EconomicGreenfield

(This is my second blog post that solely discusses pricing issues.  My first was on April 23, 2010)

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

Pricing is a very complex discipline even during periods of economic growth and stability.  With the onset of increased economic uncertainty and volatility over the last few years, pricing’s complexity has significantly grown.

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