Inflation is currently a hot topic in the media. While consumers are facing a cost of living crisis, the rising prices also represent a growing threat to companies in the consumer sector. Nevertheless, many are reluctant to raise their prices – a mistake? We surveyed companies about their ways of coping with inflation to show what the right next steps are.
Consumer and energy prices continue to rise, keeping inflation around the globe at an all-time high: as reported by the Organization for Economic Co-operation and Development (OECD) on April 5, 2022, the annual inflation rate in the OECD region rose to 7.7 percent in February 2022, the highest level since December 1990, compared with reported rates of 7.2 percent in January 2022 and just 1.7 percent in February 2021. These figures are expected to worsen, especially given the ongoing conflict in Ukraine and increasing global volatility.
As part of a study, we got to the bottom of the inflation topic and asked how consumer companies are dealing with the current circumstances. The results emphasized the high levels of uncertainty currently present in the market. Over half of the respondents (53 percent) were unable to predict how inflation will affect their cost situation. Another third (27 percent) expect costs to increase by at least 6 percent.
Few price increases despite rising costs
Whilst the challenges of inflation and rising costs are widely recognized, many companies have hesitated in their response or failed in its implementation. Almost half of all respondents (44 percent) have not increased their prices in recent months. A third have neither increased their prices already nor plan to do so. Which raises the question for many… how do you intend to compensate for cost increases?
More than half of those surveyed (57 percent) agree that price increase implementation is the right measure to counter the rise of costs. This is good news, as price management has the potential to be a highly effective measure to counter rising costs if the approach is right. However, a large minority of companies still focus on either introducing more efficient processes/cost saving (24 percent) or leveraging sales and marketing campaigns (19 percent).
Pricing standards vary significantly
Where companies are willing to increase prices, the “how” is very different: Only a quarter (24 percent) of businesses carry out price adjustments by applying a differentiated approach. In contrast, every third company increases its evenly across all customers (“the peanut butter spread approach”). A mistake: From our experience, we know that differentiating price increases are met with much more acceptance. If companies do so by considering customers’ willingness to pay, they are not only able to realize higher prices, but also reduce the risk of high customer or volume losses. Especially the latter is a very important aspect for many companies in the consumer industry.
Speaking of which, customer or volume losses remain the primary reason for companies to suspend price increases. Almost one in three (28 percent) surveyed companies categorially rule them out. The concern of losing customers is – of course – subjectively very understandable. However, in our experience, those fears usually turn out to be unfounded. At least that’s the case if prices are increased systematically and in a differentiated manner. In order to factor them in properly, we recommend that customer or volume losses should be calculated to from the very beginning. Fortunately, a third (37 percent) of companies in the industry are doing exactly this.
Not only does "how" play a decisive role in price adjustments, but also "when". Contracts that enable companies to adjust prices only once a year – and this is the case in one fifth of the companies – do not offer the necessary flexibility to reacting quickly to rising inflation rates and costs. Speed of reaction is extremely important, though. Only 19 percent of the companies in the consumer industry are flexible: They use the opportunity to change prices several times a year.
We recommend companies to carefully check their existing contracts: How quickly can you react to rising costs due to price increases? The more flexible the terms, the greater the chance of responding appropriately to cost increases. And if you want to change your price adjustment standards, now are optimal conditions for it.
Seize opportunities and break new ground
Currently, high inflation rates offer companies an environment in which price increases are easier to implement. Customers are expecting prices to rise – the media have clearly brought this to the fore. Companies should therefore take advantage of this environment.
However, price adjustment must be accompanied by well thought-out communication. We recommend taking three measures:
- Analyze price elasticities: Successfully enforcing price increases depends, among other things, on whether consumers are willing to pay a certain price for a product or service. Finding out how price elasticities is therefore the first step in setting new standards.
- Differentiate price increases: Differentiating prices and not raising them evenly helps to successfully implement them and lower customer churn as a result. This differentiation should take place on two levels: On the one hand, at the end customer level emphasizing on their budgets and willingness to pay. And on the other hand, at retailer level, considering the trading margin, the strategic importance of the retailer, and the balance of power. It is important that not only products and customers with low margins are prioritized. There are often even more opportunities for already profitable products and customers.
- Prepare for price negotiations intensively: A lack of understanding, counterarguments, and threats of retaliatory measures in the negotiation talks can put the successful implementation of price increases in jeopardy. Intensive preparation of the sales team is more important than ever to meet these challenges.
Act now and seize opportunities
Despite all the challenges, inflation brings many opportunities. Companies are finding their customers more willing to accept price increases and can therefore adjust pricing standards. It is important to start the price increase process now with a thorough strategy. Anyone who takes the most important success factors into account when raising prices can face inflation with more composure and ensure the long-term success of their company.