end of the day if your cost basis is rising, at Taylor Wells we often talk about value-based pricing as a way to avoid cost-plus pricing, obviously, but in this scenario, value-based pricing fundamentally you will have to increase your selling prices, as the value of money decreases. As your cost base rises, that rising tide if you don't want to be caught in the middle, if you don't increase your prices to customers you will face declining margins, and obviously, threaten your business continually. The big difficulty is we've been coming through a period where procurements drive down prices, you're signing multi-year contracts, your price rises are capped at a certain level. It's more and more difficult to push through those price raises. To be honest, because of the fact that it hasn't been a big issue over the last 5 to 10 years, people haven't paid that much attention to it. I've seen contracts where your price rises capped at X or capped at 1% per annum but let's be honest if your cost base has gone up by 5% per annum and you can only push up a 1% price rise. You're in some trouble.

I'm seeing just that with clients at the moment,  they used to have very robust price variation formulas in place, and they worked quite well in more stable times but then recently, in the last few months, in particular even though they're still good price variation formula they're not having the impact financially that the businesses need and they're losing money, quite significant money, which means it isn't necessarily your price rise formula or price rises that's going to help you here, it’s getting understanding on three very important things. You've got to understand inflation and the banking monetary system and be prepared for those changes. It can be something that hits you between the eyes and is a surprise. You've got to understand and have room to move when there are fluctuating costs because that seems to be with us now especially with all supply shortages, COVID etc. is putting pressure on the supply chain. But the third thing and an important thing that a lot of businesses forget are understanding the value of your product portfolio. Often, businesses try to improve margin through price rise or price adjustment strategies without understanding the value of the product portfolio at an SKU level. Generally speaking product hierarchy, price structures, discount levels are a mess even before inflation hits and when inflation hits and you haven't got all of your price architecture in place that's when you see massive declines. This is at the heart of value-based pricing. It isn't just a nice fluffy concept. It's something that really posts together both your costs, market pricing, customer value and economic trends and does in a scientific and very rigorous manner.

I’d touch on that point that Joanne has mentioned. I think we look back at the last few years before COVIDis the good times when we thought inflation was gone forever, etc. I suppose in those times people took their foot off or their eye of what was important, they stopped thinking about it and there's an entire generation of people who are not used to inflationary pressure. They're not used to what happened in the 80s, the 70s whereby mortgage rates were 20% and this sort of thing, and people became used to stuff and when you become used to things and see that not as a risk you don't look at them but this stuff exacerbates all the problems. If you don't invest in a value-based function if you don't understand the value of the product you sell if you're getting hammered by procurement teams day in and day out, if you're cutting costs, if you're discounting, if you're doing whatever the procurement team, jumping through those hoops that they're set for you. You're probably setting yourself up for even more hardship, now when there's the other side, you're between a rock and a hard place. You've got the procurement team if they're used to winning, they're not going to really stop and if you're used to giving in to that, it's gonna be a very hard turnaround for you. It's very hard for people to change their personalities or change their negotiating style and then you have the tide of the pricing pushing you from the other side. So it's a very tough scenario for sales teams, for pricing teams but I think in the longer term, from an economic perspective, keep in mind that we talk about real pricing and monetary pricing. So in real pricing, the pricing isn't actually increasing, but you need to push through a price rise. If you want a price rise of 2% and inflation is 5%, in real terms, you need to push through a 7% price increase and to do that, I think you really do need some form of value-based pricing, understanding your value, understanding what you offer, your clients value drivers, and it's all the work you should have done in the good times now it’s the time to use it. It's almost like Muhammad Ali stuff, you train hard and the fight becomes easy. Have you done the work? Have you done your value discovery? Have you done the training of your sales teams to know where it will pay off?

I agree with that. I think businesses that haven't got a price architecture that brings in all those different elements will really find and continually find that they'll have to do these ad hoc price rises guesstimates as inflation builds and the margin pressure continues to build, it's just going to be inevitable, which means that's the majority of the businesses. Because there are very few businesses that I still see today with a very good price architecture and I'm still talking about leading businesses because those are the people I'm working with. And I'm often quite surprised to see the lack of alignment in their price architecture. Sometimes it's just literally a bare-bones priceless, that's not the price architecture. But saying that so, what do you do if you don't have that price architecture? Well, you have to have a more considered and planned price rise and not be shy with price rises, because as Aidan says, increases in inflation require a considerable price increase. So what do you do? You have to plan it, you've got to consider what way you're going to focus on your product portfolio. You cannot do blanket price increases across the board that creates much more damage than good. You have to work with sales, ultimately, highly advise hiring a pricing manager if you don't have one to coordinate all these efforts, and to come up with a very robust price variation formula. I do stress that this price rise approach is only a tactical approach. The most strategic thing within that will get you through is building that product price architecture, and ensuring that's in place and then working with sales, the product team,  pricing to align everybody to this new way of pricing in a very margin pressured industry and time.

I think one final point I'd make and this is reminiscing back on when I was B2B sales. A lot of contracts would have in there, CPI adjustment once a year cap and CPI etc. CPI is an Australian based inflation measure but it's a basket of goods and anyone who's looked at inflation in the past certain areas are much more subject to inflation than others depending on drivers. Is it imported? Petrol prices could be going through the roof and raw materials may not go through the roof. So, CPI may not be a defense in some way for you and may not be appropriate for your contract. So even just to protect yourself, a final point I'd make is to really understand what you're selling and if CPI is not appropriate to defend yourself from inflation, picking up these things aren't that important when inflation is 1% across the board. But you could have sectors now with inflation of 1%, but other areas could be 10% and if you're a cap of CPI limit at 2, again, you're just in trouble. So this is really understanding of what you're selling? How are you selling? what you're subjected to? What are your risks? your continuity of supply? Those aspects of the insurance concept behind what you're supplying and have complete confidence that you're not committing yourself to a longer-term contract without that protection for you. So that's just what I would end on today.

I think that's a really good point. I think it hits the heart of the problem. People, businesses don't understand what they're selling, they don't understand the value profile of their product portfolio. So then they do this blanket price increase that often tends to be too high or too low creating disruption in the market, and ultimately, doesn't give them the financial impact ongoing that they wanted. I think Aidan summed it up quite nicely before and I note in the newspapers today that Unilever, Dollies, Pepsi is not shy with advertising that they've taken considerable price increases in response to inflation. Albeit I'm not sure how well they've increased in exactly where, but I'm sure they've got dedicated pricing teams in their businesses looking at inflation, looking at price rises very carefully, I'm sure.

One final point I make and I just noticed this on the streets recently. This affects businesses of all types and sizes. I've even seen local restaurants, Thai restaurants, who've had lunch specials probably between 10 and $12 for the last 10 years. I see a lot of them now even have signs in their windows talking about the cost of materials of food and in particular seafood, prawns, etc. and the same prices are rising for this reason. So even from the smallest local neighbourhood businesses seeing these issues, but okay, we will leave it there today.