Pricing Strategy for 2023 - 2: The Pricing Landscape in 2023
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
Prepare your company for change
2023 will be a pivotal year for pricing strategy. The trends of the last few years will come together leading to fundamental changes in the operating environment. Pricing will need to change as well. This is the 2nd in a series of posts to help investors, directors and C-level leadership prepare. Ibbaka is publishing an eBook that will serve as a guide for people accountable for pricing strategy and its contribution to growth.
Part 1: Questions Boards Need to Ask CEOs about Pricing
Part 2: The Pricing Landscape in 2023 (this post)
Part 3: Market Dynamics and Pricing in 2023
Part 4: Critical Uncertainties and Key Scenarios for Pricing in 2023 (in preparation)
Part 5: Pricing Plans at Key Technology Industry Vendors (in preparation)
Contact info@ibbaka.com to subscribe to this series.
TL:DR - How the pricing landscape is changing and how this will shape your pricing strategy and tactics
Inflation, interest rates and a possible recession will define the operating environment.
These impact different sectors and even different companies in different ways; the successful pricing strategy will focus on tactics tailored to each customer’s situation.
Some sectors are countercyclical and do relatively well in a recession (healthcare, education, finance).
Supply chain issues and talent shortages will lead most companies to pull back from adopting innovation; sustaining innovation will outperform disruptive or category creation in 2023
(See Pricing innovation and value drivers for how to price for the different modes of innovation.)Make sure you have thought through how your competitors will respond to your pricing tactics:
How will they respond if you cut prices?
How will they respond if you raise prices?
How will they respond if you introduce a defensive or flanking offer?
Will they introduce their own defensive or flanking offer?
Be careful not to reframe value at a lower level or set a new, lower, anchor price.
Any recession may be short lived. Set up for success as you exit the recession.
The Pricing Landscape in 2023
The background for your 2023 pricing strategy will be shaped by six overall trends.
Depending on the industries you serve, you can treat these as overall trends or as critical uncertainties. Treat them as trends only if you are highly confident that they are what will control decision making at your customers. If it is not certain how these will play out in the industries you serve, or if they could impact different customers in very different ways, then treat them as critical uncertainties and use them to build scenarios.
The six areas to consider are
Inflation
Interest Rates
Recession and Economic Growth
Supply Chain
Talent
Competitor Actions
Let’s look at each of these.
Inflation
Inflation has taken root in many countries and industries. The general rate of inflation is likely to be between 5 and 9 percent per year in most countries. This sets the tone for the business conversations and expectations about price changes.
The general rate of inflation is not a guide for pricing strategy. You are concerned with the rate of inflation in your own industry and the rate of inflation in your customers' industries. These are both likely to be different from the general rate of inflation.
Don’t assume that all customers will have the same response to inflation, or the same acceptance of your price changes. In B2B you need to be able to segment your customers using their behaviors and how they will respond to new challenges.
Segment your customers on how they are impacted by inflation and how they are responding.
Is the customer seeing its cost structure change with costs going up?
Is the customer raising its own prices?
Are the customers' profits going up or down? (In some industries, often referred to as countercyclical, profits go up in a recession.)
Interest Rates
Central banks respond to inflation by raising interest rates. Most central banks claim to be maintaining an inflation target of about 2%, so as long as general inflation is above the target interest rates will be comparatively high.
Different agencies predictions differ, putting US CPI inflation within the range of 7.0% to 8.1% in 2022 and 2.8 to 3.5% on 2023. All agencies predicted that CPI inflation in 2023 will be 0.8-1.5% higher compared to the Federal Reserve target of 2%. By 2025 inflation is expected to return to 2%.”
The Knowma article has links to information on other major economies.
Higher interest rates generally mean a higher cost of capital. Most of us have become used to pricing in a world where cost of capital was not a major concern for most of our customers. This has changed. Higher interest rates have made debt more expensive. At the same time, valuations are down. Twelve months ago publicly traded SaaS companies were enjoying average valuations of 15X forward revenues, this is now down to 4.2X and in many cases private companies are seeing even lower multiples, if they can raise money at all. See Tom Tunguz Grey skies in cloud earnings.
What does this mean for pricing? We are seeing two impacts.
Focus on operating capital
One is a new focus on value drivers that impact operating capital. With cash scarce any solution that promises to accelerate cash collection, reduce work in progress or shrink inventory costs is suddenly attractive.
Improved performance by ‘spread’ businesses
Higher interest costs also make ‘spread’ businesses more attractive. A ‘spread’ business is one that makes money from holding onto cash for other people and taking advantage of the spread in interest rates. Banks are the obvious example but many fintech companies are benefiting from this. So are payroll and benefits companies. If interest rates stay high (which is not a given) expect to see more interest in spread businesses and solutions that enable such businesses.
Recession
A 2023 recession looks likely at this point, but the question is how long, how deep, and for what industries. Countercyclical industries can do well in a recession, as will the companies that sell to these industries.
