Pricing for high inflation: an interview with Tim Ham (Pearson Ham)
As inflation peaks, Tom Raymond and Tim Ham, Pearson Ham, discuss how companies are or should be adapting their pricing strategies.
Different markets, different responses
“It’s about how to put through a price increase and the need to provide the rationale behind it.” Tim Ham
Pricing has always been a key consideration during transactions and it’s critical to value creation. We’ve had a long period of remarkably low and stable inflation, and this year we’ve had a sudden surge. How are companies responding to this new environment?
Inflation is ever present in people’s mindset. People are thinking about their rising costs and the impact on prices. Inevitably this raises concerns about margins being squeezed and how to pass on inflationary costs increases.
Two big things are happening simultaneously and working against each other: high inflation and the cost of living crisis. The way they’re playing out in different market sectors is very different.
Restaurant chains have got a big increase in commodity costs and their customers haven’t got as much money. They’re selling a discretionary item to customers who have less to spend. For a software provider, their costs are mostly their people, and these haven’t gone up at the same rate as commodity costs. They’ve got a stickier product and their customers will generally accept price increases.
Within b2b, how are customers reacting to the price increases they’re receiving at the moment?
There’s a degree of commerciality here. In a b2b context, they’ve probably got a purchasing department who will scream and shout about pricing. It’s just the game that they play. If that b2b company sells their products to end consumers, then they’re right to shout because they’re squeezed. The solution lies with how to support the price increase with an acceptable rationale. The ability to talk about costs is more important, and that’s because when you put through a bigger or exceptional increase, you’ve got to explain why it’s reasonable.
In b2c markets, following the pandemic and with the cost of living crisis, customers are often less able to cope with price increases, and companies can’t just raise prices. These companies are expected to be more socially responsible and principled because of changes in how society views the role of business and the integral role they have in more difficult times.
What steps should companies take to address their pricing in response to high inflation?
As before, companies need to understand their margins, customers (decision makers, awareness, perception, price elasticities) and the competition, model alternatives, then decide on the best set of moves and work out how to implement them. However, there are specific elements that are playing out differently:
- Understanding and forecasting cost changes has become more complex and important.
- In our fast changing environment, historical data on price elasticities needs augmenting with market research to understand how people’s beliefs, plans and attitudes have changed.
- There is more uncertainty and predicting competitors moves is difficult now. They often can’t be relied upon to make the same moves as in the past and to cope with this there is more scenario modelling and application of game theory required. Additionally, we will see competitors holding back to see what the others do first.
- It can be appropriate to make more frequent price moves, and these need to be modelled as they are more complex to evaluate.
- Companies need to carefully plan their communications when making big price moves. They have to explain them (ideally with cost variances), and run great internal campaigns in delivering the moves and managing discounts.
How are companies drawing the sting out of these price increases?
Partly it’s around the rationale that it’s a reasonable increase. It’s a good idea to change other things at the same time as putting through a big price increase. That might mean a change in the T&Cs or putting through a smaller increase on the expectation of developing a longer term commitment like a fixed term deal. There may be opportunities to change elements of the product, or the offering, or the packaging which reduces the like for like comparisons and broadens the conversation beyond price.
It’s really important that there’s careful management of the sales team alongside price increases. If the discounting regime is not controlled, there is the real danger of increasing headline prices and discounts at the same time. We see this often where the salesforce has too much autonomy and doesn’t have the confidence to deliver the pricing changes.
Companies will need to do more thinking about these price increases and give their people the skills, guidance and collateral to deliver them. The extent you invest in that price change process should correlate to the size of the increase. If an increase is 2% which would normally be in line with inflation, it’s business as usual. A 10% increase requires a lot of thought and planning, it needs to be treated as a campaign rather than an ongoing process.
Creating value through pricing
“Pricing is not talked about enough at the top table.” Tim Ham
What role does pricing have in value creation and how can it drive investment returns?
