Inflation does not give you a carte blanche to raise prices
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
Part 3 in a series of posts on pricing and inflation - preparing for 2023
Part 1 Pricing and Inflation: How to Respond
Part 2 SaaS Companies plan to raise prices in 2023, do they know how to do this?
Part 3 Inflation does not give you a Carte Blanche to raise prices
Part 4 Value Driver Priority and Pricing Under Growth and Interest Rate Scenarios
Part 5 Pricing in consolidating markets
Part 6 How will a recession change market dynamics and impact your pricing strategy
There is a lot of talk about price increases in 2023. As reported earlier this week, SaaStr found that more than 50% of SaaS companies are planning to raise prices in 2023. Another 22% are considering it. Overall more than 75% of companies may raise subscription prices. See SaaS Companies are planning to increase prices in 2023.
In conversations over the past few weeks I have heard some comments that concern me.
“It will be easy to raise prices next year, people are expecting it.”
“We should take advantage of inflation to increase increase our own prices.”
“Inflation is driving our costs up and we have to raise prices to keep up.”
Inflation is not a blanket permission to raise prices.
Higher costs on your side do not necessarily mean you can or should raise prices for your customers.
I put a little poll up on the Professional Pricing Society’s LinkedIn Group. This is where pricing experts from many industries, including tech and software, get together to talk about pricing issues. The initial results can be seen at the top of this page.
Almost half of the respondents said that inflation will make raising prices more difficult this year as buyer will become more cost conscious.
Thirty-seven percent said that inflation will make raising prices easier.
And 13% said that ‘it depends.”
I was one of the people who said ‘it depends.’
What does the relation between inflation and the ability to increase prices depend on?
First, remember that general measures of inflation are not necessarily relevant for most B2B companies. According the Sept. 29th data from The Economist, consumer inflation is running at 9.9% in the UK, 9.1% in the Euro Area, 8.3% in the US, 7.0% in Canada and only 3.0% in Japan and 2.5% in China. There is a lot of diversity even for consumer inflation. The main driver of inflation has been energy prices, which also drive the prices of raw materials and other inputs. The other critical input to many businesses is labor costs. Labor costs are not going up as fast as consumer prices (triggering political pain and change) and many buyers will be sceptical of price increases justified by inflation.
There are many industry specific measures of inflation and these are much more relevant. Take US healthcare, yes inflation is building, but it is much lower than consumer inflation. A price increase for a healthcare service that referenced consumer inflation would rightly be rejected.
Be careful with reactive price increases. You can become part of the feedback loop that is driving inflation, a feedback loop that policy makers are trying to squash.
The other reason that ‘it depends’ is that inflation impacts customers in different ways. The first step in crafting a pricing response to inflation is to ask
“How is inflation impacting my customer’s customers?”
Digging into this, ask
How it inflation impacting their revenues?
How is inflation impacting their costs?
Oh oh, I see a 2x2 matrix coming.
Now let’s layer in another prediction for 2023. There is a possibility of a recession. That means for some subset of customers revenues will be decreasing and costs increasing. If you were in that situation, would you accept a price increase?
That does not mean you should not be considering pricing increases for next year, but price changes will need to be targeted and justified. There are two main ways to justify a price increase.
My costs have gone up and I am passing on costs
Cost pass throughs are a common reason given for price increase, but to really make these stick you need transparency. What costs have gone up? If costs go back down, will prices go back down?
I am creating more value for you and to sustain that value creation I need part of it back
Value creation is the real lever for price increases. Changing economies open up new ways to create value.
For example, with interest rates up and investment and valuations down the cost of operating capital has become important in a way that it was not from 2010 to 2021. If you have a solution that accelerates collections or reduces work in progress an inventory. you have a winner for 2023.
The below matrix was covered in detail in the SaaS companies plan to increase pricing in 2023 post.
Pricing depends primarily on the interaction of value to customer (V2C) and willingness to pay (WTP) with value being a primary driver of WTP (competitive alternatives and cross price elasticity being the governors).
The first step towards planning pricing for 2023 is to understand how you are creating value for your customers and how that could change in 2023. Don’t put all your customers in one bucket. It is critical to segment by value and WTP. Be sure to explore different scenarios. Predictions are often wrong. What happens if the economy is robust in 2023 or interest rates come down? Pricing needs to be agile and ready to respond to different scenarios.