Pricing and Inflation - How to Respond

Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.

Part 1 in a series of posts on pricing and inflation

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 are various signals that inflation will be part of the post-pandemic economy. (Will there be a post-pandemic anything, or is this going to be a long rolling pandemic that is with us for decades?)

OECD data is forecasting continued inflation in Q4 of this year with inflation in 2022 staying higher than what we have been accustomed to.

OECD Inflation Forecast August 1, 2021

The consumer price index is also up sharply, with the United States and Canada showing more inflation than the OECD as an average.

It is worth going to the OECD site and exploring their data.

Pricing experts with enough grey hair know what to expect.

Boards, CEOs, share analysts and many others will be demanding price increases based on either general inflation or cost increases. In many cases, pricing will be expected to ‘get ahead of inflation."‘

Predictably, pricing experts are already responding to this anticipated need. As evidence, see Inflation and Pricing: Time is of the Essence from the pricing software vendor Zilliant.

This paper, which is worth reading for its comments on pricing agility (the ability to respond rapidly to pricing triggers” — external events that cause a B2B company to execute price changes) lays out four strategies for responding to inflation.

1. Take price up

2. Adjust discount structure/rebates

3. Allocation (in response to supply shortage)

4. Change sales incentives, change sales behavior (incent on margin)

Note the very first strategy is to increase prices. This is why inflationary cycles are referred to as price spirals. A little bit of systems thinking clarifies what is happening.

My costs are going up so I look to increase my prices. My prices are an input into my customers costs, which go up in response.

This is known as Cost Push Inflation. It will generally lead to falling demand and a general collapse in the business cycle. It needs to be avoided.

This is no the only kind of inflation. It is possible that what we are seeing now is better described as Demand Pull Inflation. In this scenario there are demand shortages (supply chain challenges, labor shortages for critical skills, container ships blocking canals).

Cost-Push and Demand-Pull interact to form a chaotic system. Increases in costs can drive demand down, reducing demand-side inflationary pressure, but the cost-price feedback loop can be so well established at this point that stagflation results (slowing demand with rising prices). Or demand pull and cost push can combine to trigger hyperinflation. Both of these are a central banker’s nightmare. At present, the monetary policies of the past fifteen years (from the response to the 2008 financial crisis to the Covid-19 pandemic) have left central bankers with fewer tools to manage inflation and overall demand.

A knee jerk response to higher costs by raising prices is a foolish approach at this time.

A value-based approach to managing prices in an inflationary spiral

The strategic price response to inflationary pressures (costs increases) is to ask about your differentiated value and the impact of inflation on demand.

You should be doing this work in August (I know, you have a vacation planned, so do I) to be ready for September.

1. What is inflation doing to your differentiated value?

Look at your value model (you have a value model I hope). Segment your customers by how inflation impacts value. Start by filling out the below table for each customer and then look for patterns. Price changes are not one size fits all.

2. What is inflation doing to demand?

As we all know, your business results are based how Volume, Price and Costs interact (this is another complex adaptive system).

Profit = Volume x Price - Volume x Costs - Fixed Costs

Price impacts volume. Volume impacts costs. This is also true for your customers. So any change to price will impact your volume (and through volume your costs). In most cases, increasing price leads to lower volumes, and can increase your costs.

Before you execute on a knee jerk increase in price to cover your own cost increases, work though the implications for demand and costs. I have seen many cases where the increase in prices suppressed demand enough to increase unit costs. This is stagflation on a micro level.

3. Which value drivers matter to your customers under inflationary conditions?

Inflation and fear of inflation has many psychological consequences (remember John Maynard Keynes and ‘animal spirits’). Emotional value drivers can have a big impact on value perception during an inflationary period.

Go back to your table of value drivers (point 1 above) and layer on the emotional impact of inflation. Ask which value drivers are at the top of mind for your customers as they make their own plans for inflation. For some the focus will shift to cost control, but this is not universally true. In markets where demand is expected to surge (think demand-pull inflation) the ability to spark demand (revenue value drivers) or satisfy demand (operating capital and capital investment) may be much more important.

If interest rates rise (there is no assurance of this but there are signs of upward pressure in the US and Canada) the importance of Operating Capital Value Drivers becomes more important. These are often ignored, especially in a low interest rate environment. They may come to the fore over the next 18 months.

How to prepare your pricing for inflation

Here are they key things you need to do to prepare for the demands that will be made on you over the next few months. Do not assume that price increases are your only or best option.

1. Invest in pricing agility (in a dynamic environment you need to be able to respond quickly)

2. Prepare for different scenarios (do not assume you or anyone else knows what will happen, inflation is part of a chaotic system with many unexpected phenomena)

3. Investigate the impact on value drivers (how will your value drivers change for different customers, use this to segment customers)

4. Think though the impact on demand and costs (do not fall into a stagflation cycle)

5. Have different responses prepared (preparation is the key to rapid response, have the basic responses prepared, see The jobs of pricing scenarios for guidance on how to do this)

Now is the time to start preparing for the fall. Interesting times are ahead.