Pricing Strategy for 2023 - 3: Changing Market Dynamics
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 3rd 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
Part 3: Changing Market Dynamics (this post)
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 - Market dynamics changes in a recession, segmentation and pricing do too
“The best way to thrive in 2023 is to prepare now. One of the most important steps you can take is to resegment your customers based on changing market dynamics and how competitors may respond.”
Market dynamics is the interaction of cross price elasticity and price elasticity of demand.
The effective pricing strategy is different for each type of interaction (see below).
Some customers will change their behavior during a recession and require a different approach to pricing and communication.
To prepare for 2023, resegment your customer base to see if they will change segments.
Understand risk and opportunity by seeing how the segmentation of your current customer base changes.
Prepare for different scenarios based on how customer behaviors may change and how competitors may try to exploit this.
Market Dynamics and Pricing in 2023
Price elasticity of demand and cross price elasticity define market dynamics. When the overall economy is changing market dynamics can change as well and this can impact your pricing strategy.
Change is seldom evenly distributed. This is especially true of changes in market dynamics, which frequently push customers into different segments! Responding to changes in market dynamics generally requires resegmenting your market.
Definitions
Price elasticity of demand: the degree to which overall demand changes with price. The demand curve has two important qualities, its shape and its slope. The shape can be linear, concave, convex or S-shaped. The slope is generally negative but for some luxury goods it can be positive (demand can increase with price).
Cross price elasticity: the tendency to switch suppliers in response to a price change.
Combining the two gives the basic market dynamics.
The 2x2 matrix is overly simplistic, but it is a useful way to think about the interactions and to group customers into segments..
Low Price Elasticity of Demand X Low Cross Price Elasticity
Price changes have little impact on demand or switching. Other factors such as value and brand are much more important.
These are very stable markets and are ideal for straight value-based pricing, where the price is directly based on value provided. One often prices relatively high in these markets (adopts a skim strategy as opposed to a penetration or market following strategy).
This is the attractor segment for highly differentiated solutions with high switching costs.
Low Price Elasticity of Demand X High Cross Price Elasticity
These are very risky markets. Lower prices do not increase demand, especially in a recession, but buyers change vendors quickly in response to price changes. Price wars that permanently destroy the value of a category happen in this segment. These price wars are most likely to happen in a recession.
Some of your customers will move into this segment next year. Ask if they are likely to stay in that segment even after the economy recovers.
Have a strategy for keeping customers in this category that you want to keep. This could take the form of short term price rebates or value enhancers. The value enhancers should be things it will be hard for your competitor to replicate. They could be services packages, data packages or advisory services.
Accept that you will likely lose some of the customers that move into this segment.
High Price Elasticity of Demand X Low Cross Price Elasticity
These are good markets to operate in. You can adjust prices to optimize demand. Your pricing strategy will be goal dependent.
Goal: Maintain volume to take advantage of future growth. Offer price concessions for the term of the recession (but be careful not to lock yourself in long term).
Goal: Maintain revenues. Adjust price to the revenue optimizing price. In some cases this is a price increase, in other a price decrease.
Ibbaka has a calculator that can help you find the right price for optimizing volume vs. revenue vs. gross profit.
High Price Elasticity of Demand X High Cross Price Elasticity
These are very dynamic markets. Price changes and competitor responses can interact in surprising ways generating chaotic behavior. The best way to operate when both price elasticity of demand and cross price elasticity are high is to be very agile and to pay close attention to how your competitors are likely to react.
In some categories the general market moves into this quadrant in a recession. This will challenge even the best leadership teams. Improve your competitor tracking, stay in close touch with your customers and run pricing experiments. Be ready to respond quickly as cascades are common in these markets.
Resegmenting your market
A quick way to understand how your market will change is to complete this quick tool. If you have a small number of customers (say up to 100) you can do this for all customers. If you have a lot more customers you will probably want to sample the customer base. Answer the following questions for each customer.
How likely is this customer likely to change vendors if we increase price today?
How likely is this customer likely to change vendors if we increase price and their industry is in a recession? (Remember that some industries are countercyclical and actually perform better during a recession.)
How likely is this customer likely to increase use/consumption of our products or services if we decrease price today?
How likely is this customer likely to increase use/consumption of our products or services if we decrease price during a recession?
How is our main competitor for the customer likely to respond in a recession?
Decrease prices?
Increase prices?
Offer value enhancers?
Offer non-price concessions like changes to payment terms?
Once you have done this work, see if customers change segments in a recession. Do this more than once. In the base scenario assume no competitor action. Then do the same thing assuming that competitors take action by lowering prices or offering their own value enhancers.
To simplify this, it can help to organize customers into clusters defined by what segment the customer is in today and what segment they could move to in a recession. That is sixteen possible segments though some will likely be empty.
Ask the following questions about each segment:
How has the number of customers in each segment changed?
How has the amount of revenue in each segment changed?
Which segments have the most risk?
Which segments offer the most opportunity?
You will have a different pricing strategy for each of these segments and a different communication strategy for customers who have changed segments compared to those who have not.
The best way to thrive in 2023 is to prepare now. One of the most important steps you can take is to resegment your customers based on changing market dynamics and how competitors may respond.
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
