Value Driver Priority and Pricing Under Growth and Interest Rate Scenarios
Steven Forth is a Managing Partner at Ibbaka. See his Skill Profile on Ibbaka Talent.
“Prediction is very difficult. Especially if it’s about the future.”
Neils Bohr, Nobel Prize winning physicist
Part 4 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 uncertainty about the economy in 2023 and that uncertainty is impacting pricing strategy.
The critical uncertainties turn around …
Economic growth - Could there be a recession?
Interest rates - Could they go higher, might they come down?
Inflation - Can it be tamed or will it take root?
Energy Prices - Spike? Collapse? Increasingly volatile?
Food Supplies - Will the supply and supply chain problems continue?
Supply Chain - Will the supply shortages of the past two years resolve, especially for semiconductors?
Workforce - What will happen with employment? Will wage increase match or get ahead of inflation?
With so much uncertainty, one needs to prepare for more than one scenario. Anyone that claims they know what will happen is fooling themself, or trying to fool you. Traditional planning approaches don’t work in this environment. Instead, one needs to prepare for different scenarios. Traditionally the way to do this has been scenario planning. But this is an expensive and cumbersome process, better suited to preparing for long term change and shaping major trends.
Ibbaka takes a different approach, agile scenario planning. We developed this approach in response to the Pandemic, a global change that few were prepared for. In agile scenario planning, described in more detail here, the focus shifts from stable alternative scenarios to the critical uncertainties and how they could combine.
For pricing work, different critical uncertainties combine to impact all of the four Cs of Customer Value, Customer Willingness to Pay, Competition and Costs. In this post, we focus on value to customer (V2C) as that is the foundation for pricing strategy.
Value to customer is best understood through value drivers. The standard way to organize value drivers is in terms of their impacts on
Revenue
Operating Expenses (Costs)
Operating Capital
Capital Expenditures
Risk
Options
In certain industries where the balance sheet is used to value the company one can also look at the impact there.
For some different ways to organize value drivers see How to organize an economic value model for use in pricing design
For a definition of value driver see Core concepts: value drivers
When economic conditions change the relative importance of value drivers can change. This can have a big impact on buying behavior and differentiation value.
Let’s look at two critical uncertainties for 2023, economic growth and the cost of capital.
Some people are predicting a recession in 2023 (but remember the quote from Neils Bohr that opens this post). This may or may not happen and any recession could be shallow or deep, short or sustained. It may be restricted to certain sectors or general. In any case, it is good to be prepared with a pricing strategy in case a recession impacts your customers.
You may be surprised to see ‘cost of capital’ as the second critical uncertainty, rather than inflation or interest rates. See Inflation does not give you a carte blanche to raise prices. Inflation often leads to higher interest rates and higher interest rates increase the cost of capital. In an uncertain environment it can also be difficult to raise capital at attractive valuations. So inflation leads to a higher costs of capital. I focussed in on this to make a point about the possible importance of operating capital value drivers in 2023.
When economic growth is strong and the cost of capital is low everything is coming up roses. In this scenario (wouldn’t it be nice of that is what happened in 2023) people are full of hope and the most compelling value drivers are those for Revenue and Optionality (which is often associated with investments in innovation).
When this inverts, and growth is low and the cost of capital is high buying choices are dominated by fear. The value drivers that people care most about are Operating Capital and Risk.
We have been through a decade long phase of low interest rates and easy access to capital. Many of us have forgotten about the importance and cost of operating capital. No more. Even in Q4 2022 the higher interest rates and difficult financing environment are having a big impact.
How can a solution impact operating capital?
Accelerate cash collection
Reduce work in progress
Reduce inventory costs
Reducing operating expenses can also reduce operating capital requirements, so that would be another area to consider.
I am expecting ‘cash management’ applications to have a good year in 2023 (OK, I guess I am more pessimistic than I want to admit).
The other category of value driver that moves up in importance in the Fear scenario (low growth and high cost of capital) is risk.
What are the main risks to business in 2023? Conversations with CEO gave me this short list.
Revenues and Net Revenue Retention (NRR or sometimes NDR for Net Dollar Retention in the US)
Clients going out of business or business consolidation (companies often merge or are forced to merge in hard economic times - we will do some analysis on the impact of consolidation on pricing later this week)
Cashflow pressure (lower sales, longer collections, higher inflation-driven costs)
Take a look at your solution and ask how you are creating, communicating, delivering and documenting value.
How do you reduce risk?
How do you improve cashflow?
Can you help to protect revenues?
Consider developing a package that is focussed on these value drivers. It may be too early to commit to this package, but have one in your back pocket. This package will likely have different value drivers than your current packages and you may want to develop new pricing metrics that align with these value drivers.
Value Metric: The unit of consumption by which a user gets value.
Pricing Metric: The unit of consumption for which a user pays.
How can you connect your pricing metric to your value metrics in the context of the Hope scenario? How will you do the same thing in the Fear scenario.