Firms in general have enjoyed the economic “tailwind” of rising sales for decades.  While this can be seen in a variety of measures, one of particular note is that of Retail Sales.  As seen in the following chart (from the CalculatedRisk blog of 8-13-10) Retail Sales have proven robust and (relatively) resilient, with latter-2008 being the brief major exception:

(click on chart for larger image)

Despite this “tailwind”, problems appear to be increasing especially in the area of pricing.  An August 19 Wall Street Journal article discussed pricing issues at P&G.  One part of the article was particularly noteworthy, discussing P&G’s strategy of offering premium products:

“But the long recession and creaking recovery have undermined that strategy. Consumers might be willing to shell out for iPads, but their day-to-day spending reflects an entrenched frugality that often means leaving P&G’s relatively expensive products on the shelf. Nearly two-thirds of U.S. consumers said they switched to a cheaper substitute for at least one basic household product, food or beverage in the past year, according to a Sanford Bernstein survey of 834 consumers. More than three-quarters said they believe less expensive products were as good as or better than those they replaced.

In response to the changing U.S. market, the company is doing the once unthinkable—slashing prices…”

P&G’s situation does not seem unique, given the existence of widespread discounting and promotions despite resilient overall retail sales figures.  Given this dynamic, one question that arises is whether we are now starting to experience a (downward) revaluation in product differentiation?  In essence, is product differentiation generally losing its ability to attract sales at higher prices?  If so, the implications are immense, especially for those firms that are “Premium Pricers.”

This issue is but one of many complex pricing issues now facing companies.  While it is of course difficult to generalize across all firms due to their various characteristics, the following five issues appear to be of primary significance:

First, how will those companies whose focus is offering premium products (and services) fare should the economy materially weaken (as I expect) from here?

Second, if one assumes that product differentiation is generally losing value (i.e. its ability to generate revenues at sufficiently higher prices), can “Premium Pricers” successfully adapt?  How might this be done?

Third, are products and services now considered “staples” (i.e. necessary in nature) changing to more “discretionary” in nature?  How will this impact firms?

Fourth, how will cost structures change should significant economic weakness reassert itself?

Fifth, are Pricing actions now being taken to attract sales (including discounting and promotions) undermining firms’ future pricing power?  In other words, to what extent will current pricing actions undermine the future success of firms?

In the July 9 post, I wrote “I believe that many firms will continue to face very challenging conditions…”  This belief is based upon a number of factors.  However, firms’ ability to successfully manage Pricing given the overall increasing complexity is a key reason for this belief.   On an “all things considered basis”  many firms do not appear to be successfully adapting to this new Pricing complexity.  This will prove especially problematical in a significantly weaker economic environment.

A Special Note concerning our economic situation is found here

SPX at 1104.51 as this post is written

For the recently released 2Q 2010 financial results, there generally has been decent revenue growth.   Many companies have been posting seemingly strong, double-digit growth, but this has been against weak year-ago results.  As one would expect, revenue growth appears strongest in the Asia region.

It will be interesting to monitor these revenue growth figures going forward.  Revenue growth during our current period of economic weakness is a key issue, and generally lacks recognition, especially compared to earnings growth and whether companies are matching or beating earnings “expectations.”

SPX at 1120.46 as this post is written

As I have written of previously, there are significant problem areas in today’s business environment.   While many firms have been able to achieve high profits and cash flow despite these problem areas, the manner in which they have done so is, in many cases, suboptimal.  As well, special circumstances have aided in achieving such profitability.

Of greater concern is how businesses will fare going forward as this economic situation unfolds, especially if one believes as I do that greater economic weakness will be forthcoming.

As I commented in the April 15 post, “I believe that many firms will continue to face very challenging conditions, and many will ultimately fail, unfortunately.  I base this belief on a number of factors including my overall economic assessment as well as business-specific factors.”

