With demand stagnant or dropping, most companies need to lower prices in a downturn. It’s easy to see why. Price cuts are quicker and easier to implement than, say, introducing new products or improving service. Customers often respond immediately to lower prices. A swift increase in sales can reinforce executives’ belief that they did the right thing.
But the range of outcomes can vary widely in both the short and the long term. Customers develop a craving for big discounts and an aversion to full prices. Companies grow accustomed to the boost in volume. That’s why promotional price cuts are sometimes called management heroin. Few companies can say, “We’ll lower prices today and raise them tomorrow”—at least not without risking a consumer backlash.
In our experience, companies that get pricing right manage it at three levels. They create a pricing strategy that supports their broader objectives and positioning. They set prices on individual products to reflect value to both buyer and seller. And they deploy disciplined tactics to manage the aspects of the transaction that most affect profitability.
In downturns, pricing strategy must address differences between the right short-term answers and a business’ long-term health. Pricing of individual products needs to reflect changes in the ways customers make purchasing decisions. Tactics must be carefully designed to let companies execute quickly without losing control.
In a normal business environment, the best course is almost always to first map out strategy, then set prices for products, and finally design tactics. But in a downturn, tactical decisions take on new urgency. So we’ll start there.
Customer behaviour, markets, and competitors’ actions can all change quickly in a downturn. But when firms accelerate tactical pricing moves without accurate information, they can lose control of the prices customers pay. The most effective companies quickly assess the impact of pricing moves by gathering lots of point-of-sale data, and maximize control by identifying and managing revenue leakage.
Most firms rely on discounts and promotions to boost sales. But in a downturn, it becomes essential to quickly analyse which really works and which wastes money. Consider the speciality retailer in the US that found customers loved two-for-the-price-of-one offers yet were less impressed by 50%-off sales.
Meanwhile, maintaining control of pricing execution requires clear direction to front-line employees about what’s allowed and disciplined processes to find and remedy unauthorized behaviour. One way to ratchet up discipline is by tying both sales force and channel compensation to price realization. It’s hard maintaining margins in good times; in a slowdown no firm can afford uncontrolled discounting.
Many companies lower prices too aggressively or broadly because they fail to determine why demand is falling and where it’s falling most.
Spooked consumers won’t buy more until they feel that it is safe to do so, or until they decide that prices have bottomed out. A company needs to know which of these factors is more important. If your customers can afford to buy but are nervous, lowering prices may not be the right way to help them overcome inertia. Rather, firms can combine pricing with other marketing efforts to send the message that buying is a low-risk decision.
Consider Hyundai Motor Co.’s programme in the US to allow customers who lost their jobs to return a new car. The strategy carries some risks, but it is not as risky as watching sales plummet. Hyundai’s passenger car sales rose 1.5% in the first four months of 2009, compared with the same period in 2008. Overall, US car sales dropped nearly 36%. In fact, the Korean car maker was the only auto firm to see growth in US passenger car sales in January-April this year.
Rather than relying on across-the-board discounting, sophisticated pricers find ways to lower average prices in selective ways that consider pockets of real demand variance.
Most companies underestimate how many of these pockets can be addressed effectively through targeted pricing. Not L’Oréal USA Inc.: its new 20ml petite bottle of one expensive perfume, priced at $55, compared with $175 for the traditional 100ml size, gave customers a size they could more easily afford but actually created a 57% price hike per millilitre. In India, Hindustan Unilever Ltd successfully introduced its Dove shampoo in a Rs3 sachet in 2007. The sachet now constitutes at least 30% of the brand’s hair care sales.
It’s a mistake to lower prices without considering the strategic implications. Saks Fifth Avenue Inc. hurt its brand and position in the luxury-goods market by sharply reducing prices in the 2001 recession; its earnings were slower to recover than those of competitors. Ask yourself: Where should our prices be in three years? How will short-term actions help us or hurt us on the way to that objective?
Making the right strategic decisions about pricing becomes a chess match. Understanding the market positions of competitors and profit pools in the industry is crucial. You need to anticipate competitors’ actions based on their share of key segments, relative cost position, capacity utilization, and financial health.
If it hasn’t happened already, someone in your industry is likely to launch a game-changing pricing strategy. Your ability to react quickly and skilfully will determine much of your business performance in the next 12-24 months.
You can get to work on pricing right now. The key is to focus on three levels: tactical moves, product pricing and the strategic overview. Better pricing helps companies stabilize their business in a downturn, and build profits in the future.
Ashish Singh is the managing director of Bain and Co. in India and leads the retail and strategy practices for the New Delhi office. Ouriel Lancry is a partner in Chicago and a senior member of Bain’s global customer practice. Karan Singh is a partner in the New Delhi office. Adapted from the forthcoming book, Winning in Turbulence, by Bain and Co., published by Harvard Business Press. Respond to this column at email@example.com