Pricing is done best in conjunction with product changes. Market research to inform your understanding of what the customer values can be invaluable. It gives you the insights you need for pricing, it means you understand people’s willingness to pay, and the value you create for them. In turn, the pricing agenda can drive the product development agenda. We often see this in business services with very sticky customers who will pay for more, but there are things that need to be enhanced to create value, and in turn to substantiate and enable price changes.
We also often find that the question of pricing should be changed to focus on the commercial model and by that we mean, ‘the method used to communicate and capture value”. It’s essential that the company’s value proposition, pricing proposition, value creation, value capture mechanism (broader pricing model) is all aligned. They often are not and there’s a need to adjust the value proposition, and commercial model.
How can investors ensure their investee companies and portfolios are optimising their pricing?
First, they should be asking the right questions about margins, competitors, customers, pricing opportunities and the pricing agenda. They need the organisation to focus on this, to make sure they have the necessary insights and that they’ve got a robust pricing plan.
A proper pricing plan will tell them; how the company will improve their pricing function and pricing performance, the activities the company is going to do and when they will do them, what resources are required, and the benefits gained. Pricing plans are often lacking because pricing is delegated to a junior level.
The value at stake associated with pricing is enormous. Pricing is not talked about enough at the top table. Investors should be asking how regularly pricing is discussed at the executive level and what they talk about. We advocate that for most portfolio companies they have an hour a month to talk about pricing, how they’re performing, what they’re doing, what their pricing agenda is, etc.
Often companies don’t realise how much value they’re leaving on the table. It’s not like customers will shout at you if you’re under pricing. There are some steps investors can take to address this:
- Encourage the senior team to do market research and get good insights to expose any under pricing.
- Perform back of the envelope conversation with the CEO to explore the value at stake versus the level of investment in the pricing agenda.
- Make sure you’ve got a pricing team that’s properly resourced.
Pricing consultants can be very helpful to open the investment and senior management team’s eyes to what they’re missing. They can be a good way of allowing the investors and management to spend some time and energy on the subject and help find those opportunities for them.
Be clear about pricing with customers
“We often see that customers and clients have a view about pricing and if the company doesn’t fill the gap, they’ll make it up for themselves.” Tim Ham
Do you recommend companies talk about price changes at the moment, or should they hunker down and wait?
There are two parts to this. In terms of the timing there isn’t a right or wrong, it varies by market sector. If we go back to the restaurant example, it probably does make sense to take a bit of a hit to your margins, if you can afford it. We’re seeing a point of high inflation and if you can shield your customers from that then it may well be worthwhile. For most sectors, though, I think it’s probably a false economy. People understand there is high inflation, they’ll accept bigger price increases in a way that they won’t in a year’s time when we expect inflation to be lower. So generally speaking, the current tide will allow companies to land messages and price increases will be more acceptable.
The other part of your question is, how explicit should companies be in terms of pricing? Generally speaking, we would advocate that companies get on the front foot, that companies are clear about what they’re doing, and even that they’re assertive about it. We often see that customers and clients have a view about pricing and if the company doesn’t fill the gap, they’ll make it up for themselves. Worse, they’ll often judge it more harshly than if the company had worked out what to say.
If you deliver your narrative assertively, clearly and consistently; customers generally accept what you are saying.
So, say it clearly and grab the initiative. What does good look like today?
As I’ve said, it’s different things for different markets but all companies should be doing the following in regards of their pricing:
- Acknowledge your customer’s situation and demonstrate you understand.
- Be open and clear about what you’re doing on pricing.
- Provide the explanation of why you’re doing it.
- Demonstrate why you’re balancing your needs and the customer’s needs and that it’s a fair balance.
- In some situations, demonstrate that you’re giving preferential treatment to vulnerable customer segments. This is more applicable where you provide more essential and non-discretionary goods or services.
About Pearson Ham
Pearson Ham are pricing strategy and price optimisation consultants who help companies improve their financial performance through better pricing. You can learn more here.
Tom Raymond, Chair
+44 7762 386 216