Typical examples include
Healthcare
Education and training
Finance (assuming interest rates stay high)
How will a recession impact pricing?
That turns out to be a complicated question as it depends on the market dynamics (see the upcoming post on Market and Pricing Interactions) and will differ by industry and even by customer.
In general there will be lower willingness to pay and many companies will want to avoid long term commitments. Companies that are flexible in how they price will win. The flexibility will have several dimensions:
Introduce usage based pricing and connect pricing to value. If your customers are getting less value because of the recession make it easy for them to pay less, bit to do it in a way that let’s prices scale back up automatically as the economy recovers
Introduce a lower price / lower value offer. This can be a useful tool for retention (have a fallback offer), defense and in some cases it can be used offensively against competitors who are cutting prices.
Offer alternate configurations that address the needs of customers during a slowdown. In a normal economy you would probably charge for additional configurations, but during a recession you may want to make it easier for customers to swap for the functionality and services that they need most in a slowdown.
Ibbaka 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
Supply Chain
B2B SaaS companies do not generally have supply chain challenges, but our customers do. Understanding and solving the challenges of business customers is why B2B companies exist. Supply chain is one of those challenges.
Anyone who has tried to buy an electric vehicle in 2022 knows how challenged supply chains were in 2022. The same was true for anything depending on semiconductors. China’s Covid strategy has made it slower and more expensive to source from that country and for many things there is no alternative.
Will supply chain issues resolve in 2023?
The answer is probably yes, provided that China can get things sorted, that there is a recession (which will reduce demand and provide breathing room for adjustments) and there are no new international disruptions.
Longer term, there will be a move to make supply chains shorter, more diverse and generally more resilient and adaptive. Traditionally supply chain solutions have focussed on cost value drivers, sometimes with glancing acknowledgement that the supply chain has to work for revenues to get booked. In the coming years, risk reduction and optionality value drivers will be given more weight. Companies with solutions supporting supply chains will want to update their value models to include risk and optionality value drivers. At the same time, this will open opportunities for new solutions designed for shorter, resilient and adaptive supply chains.
Environment, Social and Governance (ESG) issues are also becoming more prominent and Corporate Social Responsibility (CSR) in the supply chain is becoming a buying driver for many large brands.
Talent
Talent has been a critical growth factor for companies as they grow and adapt. The last few years has been hard on talent, the pandemic revealing the many cracks in current practices. Many people appreciated the opportunity to work from home and are not happy when told to return to the office. At the same time, there have been problems with ‘quiet quitting,’ where people move from a growth mindset to a fixed mindset and just do the minimum that they need to in order to continue to get paid. Leading companies are moving away from a job based structure to organize around flexible roles.
What does this have to do with pricing?
Your customers are probably struggling with talent issues. This means they will be more reluctant to take on new solutions or to undertake change management programs. This tendency will be reinforced by a recession.
This is one reason that Net Revenue Retention (also known as Net Dollar Retention) has become the key metric that boards are focussed on in 2023. It will be critical to protect and grow revenues from existing customers. They already understand and are using your solutions and have people in place to use and get value from what you provide. Incremental or sustaining innovations will be more important in the short term than disruptive innovation or category creation.
In general, any form of automation that makes it possible to do more with less will get a hearing, so long as it is for something that already do, and has credible cost value drivers.
Competitor Actions
Your competitors have access to the same information about the economy as you do. They are also considering price increases to take advantage of inflation, price cuts to respond to a recession, looking for ways to capture your customers while they protect your own.
Pricing is a game that plays out over time and for every action on your part expect a response from your customers and your competitors. This is 3-dimensional chess played on a changing game board.
Before you act, ask how your competitor will respond. How would you respond in their position? Try to work out what metric your competitor is trying to optimize. Studying their public statements and their investors will help you to do this. Are they …
Working to win market share?
Still focussed on ARR growth?
Shifting to NRR (Net Revenue Retention)?
Focussing on gross profit?
Trying to improve cash flow and cash collection?
Your competitors are likely focussed on different segments than you are. Try to segment the market from your competitors perspective.
Where do they deliver more value than you?
Where do they deliver less value than you?
Which segments do they have good access to?
Which segments do you have better access to?
These questions are always relevant, they are questions the board is interested in, but the answers have probably changed. In those changes, you can probably find sources of competitive advantage.
Ibbaka ebook - Pricing Strategy for 2023
This ebook will be published later in 2023.
Send an e-mail to info@ibbaka.com if you are interested in getting early access to this ebook or in getting notifications about the rest of this series.
Table of Contents
Executive Summary
Questions Boards Need to Ask CEOs about Pricing in 2023
The Pricing Landscape in 2023
Market and Pricing Interactions
Scenarios
Market Dynamics
Relative Importance of Value Drivers
Resegmenting the Market
Should Prices Increase?
Setting Up for Success in 2024
Conclusions
Ibbaka Valio
Ibbaka Talio
About Ibbaka