One reason for this outcome is what appears to be an inability for businesses, in general, to predict adverse economic conditions.  This inability was especially acute during the economic weakness that unfolded during the “financial crisis” of latter 2008 and 2009.  Of course, businesses weren’t alone in this inability as virtually all professional economic and financial forecasters also failed to predict such weakness.

Although it is difficult to visualize the extent to which businesses failed to foresee the economic downdraft of 2008, I think that the following chart can be used, at least to some extent, as a proxy of such.  This chart is from the June 29, 2010 ContraryInvestor.com commentary and shows the results of the Business Roundtable CEO Survey.  Notable is the elevated reading through mid-2008:

The other issue, aside from whether businesses can predict oncoming economic weakness is whether they can successful adapt to such conditions in a timely fashion.

Of course, there are many remedies and actions companies can take to overcome adverse economic conditions.  However, the availability of these options is predicated by what actions each firm has already taken.

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SPX at 1069.95 as this post is written

I have many thoughts on the issue of cost cutting.  The issue is complex and  particularly challenging as detailed data and analyses on the subject seem to be lacking, despite cost cutting’s widespread popularity over many years.

While prudent management of costs is of course beneficial, I believe that in general, the benefits of cost cutting are often exaggerated.  The reasons for this are various.

However, the detriments of cost cutting are rarely acknowledged or discussed.  This is unfortunate as these detriments can be very significant and pernicious across a variety of fronts.

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SPX at 1084.76 as this post is written

President Obama, during an April 2, 2010 speech

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Although the CPI and various other cost and inflation indices have been relatively subdued for many years, it is inarguable that many costs routinely experienced by the average American have dramatically increased.  Perhaps the main resultant effect of these cost increases are for the average citizen to (continually) experience a declining standard of living.

Over the last few months, many costs have been rising sharply.  These cost increases are most pronounced among many commodities, as discussed in this April 23 Wall Street Journal article “High Cost of Raw Materials.”

These pervasive cost increases are also impacting many businesses in pronounced ways.  I will be discussing this in a subsequent post as these impacts are little understood, yet will likely have large future effects.

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SPX at 1162.89 as this post is written

For the recently released 1Q2010 financial results, it is hard to generalize the revenue growth or lack thereof.   Some companies have been posting seemingly strong, double-digit growth, but this has been against weak year-ago results.  It appears that many of the firms that have the strongest revenue growth have achieved this growth via sales to the Asia region.

It will be interesting to monitor these revenue growth figures going forward.  Revenue growth during our current period of economic weakness is a key issue, and generally lacks recognition, especially compared to earnings growth and whether companies are matching or beating earnings “expectations.”

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SPX at 1173.6 as this post is written

Of course, it is impossible to characterize all firms as having the same pricing issues, as each industry and firm has a different set of circumstances.  As well, any substantive discussion of pricing, especially in today’s economic environment, would be exceedingly lengthy and complex.  However, there appears to be enough commonality among past and future pricing issues as to allow for some general comments.

Many aspects of today’s economic environment are negatively impacting pricing and profitability.  Among these are outsized excess capacity and generally weak, if any, revenue growth.  As well, many firms are encountering customers unwilling, and/or unable, to pay previously acceptable prices.  Inventory issues (mentioned in the last post), forecasting complexities (discussed in this article), and recent steadily increasing commodity costs further complicate the situation.  While many larger firms have been reporting strong profits, much of this profitability has been attained through cost-cutting and other related measures.  As such, it is not necessarily profitability derived through “pricing power” and increased gross margins.

Many firms have responded to the current economic environment by reducing prices.  Much of the heavy discounting and promotional activity appears rather indiscriminate in nature.

Although cutting prices is perhaps the easiest way to attain revenues, this tactic likely holds even greater danger now than in the past.   Gauging the effectiveness of pricing decisions is often complex, especially when viewed in a strategic sense encompassing multiple time horizons.  While pricing decisions made now can appear proper, continued economic volatility and uncertainty can serve to undermine the effectiveness of such pricing.  In essence, what may appear to be a proper pricing decision now may radically change with changing economic conditions.  The odds of inadvertently managing a firm into some type of adverse pricing situation (or trap) like a “price war” or other various profitability-depleting scenarios is increased with greater economic uncertainty as well as customers who are increasingly price sensitive.

