By George F. Brown Jr.
Business executives face tough decisions when it comes to pricing.
Increases in the costs of health care benefits, energy, raw materials, wages and other production factors cannot easily be overcome without price increases. But the question remains, How real are those price pressures?
If they reflect fundamental market forces, price increases can translate into lost business and erode market share. If they involve posturing and negotiation tactics alone, price increases can remove a lot of the pressure on the coming year annual plan.
To determine whether price pressures are real, measure indicators and evaluate them against other product lines or market segments.
Monitor the indicators to identify when a product is evolving toward commodity status. Then consider the impact of cost and price on future margins. Keep in mind that different products and market segments require different pricing strategies.
Consider these four indicators:
1. Capacity in the industry
The more excess capacity that exists in an industry, the more intense pricing pressures will be. This indicator can change rapidly over time as demand moves with the business cycle or as companies build or shutter plants. To a great extent, this indicator is largely outside the company’s control.
The firm can make decisions regarding its own capacity, but generally other industry participants determine the overall capacity balance. In industries with a massive overhang of unused capacity, the pricing pressures will be incredibly intense, overshadowing favorable implications from three other indicators.
2. Protection for business or product line
Protection can be legal in the form of patents or copyrights, but it also can involve the degree of customization, engineering, design, or service embedded into the product. These contributions place implicit barriers to competition and impose significant costs of change on customers that shift suppliers.
Customers that elect to buy customized or highly engineered products do so because of their value. As a result, they are not likely to casually shift to another supplier. When a supplier offering includes elements of high value to customers, that supplier should be able to charge more.
3. Business environment
In healthy business environments, pricing pressures are less intense. When businesses scramble to keep up with demand, price challenges generally are absent. When businesses struggle to find customers, they often look back at the supply chain and battle for every dime. As pricing pressures travel along the customer chain in a difficult business environment, the implications tend to ripple.
4. Supplier-customer relationship
This indicators takes two forms: One when parties consider each other strategic suppliers or customers, and another when the relationships are imbalanced. Pricing pressures in strategic partnerships often are less intense, because other elements of the relationship come into play. In strong relationships, the firms involved have largely solved the pricing issue and can move on to more important topics.
However, according to our research, suppliers that rank among the customer largest or whose products represent a significant portion of the customer product cost structure, sit on the bull -eye, attracting the attention of both purchasing managers and competitors.
After examining the indicators in many diverse industries and economic environments, we have found significant variation from one product or market segment to another. By understanding this, firms can make pricing decisions appropriate to the business environment in which they’re operating on a segment-by-segment basis.
Occasionally, the process spotlights sharp shifts over time, allowing firms to make forward-looking pricing decisions. The process also has allowed firms to uncover surprises, both positive and negative. For example, some firms have inappropriately accepted pricing challenges as an ongoing reality, while others were unaware of pressures sure to come.
By bringing rigor to pricing discussions, firms can get beyond the latest war story and discuss the facts behind the pricing options.
George F. Brown Jr., is chief executive officer and co-founder of Evanston-based strategy consulting firm Blue Canyon Partners Inc. and co-author with Atlee Valentine Pope of CoDestiny: Overcome Your Growth Challenges by Helping Your Customers Overcome Theirs, published by Greenleaf Book Group LLC of Austin, Texas. See http://www.codestinybook.com for more details.