Although the current economic environment holds significant peril for pricing and profitability, there is upside to the situation.  Those firms that can effectively manage pricing in such an economic environment stand to gain significant competitive and strategic advantage across many different business functions – not to mention significantly increasing revenue and profitability when viewed against a scenario of ineffective pricing management.

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SPX at 1208.67 as this post is written

Here are two charts that give a historical perspective…

This one is from the aforementioned CalculatedRisk post of March 12, in which he states: “…clearly most of the inventory adjustment is over.” :

Here is another look at inventories, from ContraryInvestor.com of April 15, 2010, in which it says “…clearly most of the inventory adjustment is over.”:

Another key question is whether current inventory levels are appropriate given the future sales environment.

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SPX at 1192.38 as this post is written

Although the entire press release is worth reading, here are some notable excerpts:

“The March reading is very low and headed in the wrong direction,” said Bill Dunkelberg, NFIB chief economist. “Something isn’t sitting well with small business owners. Poor sales and uncertainty continue to overwhelm any other good news about the economy.”

also:

“Plans to make capital expenditures over the next few months fell one point to 19 percent, three points above the 35-year record low.”

also:

“The net percent of all owners (seasonally adjusted) reporting higher nominal sales in the past three months improved 1 point to a net negative 25 percent. Widespread price cutting continued to contribute to reports of lower nominal sales.”

also:

““What small businesses need most are increased sales, giving them a reason to hire and make capital expenditures and borrow to support those activities,” said Dunkelberg.”

____

The lack of increased revenues during our current phase of the purported recovery is very disconcerting.   I have previously written of this condition among larger firms, the most recent post of which was on January 29.

Another widespread facet which is disconcerting is the amount of discounting and pricing pressures.

In aggregate, many firms are finding this economic environment to be challenging, if not exceedingly so.  Of course, this stands in stark contrast to such economic measures such as strong GDP growth and robust financial markets.

I believe that many firms will continue to face very challenging conditions, and many will ultimately fail, unfortunately.  I base this belief on a number of factors including my overall economic assessment as well as business-specific factors.

Early in 2009 I wrote an article about the extreme conditions businesses are being subjected to and how they can adapt.  The article is titled “The Value of Business Analysis During This Economic Malaise.”

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SPX at 1210.65 as this post is written

I’ve had thoughts on the matter for years.  An example is this “Letter To The Editor” I wrote concerning a BusinessWeek story back in 1995 (3rd letter down).

Here is a March 31 Washington Post story on productivity. As the article says, “One of the great surprises of the economic downturn that began 27 months ago is this: Businesses are producing only 3 percent fewer goods and services than they were at the end of 2007, yet Americans are working nearly 10 percent fewer hours because of a mix of layoffs and cutbacks in the workweek.

That means high-level gains in productivity…”

Of course, increasing productivity is often a favorable situation to businesses.  However, it can also be a misconstrued statistic, as rising productivity can have various side effects that are less than desirable.

My issue with coverage of the issue is that increasing productivity is often hailed unequivocably as a favorable occurrence, with no discussion as to the negative side effects.

Here is a simple example:  A high-level employee who, because of extensive layoffs at his firm, is now forced to perform entry-level tasks critical to the firm because if he doesn’t perform them, no one else will.  Of course, the firm is more “productive” after the layoffs because it is maintaining sales with fewer employees – but obviously having a high-level employee doing entry-level work is inefficient.  As well, think of all of the responsibilities and activities this high-level employee has to put off or ignore at his higher level so he can perform the entry-level tasks – as well as other deleterious issues arising from this gain in productivity.

I could write extensively about productivity, as it is complex, very important and far-reaching in many ways to what is currently happening in American business…

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SPX at 1178.10 as this post is written